July 28, 2020

COVID-19 and the Fed’s Credit Policy

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In March 2020, with the realization of the enormity of the threat posed by the COVID-19 virus, financial markets exhibited unusual volatility. According to the Federal Reserve’s narrative, financial markets became dysfunctional; that narrative implies the belief that market participants could no longer assess risk appropriately. However, nothing in market volatility implies that private markets can no longer assess risk or allocate credit; nevertheless, the Fed responded with numerous programs to intervene in private credit markets. This paper examines the causes of the financial market volatility, discusses the moral hazard entailed by intervening in private credit markets, and explores whether credit market interventions could undermine the Fed’s political independence. The Fed promoted its 13(3) programs as providing resources to sectors of the economy where markets have failed to do so, but the Fed’s credit programs can only allocate credit, not increase real resources. It was monetary policy actions that calmed financial markets, not the announcement of future credit market interventions. Involvement in credit policy drags the Fed into the political arena; therefore, to maintain independence, the Fed should return to the sole job of monetary policy.