The economy will recover after production has recovered
Ever since the Covid-19 recession took, the Fed has done quite a number of things to save the economy. The fed’s response has included
(a) $2.3 trillion in new loans to households, businesses, markets, and state and local governments; b) a cut in the federal funds rate to 0–0.25 percent and a promise to keep it low indefinitely; c) open-ended purchases of Treasurys and government-guaranteed and commercial mortgage-backed securities; d) short-term loans to “primary-dealer” financial institutions in exchange for collateral, including investment-grade debt; e) support for money market mutual funds; f) direct lending to banks, households, consumers, small firms, and corporations, also by purchasing investment-grade corporate bonds and commercial paper; and g) lowering banks’ loss-absorbing capital and reserve requirements. No one would accuse the Powell Fed of standing idly by!
Some people may be wondering if there is any harm in the Federal reserve trying to do all it can to save the economy. And the answer is yes there is a lot of harm that could come from all these actions.
The first and most obvious problem is that the COVID-19 recession results from policies and practices that caused a massive disruption to supply, not demand. When public officials and health experts started urging people to stay home, even before state and local officials made it mandatory (excepting officially designated “essential” workers), firms stopped producing and delivering many goods and services. Politicians and pundits, understanding little about supply chains, specialized physical and human resources, capital structure, and other aspects of production, and seeing the world only through Keynesian lenses, turned to their go-to remedy: monetary and fiscal stimulus. But printing money does not create real goods and services when workers are legally prevented from coming to work.
The Federal Reserve has since realized the economic downturn may be too severe. More help could be on the way as the Fed chair, Jerome Powell, announced that the economy will likely need more stimulus. The Federal Reserve is committed to doing everything it can in order to stimulate the economy.
The Us House of Representatives has moved to pass a second stimulus bill that adds more trillions to the country’s bill and seeks to expand state and local government budgets. While there is a low chance of this whole bill passing in its entirety in the Senate, there is a higher chance some parts of the bill will be enacted.
All of these actions should have us worried about the probable impact they will have on the economy. While there is merit in bridging an income gap and meeting people’s basic needs in a crisis, more focus hasn’t been given on how to get people back to work, producing things of value.
In order for the economy to recover, it will require demand and Supply boosts. The current unemployment incentives may encourage high unemployment thereby lead to a sluggish change in production. Prolonged unemployment will also inadvertently affects long-run demand. Recovery will require putting incentives for people to go back to work, letting businesses reopen and expand, so that economy gets back to producing at full capacity. Agreeably this will take a while, but it is the only way to ensure a sustainable path to growth; one that will not need constant propping up or never-ending stimulus.