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The Fed to the rescue

Intervention enables quick recovery from pandemic downturn


The rapid economic recovery from the Covid recession is remarkable. Just a year ago, many feared that economic recovery from the pandemic might take a five years or more. In June last year, Fed Chair Jay Powell was predicting that full recovery would take 30 months. In fact, real GDP most likely will fully recover this quarter, 15 months sooner than Powell’s projection.

This is amazing given the strains faced by the economy over the last year and is a testament to the resilience of the capitalist system. But there is more to the story. Had we just relied on capitalism and free markets, the result would have been much different than what we are observing. Heroic intervention by the Fed to ensure adequate liquidity has been critical.

The liquidity provided by the Fed has been of the firehose variety. Through the purchase of multiple classes of assets—short term and long-term federal debt, municipal bonds, private mortgages, corporate bonds—unprecedented level of cash have been injected into the economy.

Add to this, lending facilities that offer loans directly to private business and you see a full spectrum of intervention into the economy. As a measure of the vastness of the Fed intervention, consider this fact: Total Fed provided liquidity has doubled since the beginning of the pandemic.

This massive intervention has associated with it two major concerns. First is the fear of a taper tantrum. Financial markets have come to depend on the Fed to maintain liquidity in markets, so as the Fed tapers off purchases, markets could react badly. It happened before and in circumstance far less extreme. In 2013, coming out of the Great Recession, the Fed announced the slow reduction in asset purchases; federal government bond yields spiked. That time, markets eventually recovered, but the fear is that this time, with markets even more heavily dependent on Fed purchase, the consequences of a tapering could more dramatic.

The second concern is, of course, inflation. Many economists expect inflation to be around 3 ½ percent during 2021. This is more than in recent years, but put in historical context, is not that high. Long term inflation is expected to hover at about 2 percent annually.

Given the extreme dislocation suffered by our economy since Covid, it would be surprising if the economy didn’t suffer from transitory shortages and consequent price spikes. Indeed, if you look in detail at price data for April, it turns out that 10 percent of the price hike can be attributed to a single product category, which is automobiles.

The auto industry famously has been victim of a shortage of computer chips arising from decisions early in the crisis to cut back on orders. But such problems are clearly transitory and with time, auto prices will settle down. Similar stories can be told in other industries, from construction to disposable diapers. These too shall pass.

Still, the chance that the extraordinarily expansive monetary policy now in effect will result in sustained high inflation can’t be ruled out. But if higher inflation is the price to pay for the rapid recovery, then so be it. Putting people back to work is an important goal and if 4 or 5 percent inflation is the cost, it’s worth it.

Christopher A. Erickson, Ph.D., is the Carruthers chair for economic development. As of July 1, Chris has been working at NMSU for 34 years. The opinions expressed are not necessarily shared by the regents and administration of NMSU. Chris can be reached at chrerick@nmsu.edu.

Chris Erickson