I remember people talking about Covid-19 in January of 2020. There had been several epidemic scare-claims from major news outlets in the decade prior and those all turned out to be nothing. So, I was not excited about this one. By the end of the month, I saw people making substantiated claims and I started to suspect that my low-information heuristic might not perform well.
People are different. We have different degrees of excitability, different risk tolerances, and different biases. At the start of the pandemic, these differences were on full display between political figures and their parties, and among the state and municipal governments. There were a lot of divergent beliefs about the world. Depending on your news outlet of choice, you probably think that some politicians and bureaucrats acted with either malice or incompetence.
I think that the Federal Reserve did a fine job, however. What follows is an abridged timeline, graph by graph, of how and when the Fed managed monetary policy during the Covid-19 pandemic.
February, 2020: Financial Markets recognize a big problem
The S&P begins its rapid decent on February 20th and would ultimately lose a third of its value by March 23rd. Financial markets are often easily scared, however. The primary tool that the Fed has is adjusting the number of reserves and the available money supply by purchasing various assets. The Fed didn’t begin buying extra assets of any kind until mid-March. There is a clear response by the 18th, though they may have started making a change by the 11th. One might argue that they cut the federal funds rate as early as the 4th, but given that there was no change in their balance sheet, this was probably demand driven.
March, 2020: The Fed Accommodates quickly and substantially.
In the month following March 9th, the Fed increased M2 by 8.3%. By the week of March 21st, consumer sentiment and mobility was down and economic policy uncertainty began to rise substantially – people freaked out. Although the consumer sentiment weekly indicator was back within the range of normal by the end of April, EPU remained elevated through May of 2020. Additionally, although lending was only slightly down, bank reserves increased 71% from February to April. Much of that was due to Fed asset purchases. But there was also a healthy chunk that was due to consumer spending tanking by 20% over the same period.
In the 18 months prior to 2020, M2 had grown at rate of about 0.5% per month. For the almost 18 months following the sudden 8.3% increase, the new growth rate of M2 almost doubled to about 1% per month. The Fed accommodated quite quickly in March.
April, 2020: People are awash with money
Falling consumption caused bank deposit balances to rise by 5.6% between March 11th and April 8th. The first round of stimulus checks were deposited during the weekend of April 11th. That contributed to bank deposits rising by another 6.7% by May 13th.
By the end of March, three weeks after it began increasing M2, the Fed remembered that it really didn’t want another housing crisis. It didn’t want another round of fire sales, bank failures, disintermediation, collapsed lending, and debt deflation. It went from owning $0 in mortgage-backed securities (MBS) on March 25th to owning nearly $1.5 billion worth by the week of April 1st. Nobody’s talking about it, but the Fed kept buying MBS at a constant growth rate through 2021.
May, 2020 – December, 2021: The Fed Prevents Last-Time’s Crisis
Jerome Powell presided over the shortest US recession ever on record. The Fed helped to successfully avoid a housing collapse, disintermediation, and debt deflation – by 2008 standards. The monthly supply of housing collapsed, but it had bottomed out by the end of the summer. By August of 2021, the supply of housing had entirely recovered. The average price of new house sales never fell. Prices in April of 2020 were typical of the year prior, then rose thereafter. A broader measure of success was that total loans did not fall sharply and are nearly back to their pre-pandemic volumes. After 2008, it took six years to again reach the prior peak. A broader measure still, total spending in the US economy is back to the level predicted by the pre-pandemic trend.
The Fed can’t control long-run output. As I’ve written previously, insofar as aggregate demand management is concerned, we are perfectly on track. The problem in the US economy now is real output. The Fed avoided debt deflation, but it can’t control the real responses in production, supply chains, and labor markets that were disrupted by Covid-19 and the associated policy responses.
What was the cost of the Fed’s apparent success? Some have argued that the Fed has lost some of its political insulation and that it unnecessarily and imprudently over-reached into non-monetary areas. Maybe future Fed responses will depend on who is in office or will depend on which group of favored interests need help. Personally, I’m not so worried about political exposure. But I am quite worried about the Fed’s interventions in particular markets, such as MBS, and how/whether they will divest responsibly.
Of course, another cost of the Fed’s policies has been higher inflation. During the 17 months prior to the pandemic, inflation was 0.125% per month. During the pandemic recession, consumer prices dipped and inflation was moderate through November. But, in the 16 months since April of 2020, consumer prices have grown at a rate of 0.393% per month – more than three times the previous rate. Some of that is catch-up after the brief fall in prices.
Although people are genuinely worried about inflation, they were also worried about if after the 2008 recession and it never came. This time, inflation is actually elevated. But people were complaining about inflation before it was ever perceptible. The compound annual rate of inflation rose to 7% in March of 2021. But it had been almost zero as recent as November, 2020. That March 2021 number is misleading. The actual change in prices from February to March was 0.567%. Something that was priced at $10 in February was then priced at $10.06 in March. Hardly noticeable, were it not for headlines and news feeds.