By many measures, the Federal Reserve’s efforts to rescue the economy this spring were a resounding success.
The financial system is stable, the stock market is back to pre-pandemic levels, and creditworthy companies (especially larger ones) can borrow money on favorable terms.
But as the central bank meets this week for its regular policy meeting, its leaders, including Chair Jerome Powell, face a paradox: The very success of the Fed’s efforts at boosting financial markets has lessened the sense of urgency on Capitol Hill to take corresponding steps to funnel money toward small businesses, unemployed workers and average Americans.
It is creating a bizarre two-tiered economy. The number of workers filing new jobless claims each week remains higher than at its peak during the Great Recession, and hundreds of thousands of smaller businesses are at risk of failure — while many large companies experience record stock prices, and the portfolios of wealthy Americans are in great shape.
The Fed’s tools work through the financial system. The central bank can stimulate the economy, but only through a sort of Rube Goldberg process: It buys securities on the open market, pushing up asset prices and lowering the cost of credit through the economy. That, in theory, leads businesses and consumers to spend and invest more.
Those first-order effects — of pumping up financial markets — are quicker to take hold and easier to measure than the indirect effects on things like job creation and wages.
Since March, the Fed has bought up Treasury bonds, mortgage-backed securities and corporate debt, using its bottomless capacity to create money from thin air, all of which have helped fuel a recovery in financial markets.
Fiscal policymakers, by contrast, can direct money with greater precision, transferring cash directly to households and businesses that need it. And in the spring, with remarkable speed and bipartisanship, that’s what Congress and the Trump administration did. The result: direct $1,200 payments to Americans, expanded unemployment insurance benefits, and hundreds of billions of dollars directed to the Paycheck Protection Program for small businesses.
“Fiscal policy,” Mr. Powell said in a July news conference, “can address things that we can’t address.”
While congressional Democrats and Republicans agree on some aspects of a new economic assistance bill, negotiations have broken down over extending those programs further. It now appears unlikely there will be any large-scale economic package at least before the November elections. While there are many reasons for this, including election-year politics and some improvement in economic data, the fact that financial markets have largely recovered since March made for a very different backdrop to the negotiations than those that took place in the spring.
On the day the CARES Act passed, March 27, the S&P 500 closed about 25 percent below its February high. On Monday, it closed at 0.07 percent below that high.
Unless something breaks the logjam, the economy is in the same predicament that made the years following the last recession so frustrating for so many. After the 2009 Obama fiscal stimulus legislation, congressional appetite for more spending to try to strengthen the economy waned — and the chances were obliterated once Republicans took control of the House at the start of 2011.
That left the Fed as the only game in town, as it repeatedly turned to quantitative easing and other unconventional strategies to keep the expansion on track. It worked: The expansion would be the longest in American history, ending only when the pandemic-induced recession began this year. But it was an unequal and unbalanced expansion, with weak growth in workers’ wages and a glacial decline in joblessness even as financial markets boomed.
Hypothetically, the Fed could take a more aggressive approach, holding back on its own stimulus unless Congress moves in concert. But having unelected technocrats tank financial markets in pursuit of their preferred fiscal policy would be decidedly undemocratic.
“It’s not a very small-d democratic way to operate,” said Sarah Binder, a George Washington University professor who has written extensively on the interplay between the Fed and Congress. “The dilemma here is that Congress created the Fed to perform this role, and expects the Fed to act. The Fed can’t decide: ‘Let’s make things worse, let’s not do whatever it takes, in hopes that Congress will step up to the plate more quickly.’”
Instead, Mr. Powell has used his bully pulpit to try to encourage Congress to act to help the economy directly, without weighing in too specifically on what those actions might consist of.
“We’re an independent agency and we have protections that allow us to make our decisions without political interference,” Mr. Powell told NPR early this month. “And the other side of that is we need to stick to the authorities we got. We don’t give Congress advice and we try to stick to what Congress has asked us to do.”
The outcome of the November elections will shape what fiscal policy will look like in 2021 and beyond, and the course of spending and tax policy will depend on many factors beyond what the Federal Reserve does or how turbulent the stock market may be.
But an important lesson of 2020 — as well as the post-2008 years — is that the Fed’s actions create a feedback loop not only in financial markets and the economy, but in politics as well.