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This article is from the WeChat public account: Atom Think Tank-Tencent News (ID: AtomThinkTank) , author: Yu Zhen, from FIG title: IC photo

In the past two weeks, the U.S. stock market has experienced unprecedented four consecutive meltdowns, shocking the world. The Fed naturally stood on the cusp. In addition to the response measures it has already taken, will it use negative interest rates? Has its ammunition run out? Will the Fed face a “liquidity trap”?

Professor Yu Zhen, Executive Director of the American and Canadian Economic Research Institute of Wuhan University, has the following analysis of the Fed’s “Three Questions of the Soul”:

The possibility for the Fed to implement negative interest rates is very small-even if this policy is implemented, the Fed will be cautious;

From historical experience, the Fed ’s policy tools are indeed abundant. Whether the Fed buys corporate bonds directly remains to be seen, but this is undoubtedly one of the last “big killers” of the Fed;

If the new crown epidemic is not effectively controlled, sooner or later monetary policy will face a “liquidity trap”;

But the effect of monetary policy has indeed been limited for a long time and cannot stabilize the stock market. “What we need is a targeted fiscal policy.”

The new crown virus epidemic is still spreading rapidly in the past week. As of 12:00 on March 20, 2020, a total of 171 regions and countries worldwide have confirmed cases. Among them, a total of 14,250 cases were confirmed in the United States, and 205 cases were fatal.

At the same time, the global financial market continued to fluctuate. US stocks triggered fuses 4 times. European, Asian, South American and other multi-national stock markets were also unavoidable. The crude oil market plummeted overnight …. A variety of extreme stock market bursts. To make the investment environment foggy.

Taking the US financial market as an example, March 9, 2020, March 12, March 16, and March 18, 2020Japan stocks experienced 4 blowouts within two weeks. Five times in history, we have witnessed 4 times in two weeks . What’s even more cruel is that Trump’s favorite self-proclaimed bull market not only ended, but also wiped out all the gains since his inauguration after the collapse on March 18. During his short 800-day tenure, U.S. stocks experienced a 42-year rise of 42%, approaching Clinton, and also experienced a miracle of collapse of 42% within a month, catching up with Bush Jr.

Trump, a businessman, values ​​the stock market. He shouted to the Fed: “Our sad, slow-moving Fed, under Jay Powell’s leadership, raised interest rates too quickly and cut them too late. The Fed’s interest rates should fall to the level of competitors-they now have The advantage of up to two points, and greater help in exchange rate, and stimulate the market! “

It can be seen that Trump is extremely dissatisfied with the Fed and Powell. He even said on Twitter: “The Fed must be the leader, not the bullshit, and it must always be the latter!”

Facing the uncertain economic prospects and the “stressful” Trump, what has the Fed, the so-called world’s most independent central bank, been doing recently?

Busy Federal Reserve under the New Crown epidemic

What the Federal Reserve has done recently is, in a nutshell, to save money and a lot of money.

On March 3, the Federal Reserve announced a 50 basis point rate cut. This is the first unconventional interest rate cut since 2008. The specific amount of liquidity that can be released cannot be quantified, but a message is sent to the market: water is coming!

Then, the so-called world’s most independent central bank, continued to follow this logic. On March 12, the Federal Reserve announced that it would launch a reverse repo operation to supplement short-term liquidity. The operation period of this period starts from the same day and ends on April 13. The next purchase plan will be announced on April 13. According to the repurchase schedule released by the Fed’s New York branch, the Fed will inject liquidity into the market every day for the next month. To put it simply, the total size of these funds is nearly $ 5.5 trillion.

On March 15, the Fed suddenly announced another 100 basis point cut in interest rates. At this point, the U.S. federal benchmark interest rate has fallen to the range of 0 to 0.25%, and there is basically no way to reduce it in the future.

At the same time, the Federal Reserve also launched a large-scale quantitative easing of $ 700 billion (QE) Monetary policy plan to deal with the impact of the New Crown epidemic on the US economy. The new round of measures includes the purchase of US $ 500 billion in Treasury securities and US $ 200 billion in mortgage securities. The batch purchase amount is 40 billion US dollars. QE and reverse repurchase are both Fed purchases and buys, the difference is that reverse repurchase is short-term, and the assets purchased by QE are long-term, and long-term capital entry can stabilize confidence. / p>

On March 17, the Federal Reserve opened the commercial paper financing mechanism again (CPFF) , bypassing banks to lend directly to enterprises. The Ministry of Finance’s Foreign Exchange Stability Fund will provide $ 10 billion in credit protection for the mechanism. The last time the tool was used was in 2008.

In addition, in order to rescue convulsive financial markets, the Fed decided to start the tier one dealer credit facility from March 20th. (PDCF) The expiration time is up to 90 days and lasts at least 6 months.

On March 18th, the currency instruments were added, and the Federal Reserve announced the launch of the currency market mutual fund liquidity tool (MMLF) , which will continue until this year September. Like CPFF and PDCF, this MMLF is also the first time the Fed has used the financial crisis since 2008.

So, in just half a month, the Fed cut interest rates by 150bp and theoretically plans to inject 6.2 trillion (5.5 + 0.7) Sex, take out 3 of the unconventional currency instruments during the 2008 financial crisis. Market performance is hard to say.

Does the Fed use negative interest rates?

At present, the Federal Reserve has reduced the federal benchmark interest rate to 0 ~ 0.25%. The question that everyone is more concerned about is: If the market does not buy the Fed’s interest rate cuts and quantitative easing, will the Fed lower the interest rate below zero?

Negative interest rates are not without precedent. In June 2014, the European Central Bank announced that it would reduce the overnight deposit rate to -0.1%, officially opening the era of negative interest rates in the Eurozone. In February 2016, the Bank of Japan began to implement negative interest ratesPolicy, entering the era of negative interest rates.

In theory, after the implementation of negative interest rates, companies or individuals can borrow money from banks, not only without paying interest, but also gaining income. Therefore, a negative interest rate policy can effectively stimulate investment, stimulate consumption, and create employment.

In February 2015, the Swedish central bank used the negative interest rate policy. After the implementation of this policy, Sweden’s GDP growth rate rose sharply in 2015, reaching 4.5%. The Swedish house price index rose by about 30% between 2015 and 2019. Its inflation rate rose to about 2% in 2018, reaching the central bank’s target. The unemployment rate fell from 7.5% in December 2014 to 6.6% in October 2019. Therefore, judging from these indicators, negative interest rates have fulfilled the policy goals set at the beginning, which indeed stimulated economic growth, increased the price index, and increased employment levels.

However, in the longer term, there are many hidden dangers of negative interest rate policies. The biggest hidden danger is that the negative interest rate policy will hurt the long-term returns of the banking industry, so that they do not have the ability to provide cheap loans to businesses and individuals for a long time. In the long run, the decline in profits will instead prompt banks to reduce credit to businesses and individuals. This result is clearly contrary to the original intention of the negative interest rate policy.

In addition, negative interest rates will also create a real estate bubble and increase household debt levels. Because borrowing money has not only costs, but also benefits, it makes borrowing money easy and cost-effective. If the money borrowed from the bank flows to the stock market and the property market, it will also increase the possibility of a financial crisis in the future.

More seriously, negative interest rates change bond yields. In a negative interest rate environment, financial institutions such as insurance companies will increase the allocation ratio of stocks. If the stock market crashes in the future, the insurance company’s ability to settle claims for customers will be weakened. Such negative effects may not occur in the short term, but they cannot be ignored in the long term. Therefore, most central banks will not implement negative interest rates for a long time.

It is precisely because of the above hidden dangers that the Swedish central bank will end its negative interest rate policy at the end of 2019.

Combined with the experience of other central banks and the actual situation in the United States, whether the Fed will implement negative interest rates will mainly face the following restrictions or pressures.

First, legal restrictions. United States Federal Reserve Act (Federal Reserve Act) does not specify negative interest rates. In other words, depositors can receive interest by depositing money in the bank, but there is no mention that banks can charge interest to depositors. If you want to allow banks to collect interest from depositors, you need to pass amendments to related bills.

Second, psychological stress. Currently in the US capital market, there are about 4 trillion US dollars of money funds. Similar to Yu’ebao in China, many consumers use money funds as bank deposits because they can provide higher interest rates than banks and have good liquidity. Once the Fed implements negative interest rates, the interest returns on these money funds are likely to become negative. During the 2008 financial crisis, the net value of a currency fund dropped below 1, which caused panic among many investors and exacerbated the decline in the stock market. In the context of the current new crown epidemic, the Fed is definitely not willing to aggravate financial market panic because of a certain policy.

Third, international pressure. At present, as the safest asset in the world, U.S. Treasury bonds are widely loved by governments in many countries and have become part of the foreign exchange reserves of many countries. If the dollar benchmark interest rate is negative, the yield on the entire US Treasury bond will fall, forcing countries with huge US foreign exchange to sell Treasury bonds. Such changes will undoubtedly have a significant impact on the global bond market and foreign exchange market. In particular, in order to cope with the new crown epidemic, the US government continues to increase fiscal expenditure. How to get investors to buy government bonds will be a very important thing.

Overall, the Fed is unlikely to implement negative interest rates. Even if this policy is implemented, the Fed will be cautious.

Has the Fed’s bullet run out?

Facing the continuous development of the epidemic, the market is also curious about the Fed’s future policies. In response to reporters, Fed Chairman Powell previously said that the Fed’s remaining toolbox “energy” is still very large [span class = “text-remarks” label = “Remarks”> (power) . The Fed still has considerable room to adjust its policies, and he emphasized the importance of liquidity tools.

Historically, there are many ways the Fed responds to the crisis. Generally speaking, the Federal Reserve can provide liquidity to the market from non-bank financial institutions, enterprises and individuals such as commercial banks and primary dealers. Table 1 below shows the policy tools used by the Fed during the 2008 financial crisis.

Source: Liu Shenghui, “The Fed’s Monetary Policy Tools Innovation and Enlightenment in the Financial Crisis”, International Finance Research, Issue 8, 2009 >

So, from the historical experience, the Fed’s policy tools are indeed abundant.

However, there is also a very “crazy” idea in the market: Will the Fed buy corporate bonds directly? Because in this financial turmoil, the “default risk that corporate high leverage and high-yield debt flooding may bring” has always been worrying the market. Therefore, buying corporate bonds directly is the most effective way to solve the core risks of the bond market. Therefore, some people think that the Fed may extend the purchase of assets to the level of corporate bonds, such as to provide support to the aviation, hotel, automotive and energy industries that have been most affected by the epidemic.

However, due to the nature of direct purchase of corporate bonds, the nature of excessive intervention and distortion of the market mechanism is too severe, and it has never been used in the history of the Federal Reserve. Article 13, paragraph 3c of the Federal Reserve Law states that “The Fed needs to submit a report to the Senate Committee on Banking, Housing, and Urban Affairs and the House Financial Services Committee within 7 days and report its net worth every 30 days . “Even if the Fed wants to do this, it needs to go through a very tedious process.

Given that the major central banks including the European Central Bank, the Bank of Japan and the Bank of England have already carried out this operation, it remains to be seen whether the Fed can follow suit. But it is certain that if you buy corporate bonds directly, it is undoubtedly one of the last “big killers” of the Federal Reserve.

Will the Fed face a “liquidity trap”?

Under normal circumstances, whether through the currency channel or the credit channel, the basic principle of the central bank ’s monetary policy effect is: By changing interest rates and credit scale, the central bank changes the returns and risks of different assets, leading to asset substitution, thereby Affect economic behaviors such as consumption and investment of residents and enterprises, and ultimately affect the macro economy.

Thus, the effectiveness of monetary policy depends mainly on the smoothness of the above channels. If the above channels are not smooth, and despite nominal interest rates falling to zero, pessimistic expectations and sluggish money demand cannot stimulate consumption and investment, then the central bank will face a so-called “liquidity trap.”

At present, the plight of the US economy is not a simple liquidity problem. The root cause is the new crown epidemic. From the perspective of the US economic structure, the service industry accounts for a large proportion, of which culture and entertainment account for a considerable proportion. The spread of the new crown epidemic mainly affects “face-to-face” economic activities.

For example, all current U.S., NBA, rugby and other events are closed, Disney is closed, Las Vegas casinos are closed, movie theaters are closed, “Mulan”, “Speed ​​and Passion 9” are withdrawn, and “Mission Impossible” Stop shooting, issue travel bans to the world, and more. Until the New Crown epidemic is brought under control, it is difficult to imagine that US consumption and private investment will pick up. It can be said that the new crown epidemic will have a greater impact on the US economy than in the 2008 financial crisis.

Under the epidemic, the employment and income of the American people will decline and the savings rate will be relatively low. Their consumption will not only decline during the epidemic, but also remain depressed for a period of time after the epidemic. If companies also anticipate this, private sector investment will not improve for a considerable period of time.

What’s more serious is that the global spread of the new crown epidemic will also affect the United States, and its domestic consumer goods imports, intermediate goods imports, and external capital inflows will be affected. The problems these real economies face are no longer as simple as insufficient liquidity. In other words, if the new crown epidemic is not effectively controlled, sooner or later monetary policy will face a “liquidity trap.”

Nobel Laureate in Economics and former World Bank chief economist Stiglitz said that without the Fed taking action, the situation could beIt can be worse; but obviously this will not stabilize the stock market. What we need is targeted fiscal policy. The effect of monetary policy has been limited for a long time.

This article is from the WeChat public account: Atom Think Tank-Tencent News (ID: AtomThinkTank) , author: Yu Zhen (Executive director of the American Institute of economic Research, Wuhan University, Canada)