The basic economic misunderstanding that's screwing up the coronavirus response
Economic action by the United States government comes in two flavors: Fiscal policy and monetary policy. The first encompasses the taxing and spending decisions by Congress and the president. The second is basically whatever the Federal Reserve does. This division is taken as a natural fact by mainstream economists and policymakers. But it's actually pretty arbitrary, and it sows confusion about what the U.S. government's economic powers actually are.
With the coronavirus crisis barreling down upon us, that confusion has proven to be a major impediment — both to practical action, and to public trust that the government isn't simply bailing out wealthy elites.
Last week, for instance, the Federal Reserve announced an emergency offering of $1.5 trillion in cheap loans to the financial system, to keep the markets from seizing up under the strain of the coronavirus panic. That move has already been overshadowed by subsequent events, but it set off a momentary mini-firestorm at the time. Populists on the left asked why, when demands for ambitious progressive policies are stymied in Congress by questions of "how to pay for it," the Fed can just snap its fingers and create $1.5 trillion to offer up to Wall Street traders? Then more centrist and wonky commentators protested that this was apples-and-oranges; it was loans, not a bailout, and not the same as cash spending at all.
Which side was right? Well, they both were.
The Congress and the Treasury Department (which handle fiscal policy) and the Federal Reserve (which handles monetary policy) are all part of the U.S. government. And the U.S. government has a unique power: It creates U.S. dollars. But how these two setups inject that money into the economy is quite different.
Fiscal policy is a straightforward transfer: The government spends the money — on contractors, on welfare benefits, on Social Security checks, etc — other people and businesses get the money, and that's that. The central bank, on the other hand, being a bank, loans money into the economy or facilitates loans — mostly by buying Treasury bonds from banks and other actors in the financial system. And loans, unlike transfers, eventually have to be paid back with interest. But the Fed is also different from any private bank: it can never go bankrupt by making bad loans, because it shares the government's money-creating powers. Which means it can offer a lot more credit at far cheaper rates than any other entity.
Now, the prospect of Congress just creating money out of nothing and using it to finance its fiscal policies freaks out policymakers. Instead, Congress is legally required to sell Treasury bonds to the financial markets (i.e. to borrow money) whenever spending outpaces tax revenue, and the Federal Reserve is legally barred from directly buying the bonds issued by the U.S. Treasury Department. Rather, in order to conduct its policy, the Fed creates money to buy the Treasury bonds from the financial industry — or accepts bonds as collateral for loans, as in the case of last week's $1.5 trillion offer. Thus, the U.S. government's money-creating powers are hived off in the Federal Reserve, and this whole constellation of institutional divisions and legal directives encourages the Congress to think of itself as cash-constrained, just like a household or business.
Meanwhile, the private financial industry functions as a middle-man between the Fed and the Treasury Department — a wildly profitable situation for it to be in. I mean, imagine how easy you'd have it if you had abundant access to super-cheap loans. The Fed's job is to basically see to it that the financial industry never suffers too much for its mistakes, lest those mistakes cause a panic and bring down the economy. The central bank makes sure there is always enough demand in the markets to buy whatever bonds the Treasury Department offers — partly because the Fed wants to make sure that the government's fiscal policy decisions go smoothly, but also because the Fed's job is to prevent panics and keep the financial system stable, and U.S. Treasury bonds have become the lifeblood of the global financial system.
The terms "subsidy" or "bailout" really don't encompass what's going on here. They imply an outside government intervention into a pre-existing market state. But for the financial industry, there effectively is no "pre-existing market state" outside of what the Fed chooses to do. To give a concrete example: Last week's $1.5 trillion offer to the financial industry was essentially the equivalent of the short-term collateralized loans individuals can get at pawn shops. But while those pawn shop loans will generally charge you an interest rate of 200 to 300 percent, the Fed aimed for interest rates under one percent. Individual Americans and regular businesses do not get accounts at the Fed; they cannot access credit anywhere this abundant or cheap.
The entire system is effectively one giant subsidy. The central bank must make sure private banks and financial firms enjoy smooth sailing, because it must make sure the government and society continue to function. That is certainly a worthwhile goal. But because the Fed is limited to certain tools, its efforts to help the public good inevitably shower their most immediate benefits on those private banks and firms — who get to make gargantuan profits for filthy-rich shareholders, while essentially operating as private adjuncts to a public system.
Meanwhile, fiscal policy controlled by Congress is what is designed to help regular Americans and smaller companies, as it can drop money directly into people's pockets without the need for it to be paid back. But because of the institutional divide between fiscal and monetary policy, Congress does not seem to understand its own powers.
As mentioned, the Fed works with the financial markets to finance Treasury bonds. Thus, in truth, Congress can deficit spend to its heart's content so long as inflation doesn't get out of control. But Congress and elected officials don't seem to realize this. As a result, the fiscal policy response to the coronavirus has been hamstrung by debates over where to get the money: a bill to increase paid sick leave has been gutted, and House Speaker Nancy Pelosi (D-Cali.), reportedly nixed the idea of universal cash transfers to help people through the crisis because she viewed congressional spending as a scarce resource that shouldn't be wasted on millionaires. Indeed, Pelosi has been fixated on reducing deficits since taking back power in the House, and former Vice President Joe Biden even said that President Trump's deficit-financed tax cuts had already eaten a lot of the fiscal "seed corn" we need to fight the coronavirus crisis. (The latter is just bad economics: recessions by definition open up the economic space to absorb new money creation without inflation.)
Granted, at this point the sheer scale of the crisis seems to have temporarily quieted Congress' deficit fears. But we're also in a bizarre situation in which the Democrats, because they genuinely believe in "fiscal responsibility," have allowed the more-cynical GOP to get to their left in terms of welfare aid to regular Americans.
To sum up, the very design of our economic policymaking institutions — the fiscal-monetary split — has created a perverse situation: The portion of our policymaking toolkit that most directly benefits the financial industry can respond at enormous speed and scale in emergencies. The Fed is a technocratic agency, staffed by appointed officials one-step removed from the deliberations of Congress. It suffers little oversight or bureaucratic slowdown, because what the Fed does is seen as mysterious and "nonpolitical." At the same time, Congress' fiscal policy — the tool that gets aid directly to you and me and all the other non-financial elites — is bogged down in politics and the economically irrational fear of deficits, stumbling over itself to provide the same kind of help that the Fed can dish out at a moment's notice. And the only reason the government does this absurd dance is because everyone is terrified of admitting Congress can create money ex nihilo.
It's a setup that virtually guarantees economic outcomes tilted to benefit the wealthy and powerful, in good times and bad. It's a setup that cannot help but inspire ever-growing cynicism and distrust in the population at large. And it won't be fixed until either Congress figures out what its powers actually are, or until we redesign the entire system from the ground up.
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