Business Economics Report: Fed's Response to COVID-19 Crisis

This report provides an analysis of the Federal Reserve's actions in response to the COVID-19 crisis. It begins with an overview of the various measures taken by the Fed, including cuts in the federal funds rate, quantitative easing, discount window adjustments, and currency swap lines. The report then explores the role of these actions in mitigating the economic impact of the pandemic, focusing on how the Fed supports the financial system, credit availability, and overall economic stability. Finally, the report analyzes the effects of these actions using the AD-AS model, demonstrating how the Fed's policies aim to restore potential GDP and stabilize the price level. The report references several sources to support its analysis. This content is available on Desklib, a platform offering past papers and solved assignments for students.

Running head: BUSINESS ECONOMICS
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1BUSINESS ECONOMICS
Table of Contents
Federal Reserve response to COVID-19 crisis................................................................................2
Role of Fed’s action in mitigating COVID-19 crisis.......................................................................3
Analysis of the effect of Fed’s action..............................................................................................4
References........................................................................................................................................6

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Federal Reserve response to COVID-19 crisis
Federal Reserve has actively intervened to stabilize the economy of United States in the
face of current COVID 19 pandemic. The Federal Reserve has taken a broad array of action to
limit the likely damage of the economy from the pandemic. Fed has given around $2.3 trillion
lending support to the household, financial market, employers and local and state government.
The steps so far have been taken by Fed are as follows.
Cut in federal fund rate
Federal Reserve has cut the overnight borrowing rate for banks by a total of 1.5 percent
since 3rd of March. With this the Fed has brought the fund rate down to a range from 0 to 0.25
percent basis point.
Quantitative Easing
Fed first adapted the policy of quantitative easing during the financial crisis of 2008. The
objective is to keep the long term interest rate low through purchase on bank securities and
treasuries (federalreserve.gov, 2020) On March 15, Fed has cut the rate close to zero by
restarting large scale purchase and making open-ended commitments.
Discount Window
Banks have borrowed the highest since 2009 on an urgent basis from the central bank.
Policy makers have reduced the rate applied on funding to 0.25 percent and extended the length
of loans from 1 day to 90 days.

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Central bank foreign currency swap lines
Fed has recently increased the frequency of foreign exchange operation from weekly to
daily (Marte, 2020). It is also offering swap lines to additional nine countries for easing access to
dollars.
Other measures taken by Fed to support activities in the financial market include Term
Asset Backed Securities Loan Facility, Commercial Paper Funding Facility, Primary Dealer
Credit Facility, Primary Market Corporate Credit Facility and Secondary Market Corporate
Credit Facility.
Role of Fed’s action in mitigating COVID-19 crisis
The financial system in U.S has a critical role for functioning of the overall economy.
Banks are the central in the system. Apart from providing substantial employment the financial
system serves three main purposes. The first is provision of credit. Available credit allows
business to carry out investment beyond the amount of cash in hand, helps household to finance
purchase of assets and government to finance spending in different areas (Guttmann, 2016). The
second and third important functions of financial systems are liquidity provision and risk
management service.
Keeping in mind the role of financial system to smoothen economic activity Federal
Reserve has taken different step to maintain a strong financial system. Cut in federal fund rate is
the benchmark rate of short term interest and also influence long term interest rate. As Fed has
lowered the fund rate this reduces the borrowing cost of loans implying borrowers can have
access to sufficient credit even in times of low. The policy of government quantitative easing
aims to keep long term interest rate at a low level. This will keep purchases made by businesses

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and consumers affordable and support spending. The facility of discount window increase ability
of commercial banks to lend money even during crisis (Heijdra, 2017). The policy of currency
swap line by increasing supply of US dollar will support foreign companies denominated in U.S.
currency and different foreign governments having liabilities to US government. Overall, the
policies of federal reserve by supporting the financial system and credit availability will help the
economy to counter the economic damage likely to cause from COVID-19 pandemic.
Analysis of the effect of Fed’s action
Figure 1: AD-AS model
Suppose the US economy before the crisis was at E which is the long run equilibrium of
the economy. Now, because of the crisis there is likely to be a decrease in aggregate spending of
the economy in terms of decrease in consumption and investment spending. Fall in aggregate
spending shifts aggregate demand curve to the left (Uribe & Schmitt-Grohe, 2017). The
equilibrium then is likely to shift to E1 causing real GDP to fall to Y1 and price level to fall to P1.

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In response to crisis, if Fed takes different policies to support the financial system then this will
increase the availability of credits in the economy. The available credit at a lower cost supports
households, business and government spending. Gaining support from Fed, aggregate spending
in the economy is likely to recover. As aggregate spending increases, there is a likely increase in
aggregate demand. Consequently, the aggregate demand curve moves back to its long term
position (Guilmi, Gallegati & Landini, 2017). The economy then again moves to its stable long
run equilibrium restoring potential GDP and price level.

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References
federalreserve.gov (2020) Federal Reserve issues FOMC statement. Board of Governors of the
Federal Reserve System. Retrieved 17 April 2020, from
https://www.federalreserve.gov/newsevents/pressreleases/monetary20200315a.htm
Guilmi, C. D., Gallegati, M., & Landini, S. (2017). Interactive Macroeconomics. Cambridge
Books.
Guttmann, R. (2016). How Credit-money Shapes the Economy: The United States in a Global
System: The United States in a Global System. Routledge.
Heijdra, B. J. (2017). Foundations of modern macroeconomics. Oxford university press.
Marte, J. (2020). Explainer-What the Federal Reserve has done in the coronavirus crisis.
Retrieved 17 April 2020, from https://www.nasdaq.com/articles/explainer-what-the-
federal-reserve-has-done-in-the-coronavirus-crisis-2020-03-31
Uribe, M., & Schmitt-Grohe, S. (2017). Open economy macroeconomics. Princeton University
Press.