This time monetary policy is not the cure!

The pandemic can only be overcome with fiscal expansion and macroprudential measures, a reality shared by major global economies.

During the COVID‑19 crisis, financial markets initially displayed full confidence in the Federal Reserve.

Yet, this time is different. Even the Fed acknowledged that monetary policy alone is insufficient.

1. Lessons from 2008: Monetary Policy as the Main Tool

In the 2008 Global Financial Crisis, the Federal Reserve played a central role in economic stabilization:

• After Democrats lost the Congress majority in the 2010 midterms, fiscal policy could no longer expand (US News, 2010).

• Conventional monetary tools were exhausted, as short-term interest rates approached zero.

• Quantitative Easing (QE) became the primary tool to reduce the spread between short- and long-term rates.

Impact on the Fed balance sheet:

• 2007: ~$1 trillion

• 2010: ~$2 trillion

• 2015: ~$4.5 trillion(Source: Federal Reserve, 2012)

Effectiveness: By buying MBS and long-term Treasuries, the Fed:

1. Lowered mortgage rates

2. Revived the ABS market

3. Encouraged credit flows to households and firms

In the absence of strong fiscal support post‑2011, QE generated meaningful macroeconomic effects (Hesse et al., 2017).

2. COVID-19: A Different Challenge in the U.S.

Against the COVID‑19 shock, the Fed again launched large-scale asset purchases, but the context is different:

• Both short- and long-term interest rates are already at historic lows.

• 10-year US Treasury yields ~1%, leaving little room for real interest rate stimulus.

• Forward guidance and QE now have weaker effects on spending.

Economic feedback loop:

1. Weak demand → Firms cannot cover expenses → Layoffs and shutdowns

2. Layoffs → Lower consumption → Deeper recession

3. Investors flee to Treasuries → Fed must buy more corporate securities to keep markets liquid

The Treasury guarantees Fed purchases, but continued expansion may require new Congressional authorizations.

3. Global Policy Responses: Europe and Asia

The COVID‑19 crisis demonstrated similar monetary limits across major economies:

• Euro Area:

  • The ECB pushed its deposit facility to -0.5% and launched the Pandemic Emergency Purchase Programme (PEPP).

  • Like the Fed, the ECB faced diminishing returns, as bond yields were already near zero.

• Japan:

  • With rates near zero for decades, the BoJ relied on massive asset purchases and yield curve control.

  • Fiscal expansion became essential, as monetary tools had little extra effect.

• Emerging Markets:

  • Countries like Brazil, India, and Turkey used rate cuts and liquidity injections, but capital outflows limited the scope of monetary policy.

  • Many had to rely on fiscal stimulus and IMF credit lines to sustain recovery.

Key takeaway: Globally, monetary policy alone proved insufficient in a low‑rate world. Recovery required fiscal and macroprudential coordination.

4. The Role of Fiscal and Macroprudential Policies

Fed Chair Jerome Powell and other central bankers emphasized that fiscal policy is critical for recovery. Monetary policy alone cannot rescue the economy if demand remains depressed.

Macroprudential measures complement fiscal policy:

• Forcing banks to expand credit to households and firms

• Supporting business survival and limiting job losses

• Sustaining consumption to break the contraction loop

Global example: European authorities used state-backed loan guarantees to protect bank lending, while countries like Germany and France deployed large fiscal packages that complemented ECB liquidity operations.

Beforehand, fiscal authorities may need to inject capital into leveraged financial institutions, enabling them to extend credit without breaching regulatory limits.

Conclusion

The COVID‑19 crisis highlights the limits of monetary policy in a low‑rate environment, both in the U.S. and globally. While the Fed, ECB, and BoJ stabilized financial markets, they could not drive full recovery without fiscal stimulus and macroprudential action. Coordinated policies—credit support, fiscal expansion, and capital injections—are essential to prevent prolonged recessions.

References

• Hesse, Henning, Boris Hofmann, and James Weber. 2017. Effects of Asset Purchases Revisited. BIS Working Papers No. 680.https://www.bis.org/publ/work680.pdf

• The Federal Reserve System. 2012. Recent Balancesheet Trends.https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm

• US News. 2010. 2010 Election Poll Roundup: Obama Approval Rating Hits a New Low.https://www.usnews.com/news/articles/2010/10/21/2010-election-poll-roundup-obama-approval-rating-hits-a-new-low

• European Central Bank. 2020. Pandemic Emergency Purchase Programme (PEPP).https://www.ecb.europa.eu/mopo/implement/pepp/html/index.en.html

• Bank of Japan. 2020. Monetary Policy Measures in Response to COVID‑19.https://www.boj.or.jp/en/announcements/release_2020/index.htm