We are going through an unprecedented time as governments and central banks around the world offer massive amounts of stimulus.
As economic activity has been in decline, the US economy has been entering a downturn and the government has been seeking a record-breaking $2 trillion stimulus package.
This fiscal stimulus package is designed to aid the public, business and states through the recession and to promote economic recovery on the other side. For example, $500 billion is being used to back loans and assist companies as well as $350 billion for small business aid.
The stimulus will help businesses in the short-term and hopefully reduce the number of businesses that collapse and the number of jobs that are lost. That way, once the virus subsides, the economy can get back up and running as quickly as possible.
Tax cuts are also fairly common in stimulus packages as they mean consumers and business have more money to spend and invest. Something known as 'helicopter money' is included in this bill which has a similar effect but puts the money directly into citizens' hands.
This bill isn’t all about just keeping the economy chugging along, it also has elements to aid the fight against the coronavirus, such as over $117 billion for hospitals.
Typically a by-product of stimulus is an increase in asset prices. Markets saw a huge one-day increase and the first back-to-back gains since the bear market began.
The downside of fiscal stimulus is that it will add to the government deficit, this package worth 10% of GDP may mean bigger tax rises and budget cuts in the future to keep the budget under control.
There has also been a historic amount of monetary stimulus, which is provided by the central bank. The central bank’s primary goals are to support sustainable economic growth, financial stability, low unemployment and to control inflation. The type of stimulus they offer differs from the government.
One of the first tools the central bank typically employs is lowering interest rates and since the start of the crisis the Federal Reserve cut interest rates twice. This encourages higher consumer spending and investment.
More notably, the Fed has also announced quantitative easing (QE) which is a form of producing money and injecting it directly into the economy very quickly. This was a popular policy during the last recession as lowering rates on their own was not enough.
QE is used to increase the money supply and to reduce long term interest rates. The central bank can lower long-term rates by buying government bonds which reduces the rates on them. Since the interest rate on government bonds is directly related to other types of investments, it means when those rates fall they pull down other interest rates within the economy, such as on mortgages and business loans. This makes it cheaper to borrow money and therefore promotes spending.
What makes it unusual this time is that they have announced an unlimited amount of QE to support the economy.
The Fed won’t just buy government bonds though, they will also purchase mortgage-backed securities so the government and banking system has access to liquid cash. For the first time, corporate bonds will also be included in asset purchases.
The Fed has been injecting a lot of money into short-term money markets as the US dollar has been having liquidity problems. This has been due to the increased demand for the currency, which could become a major issue and create systemic risk.
Similar to fiscal policy, a by-product of monetary policy is that it will inflate asset prices although any market gains so far have quickly retreated due to the scale of the problem the virus can create in the economy.
Even though we are seeing unprecedented amounts of stimulus for the central bank and government, this may still not be enough and we could still see more.