By Skanda Amarnath

The impact of COVID-19 is likely to be sizable. Regardless of the precise composition of the shock to supply and demand, further macroeconomic policy action is now necessary. The Fed can cut the benchmark Federal Funds Rate a few more times, but only Congress and the White House can provide a surefire solution that prevents the short-term impact from COVID-19 from causing more persistent damage to employment and incomes. The current predicament also provides an opportune moment to pass permanent enhancements to automatic stabilizer programs so that fiscal policy can adjust dynamically to changes in recession risk, whether they stem from COVID-19 or otherwise.


  • Judging by the accelerating spread of COVID-19 and its corresponding effects on major economies and financial markets, fiscal stimulus is likely necessary if the economic costs are to be contained. We will never know the precise decomposition of the impact between “supply” and “demand,” but COVID-19 is a substantial income shock for many households and businesses. Without macroeconomic policy buffering against such income shocks, financial constraints are more likely to bind and risk setting off a vicious cycle of layoffs and bankruptcies.
  • The Fed has been the primary institution for managing macroeconomic policy, but it now has limited ability to unilaterally support demand. Short-term interest rates can only be lowered a few more times. Long-term interest rates are so low that asset purchases (LSAP / QE) and forward guidance are of little affirmative value. That said, the low level of government borrowing costs should also provide a powerful price signal to Congress and the White House: now is the time to err on the side of borrowing and investing aggressively to avoid future economic losses. The benefit of avoiding nasty spillover economic costs in the private sector would outweigh the marginal cost associated with additional government borrowing.
  • With supportive and flexible macroeconomic policies, economic activity can rebound sharply from COVID-19, just as it does from natural disasters. A number of policies are likely to help in the current context: ensuring that impacted small and medium businesses have sufficient access to low-cost loans as is typically done through the Small Business Administration in natural disasters, direct payments to households similar to the Economic Stimulus Act of 2008, and some of the proposals already suggested in Jason Furman’s recent op-ed: expansion of Medicaid and public health funding for state governments, paid sick leave, and extensions to unemployment insurance.
  • Given the unknown scope and scale of the fallout from COVID-19, there needs to be some degree of contingency planning underlying a fiscal response so that it can be appropriately scaled to scenarios in which the impact is both better and worse than currently expected. The ideal outcome is for fiscal policy look a lot more like the automatic stabilizer programs that have already been proposed in Recession Ready. Such programs rely on Congress preemptively authorizing stimulative measures so that fiscal policy can respond quickly enough to changing conditions. If Congress were to pass such enhanced automatic stabilizer programs, this would also help to diminish concerns associated with the Fed’s capacity to fight recessions when interest rates are already so close to the zero lower bound. Regardless of the source or timing of recession risk, automatic stabilizers enable fiscal policy to play a more a reliable role in insuring against recessionary outcomes.

COVID-19 and Low Interest Rates Make Fiscal Stimulus And Enhanced Automatic Stabilizers A No-Brainer

The Case For Macroeconomic Policy Action

As we continue to re-evaluate the health effects associated with the spread of COVID-19, macroeconomic policymakers in the United States need to pay correspondingly close attention to its effects on financial markets and major economies. Without an appropriate evaluation and response to these effects, a temporary shock to business revenues and individual wages can easily snowball into something much larger, persistent, and potentially recessionary.

Econ 101 has led to some anxiety about whether macroeconomic policy can even do much in this environment. Isn’t a virus that prevents individuals from working and factories from running a “supply” shock that “demand-side” fiscal policy can’t do much about? Austan Goolsbee argued recently in the New York Times that perhaps it is a demand shock after all:

So for all the talk about the global “supply shock” set off by the coronavirus outbreak and its impact on supply chains, we may have more to fear from an old-fashioned “demand shock” that emerges when everyone simply stays home.

The truth is we will never know, especially in real-time, how much of this economic impact is strictly about “supply” or “demand,” but it is quite clearly an income shock. The loss of income for private sector actors needs to be seen not just in terms of resource constraints, but also in terms of financial constraints. In the private sector, lost income can quickly lead to spending cutbacks that directly affects the incomes of others. The spillover costs can be large because of a lack of private sector financial capacity, even if the economy has the resource capacity. This is precisely what macroeconomic policy is best-suited to resolve and prevent. By buffering the incomes and revenue streams of households and businesses, macroeconomic policy can quickly short-circuit the vicious cycle of layoffs and bankruptcies.

With Interest Rates Already So Low, Fiscal Policy Is Clearly Superior To Monetary Policy

The Fed has been the conventional institution for managing macroeconomic policy, but with interest rates already historically low, it has little room left to unilaterally support credit and income growth. Short-term interest rates can only be lowered a few more times; the Federal Funds rate is just 1% above what it defines as the “effective lower bound.” The Fed’s large scale asset purchases (LSAP, aka “QE”) of Treasury securities and forward guidance about the future path of the Federal Funds Rate are also of little affirmative value now. Long-term interest rates are already so low that the slope of the yield curve cannot be flattened much further. Long-term Treasury yields are lower now than they ever were during the global financial crisis or this ongoing business cycle expansion.

The low level of government borrowing costs is a challenge for unilateral monetary policy, but in the context of macroeconomic policy as a whole, it is a historic opportunity. The government is not equivalent to the private sector, but if it were, the signal from Treasury yields is that now is the time for the Federal Government to borrow and invest aggressively to preserve future economic growth.

“V-Shaped” Rebounds Remain In Grasp But They Need Supportive Policies That Sufficiently Counteract The Scale Of The Shock

Economic activity is likely to be depressed for a temporary period as supply chains are forced to adjust to the impact of COVID-19. Risk-mitigation efforts could also have out-sized effects within the services sector, as businesses and workers are forced to postpone activity and reduce their hours. The human costs of this alone are significant, but it would be all the worse if businesses are forced to shed jobs and cut investment due to the lack of adequate financing options. Similarly, we don’t want workers facing lost hours and incomes to be forced to curb their consumption more aggressively for what should otherwise prove to be a temporary phenomenon. However, if we fail to address the risk of such a vicious cycle, this fundamentally “temporary” phenomenon can have more persistent effects on the current economic expansion.

While the uncertainty and persistence associated with the impact of COVID-19 is of a much larger magnitude than the typical natural disaster, with the appropriate policies in place, a “V-shaped” economic rebound still remains feasible. Without such policy support, the vicious cycle of layoffs and insolvencies will be much harder to reverse. This in large part describes why recessions, despite being “temporary,” have increasingly coincided with multi-year “jobless recoveries.”

A number of policies are likely to help in the current context. While the Fed can still reduce short-term interest rates in the hope of lowering the discount rates associated with riskier financial assets, the Fed’s recent 50 basis point emergency interest rate reduction has not proven as effective for supporting financing conditions. For larger firms with more privileged access to capital markets, borrowing costs have continued to rise. The reality for small and medium-size firms, which already face more limited financing options, is likely to be even more challenging.

With the appropriate coordination across the Fed, the Secretary of the Treasury, and Congress, low-cost financing could be made available to businesses regardless of their size. Due to the “unusual and exigent circumstances” of the financial crisis, the Fed had the authority to create the Commercial Paper Funding Facility, which allowed it to lend directly to larger firms via the short-term commercial paper market. Following the passage of the Dodd-Frank Act, the Fed’s authority to take such action under Section 13(3) of the Federal Reserve Act now comes with the added requirement of approval from the Secretary of the Treasury. Even if the Fed did something similar now with Treasury approval, such a facility would not necessarily reach smaller firms directly. In natural disasters, Congress authorizes funding for the Small Business Administration to provide low-cost loans to such firms so that they can cover operating expenses, including payroll, during periods of temporary economic weakness. Congress should ensure that similar institutional capacity is made available for addressing the current economic shock.

In addition to broadening the direct provision of credit to businesses of all sizes, Congress and the White House should also be working to enact a variety of measures that can provide a targeted boost to households. Direct payments to all households, similar to the Economic Stimulus Act of 2008, can help ensure that temporary reductions in labor income do not translate into additional reductions in household consumption. Jason Furman’s recent op-ed in the Wall Street Journal included additional proposals that would be effective for targeting income where it is most likely to serve as a buffer. Expanding Medicaid and additional public health funding to all state governments would be especially effective since balanced budget laws make State governments inclined to cut spending when the economy is already weakening. Forcing States to penny-pinch their way through the current shock runs the risk of more substantial costs down the road if the impact of COVID-19 is not properly contained. The case for ensuring paid sick leave and extending unemployment insurance are equally compelling since the benefits would be directed to the most adversely effected individuals. These individuals would also be the most likely to make use of such income in a manner that further supported economic activity.

To Meet The Immediate And The Structural Policy Challenges, Congress Should Enhance Automatic Stabilizer Programs

Given the unknown scope and scale of the fallout from COVID-19, there needs to be some degree of contingency planning underlying a fiscal response so that there is an appropriate adjustment for better- and worse-than-expected scenarios. The ideal outcome is for fiscal policy to look a lot more like the automatic stabilizer programs that have already been proposed in Recession Ready. Automatic stabilizer programs mechanically increase government spending and reduce tax burdens as the economy weakens. Preemptive Congressional authorization for stimulative programs ensures that fiscal policy adjusts dynamically to the evolving impact of COVID-19. Otherwise, if each new development requires an additional iteration through the legislative process, urgent issues of macroeconomic and public health are likely to be slowed down and excessively politicized.

Enhancing automatic stabilizer programs would also go a long way to resolving the questions at the center of the Fed’s ongoing Review of Monetary Policy Strategy, Tools, and Communications. With short- and long-term interest rates already historically low and inflation continuing to run persistently below its 2% target, the Fed is particularly worried about its capacity to fight off a recession. If fiscal policy more reliably insured against recessionary outcomes, then much of the concern associated with monetary policy near its effective lower bound would also subside. Automatic stabilizers offer a robust solution, regardless of whether the precise source of recession risk is a financial panic, a deleveraging private sector, a natural disaster, or a pandemic.