Policy Responses to Modern Economic Crises

In March 2020, Jay Powell, Federal Reserve (Fed) chairperson, faced a daunting prospect that only a few months prior seemed like a remote possibility: massive expansion of the Fed's balance sheet. Over the past five years, the economy had experienced steady economic growth, permitting the Fed to reduce its balance sheet. The Fed's economists expected the trend to continue. But the rapidly spreading global coronavirus pandemic (known as COVID-19) had rendered moot all prior forecasts. In addition to the health crisis, the United States—and the world—faced the prospect of another economic crisis—just over 10 years after emerging from the largest recession since the Great Depression. How should Powell and his counterparts who ran fiscal policy respond to the crisis? And to what extent could the policy experiments implemented in response to the Great Recession of 2008 guide the monetary and fiscal policy interventions in response to the pandemic crisis? Excerpt UVA-GEM-0182 Rev. Oct. 28, 2020 Policy Responses to Modern Economic Crises In March 2020, Jay Powell, Federal Reserve (Fed) chairperson, faced a daunting prospect that only a few months prior seemed like a remote possibility: massive expansion of the Fed's balance sheet. Over the past five years, the economy had experienced steady economic growth, permitting the Fed to reduce its balance sheet (see Exhibit1 for the monetary base). The Fed's economists expected the trend to continue. But the rapidly spreading global coronavirus pandemic (known as COVID-19) had rendered moot all prior forecasts. In addition to the health crisis, the United States—and the world—faced the prospect of another economic crisis—just over 10 years after emerging from the largest recession since the Great Depression. How should Powell and his counterparts who ran fiscal policy respond to the crisis? And to what extent could the policy experiments implemented in response to the Great Recession of 2008 guide the monetary and fiscal policy interventions in response to the pandemic crisis? Global Financial Crisis As is characteristic of economic crises, the global financial crisis of 2008 came as a surprise that forced policymakers to adapt to evolving events. Mortgage delinquencies accelerated, and indices of national home prices started to decline in early 2007 (Exhibit 2). Lenders such as HSBC experienced large losses, and some filed for bankruptcy. Despite the issues in the housing market, policymakers at first maintained an optimistic outlook. On March 17, Fed Chairman Ben Bernanke stated: “We believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.” . . .