Updated: Jun 14, 2020
By: Kristen Ng
Due to the recent outbreak of COVID-19 pandemic, U.S. economic activities were all stopped by the government’s restriction, including barring people from going out to places/events and demanding people to work from home. Also with the majority of businesses shuttering or even closing, the unemployment rate is triggered to surge all of a sudden leading to a decline in the Gross Domestic Product (GDP). Therefore, to save the economy from worsening so drastically, the Federal Reserve (Fed) intends to use an expansionary monetary policy in response to this COVID-19 crisis.
Ideal Plan of Quantitative Easing
With the Federal Reserve implementing an expansionary monetary policy by directing the U.S. central banks to constantly print banknotes without back-ups. They are allowed to do this because the United States is the most credible country. From this policy, the Fed wishes to restart quantitative easing (QE) by increasing the money supply of USD and use them to buy corporate bonds and exchange-traded funds from other parties. However, this stimulus effort has decreased USD to a near-zero interest rate, making a significant decrease in the cost of borrowing. Such a low level of interest rate has encouraged banks to lend to households and firms by 1.5 percentage points, from 1.75 percent to 0.25 percent, lower than the one during the Great Recession. With Fed creating a new Secondary Market Corporate Credit Faculty, they mentioned that such facilities “allow companies to access credit so that they are better able to maintain business operations and capacity during the period of dislocations related to the pandemic”. Consequently, in response, households are also more willing to borrow for more consumption of goods, services, and investment while companies are more capable to employ more workers for their daily operations. This eventually leads the aggregate demand and GDP to upsurge and unemployment lessen.
Will QE stimulate the economy effectively?
To a very large extent, I think this policy is ineffective compared to the same implementation of the financial crisis in the years 2007 and 2008. Firstly, when implementing this policy, leisure activities and businesses are still close and most households, under the government’s demand, are still staying home or working from home to avoid pandemics, meaning that the activities have yet to be resumed. In other words, even when interest rates decrease, this does not help companies to resume their revenues. Hence, firms and households will not further borrow for investment or consumption respectively as they normally will when everything in the market is open in the financial crisis 2007-2008. So, when investments and consumption do not increase, GDP would not escalate, and unemployment would not be reduced.
Secondly, since many people are having depression and a permissive attitude toward the future profit and income, they are not willing to borrow more to expand their business for a bigger risk but rather save their money. As a result, when investments and consumption plummet, GDP drops and unemployment rises.
In summary, QE is not an effective solution for the current situation. On the other hand, it potentially brings many more possible negative impacts on society. Can the U.S. afford to see the possibilities of citizens having a high inflationary pressure but lower returns on savings because of low-interest rates and thus reducing their consumption of goods and services? Is it worth losing their currency manipulation which leads their exports cheaper compared to those by other countries and reduces the U.S. 's competitiveness? Can the U.S. risk losing their borrowing ability if bonds bought by central banks are unable to be sold? When the same old policy is proven to have dwindling effective overtime over the course of ten years or so, it is probably high time the U.S. government think of a new method to deal with the current situation rather than applying the old 2007-2008 method to address the current situation which is far different from that in 2007-2008.