On Sunday, May 17th, Federal Reserve Chairman Jerome Powell gave an interview to 60 Minutes. Naturally most of the questions asked by the interviewer, Scott Pelley, were about COVID-19 and the Fed’s policy response. The interview was cordial and informative, and Powell acquitted himself well. But a close look at the transcript suggests the Fed’s mission has changed.
Pelley asked Powell to compare the Fed’s response to COVID-19 to its interventions following the 2007-8 financial crisis. “So the things we’re doing now are substantially larger,” Powell frankly admitted. “The asset purchases that we’re doing are a multiple of the programs that were done during the last crisis. And it’s very different this time. In the last crisis, the problems were in the financial system. So they were providing support for the banking system. Here, really, the problems are in what we call the real economy, actual companies that make and sell goods and services. And what’s happening to them is that many of them are closed or just not having any revenue.”
Powell has acknowledged two things here. First, and most obviously, the magnitude of the Fed’s response greatly exceeds its response to the financial crisis. Second, at least according to Powell, the economic turmoil caused by COVID-19 has not precipitated distress in financial markets. Instead, Powell claims, the troubles are in the real economy—that is, markets for final goods and services.
Lest there be any doubt about Powell’s view on the latter, he explains further how banks and other financial institutions have performed reasonably well in the face of COVID-19. “After the last financial crisis,” he notes, “the banks more than doubled their capital and liquidity and they’re far more aware and better at managing the risks they’re taking. They’re so much stronger than they were before the financial crisis, the last financial crisis […] So the banks have been strong so far.”
By acknowledging that the magnitude of the Fed’s response is unprecedented despite relatively strong financial markets, Powell makes a damning admission. The Fed is tasked with providing monetary stability and supporting financial markets, not directing the real economy. What’s happening right now is outside the Fed’s purview. And, yet, the Fed is doing more than ever.
That the Fed’s efforts of late have focused on supporting the real economy, not financial markets, is obvious. Powell says as much himself. “We’re trying to do what we can to get them through this period where they’re perfectly good companies that have had, you know, sound financial condition [sic] as recently as February, but now they have no business. And they have fixed costs,” he said. “So we’re trying to help them get through that period.”
A more charitable interpretation of recent Fed actions might claim its support of the real economy is in line with its other objective—namely, providing monetary stability. By supporting the real economy, the argument goes, the Fed is merely trying to stabilize money demand. And, in doing so, it makes it easier to conduct monetary policy appropriately.
If that were the case, the Fed’s new approach might be justified. But there is little if any support for this more charitable view. Indeed, the data suggests that, whatever else it is doing, the Fed is not currently attending to its monetary stability objective.
Inflation expectations have collapsed, a sure sign that the Fed is allowing aggregate demand to fall. Instead of offsetting that fall with monetary policy, Powell’s Fed appears to be focused on allocating credit to large corporations, small- to mid-sized businesses, and state and municipal governments.
That the Fed is allowing aggregate demand to fall significantly while engaging in preferential credit allocation would appear to mark a significant change in its mission. As Powell admits, the Fed is now concerned with specific resource allocations in the real economy. And it no longer seems to believe that providing a secure nominal anchor is the proper way to pursue its mandate of full employment and stable prices.
While the Fed’s apparent change in mission is quite recent, it was arguably foreshadowed in the Great Recession. Like today, the Fed similarly stood by while aggregate demand plummeted in 2008. But, unlike today, it limited extending preferential credit to those in the financial system. It refused to lend to General Motors, for example, on the grounds that doing so was beyond its purview.
The Fed’s apparent shift in mission is not only troubling. It is also legally dubious. As my Sound Money Project colleague Thomas Hogan has argued, the Fed is not authorized to make loans to distressed companies. Section 13(3) of the Federal Reserve Act only permits the Fed to lend to non-banks “for the purpose of providing liquidity to the financial system.” That is not the objective of the Fed’s new lending programs.
Powell has explicitly conceded that there is no financial distress in this case. Financial markets are not illiquid. Banks are not failing. Systemic insolvency is not a risk we currently confront.
When asked by Pelley whether he is “now satisfied that the markets, the equity markets, the bond markets, are functioning properly,” Powell’s response could not have been clearer. “They have been,” he said. “The markets have been functioning well.”
In failing to assure markets that it will provide monetary stability, the Fed falls well short of its mandate. But, at the same time, in allocating credit preferentially for reasons other than providing liquidity, the Fed goes well beyond its mandate. Congressional oversight is sorely needed. Alas, such oversight seems unlikely to come.