A Concrete Policy Response to the Covid-19 Crisis
March 15, 2020
Dear Colleagues and Friends,
As any crisis, the CoViD-19 crisis is different. The policy responses that are being applied by the Fed and other central banks are not working because these are medicine for a different crisis. Policy rate reductions by the Fed are likely to have no effect on the economy because consumption and investment are simply not responsive to rate cuts. Although purchases of mortgage-backed securities can ease liquidity in financial markets, this is not tackling the main root of the problem. The main economic risk is the collapse of the payments chain: The service sector is soon going to be soon stripped out of cash. Small and medium-sized enterprises (SME's)—including millions of self-employed—are simply not going to be able to honor any short-term contracts. Payments like rent, tuition, or payroll as well as unavoidable spending such as gas or utilities will not be met. This will also strip off cash from those who have receivables against these. The problem will trickle down and will trigger freezes in the chain of payments . This will severely cut back the ability to spend on basic goods or medicine. Firm operations will decline beyond what they should, given the adverse circumstances. This is what macroeconomic policy should prevent.
The next question is what to do and what is the fastest way to do so. For me the answer is clear: cash has to reach the pockets of consumers and small business in the fastest way possible. The fastest route is a monetary operation that stimulates credit to SMEs and consumers. Several economists are calling for fiscal transfers, which I concur with. I'm afraid any fiscal operation will take time to be executed. I think fiscal policy can take over in a month's time. The answer is an unprecedented expansion in credit, stimulated by Government.
My concrete proposal is as follows: I propose any central bank to commit to a large-scale open-market operation directed at purchasing paper backed by consumer credit and working capital loans; similar to ‘07 TAF operations, but this time directed to SME and credit-card lines. In the case of the US, this operation should be in coordination with the biggest four banks in the US, which are easy to coordinate with and account for 50% of the market. Part of the credit risk should be government absorbed. The rest of the banking industry will follow. The operation should guarantee the heads of banks, which will face resistance from risk-management departments, to extend existing lines of credit. I think that with appropriate coordination, it is feasible that in just a few weeks, to have every SME or household with a credit card receive an email from their bank, offering to double their outstanding credit lines. Credit lines should be extended in mass with a simple button. It is imperative that firms and consumers do not fear to spend.
One final important challenge is circumventing Basel III regulation. I think the governments should commit to suspend it for year. No time to fear moral hazard. Time to unleash the power of financial markets.
Saki Bigio
Economics Department, UCLA & Visiting Scholar FRS San Francisco
(The views expressed here are my own and do not reflect the views of the FRB San Francisco)