At a campaign speech on February 29, Senator Elizabeth Warren (D-Mass.) introduced her economic plan for combating COVID-19, more commonly known as the coronavirus.
The Warren plan has two elements. First, it calls for “a major targeted fiscal stimulus” to counteract the negative economic effects of the coronavirus. In particular, she calls for the federal government to “provide direct support to businesses of all sizes that have seen their supply chains disrupted.” Second, and more controversial, her plan calls on “the Federal Reserve to take action to help out American companies.”
“During the financial crisis, the Fed quietly gave big banks access to trillions of dollars in low-cost loans to prop them up,” Warren said. Building on this crisis-era policy, she proposed that “the Fed should stand ready to offer low-cost loans to companies that agree to support their workers and that need a little help to make it through the next few months.”
President Trump has also made it clear that he would like the Fed to intervene to combat the coronavirus. “I hope the Fed gets involved, and I hope they get involved soon,” he told White House reporters last Friday. But this is hardly a departure from his usual calls for the Fed to lower interest rates in an effort to boost economic growth. Trump’s pressure on the Fed isn’t wise. But Warren’s proposal goes much further in the wrong direction by calling on the Fed to expand its controversial, preferential lending.
Warren’s plan is dangerously wrong on many fronts. It presumes the Fed’s response to the financial crisis is worth emulating. It’s true that the Fed, in its role as a lender of last resort, should provide enough liquidity during financial panics to stabilize total spending and prevent the unnecessary tidal wave of bank failures that were experienced during the Great Depression.
Providing liquidity to solvent but illiquid banks at above-market interest rates on good collateral, as Walter Bagehot famously prescribed, is advisable. But this is a far cry from what the Fed actually did – providing sterilized loans to dozens of potentially insolvent banks at below-market interest on bad collateral. Contrary to popular belief, there is no compelling evidence that these actions did anything but prop up poorly run institutions and generate moral hazard for decades to come.
In suggesting that the Fed should extend low-interest loans to nonbanks, Warren’s proposal is potentially even more dangerous. It’s true that, during the Great Recession, the Fed used its emergency powers to extend loans to nontraditional banks in the shadow banking sector. Whether these actions were warranted or within its mandate remains controversial. But, at least in those cases, the Fed could plausibly argue that it was acting in line with its original mission. It has no authority to provide bailouts to firms outside the financial sector.
Warren’s plan highlights the dangers of blurring the lines between monetary and fiscal policy. As Lawrence White and I recently argued in the Cato Journal, offering subsidies and bailouts to specific firms and sectors isn’t monetary policy – as it “neither aims to provide liquidity to the financial system as a whole, nor to alter the trajectory of the money supply to achieve macroeconomic objectives.” It is fiscal policy masquerading as monetary policy.
Politicians should not be able to offload fiscal policies on the Fed. If they want to conduct fiscal policy, let them do so in the open, so that their actions might be judged by voters. We certainly do not want politicians to view the Fed as merely an extension of the Treasury, as it once was. If they do, we would lose the modest bit of central bank independence gained over the last seven decades in a sneeze–and, with it, any hope for sound monetary policy divorced from shortsighted politicians.
Ultimately, Warren’s coronavirus plan is just the latest symptom of a disease afflicting monetary discourse: the ever-increasing politicization of monetary policy. One can hardly blame Warren for wanting to use the Fed to conduct fiscal policy. The Fed’s emergency lending powers have, in fact, been used and abused in this way in the not-so-distant past. If enacted, her plan would represent another big step toward breaking down the quarantine wall that separates monetary and fiscal policy. But it would hardly be the first step.