I have no expertise on the economics of pandemics, and I imagine that this will become an area of intense research in the coming years. But the existing research on financial crises, both the Great Depression and the 2008-2009 financial crises, can offer some useful perspectives and cautionary tales. There is plentiful evidence now that the Federal Reserve’s policy interventions in 2008-2009 helped to contain the crisis. Asset purchases increased the price of US Treasuries, stabilized the US housing market and improved credit flows to firms. The commercial paper funding facility also helped to stave off the run on non-banks—such as captive car finance companies—while TARP reduced fire-sales at banks. Together, these policies reduced the real costs of the panic that started on Wall Street.
But this time the panic is emanating from Main Street, and there is reason to believe that the effectiveness of the Federal Reserve’s arsenal might be weaker this time around. In scientific jargon, the estimates obtained from earlier work might not apply in the current context. Put differently, the external validity of research based on the 2008-2009 crisis could be more limited than researchers had thought. In the current setting, small and medium sized firms—the bank dependent borrowers—are the ones that are now facing a sudden stop in cash flow; these are local coffee shops and restaurants. Bond buying by the Fed does not directly reach these firms, since these firms do not issue debt. Hence, while the Fed’s arsenal might keep the bigger firms afloat longer, helping them to finance the liquidity shock or cash crunch, many of the smaller bank dependent firms could fail well before a vaccine is ever found.
It is hubris to prescribe policy when we know so little, but the Main Street nature of this shock suggests that the government could back-stop loans at community banks, credit unions and other lenders. Even further, in addition to stabilizing broader financial markets, the government could also provide a large equity injection into local financial institutions, requiring them in exchange to continue lending to small and medium sized firms for a given period of time—say 18 months. These lenders are better informed about local businesses than the Fed in DC. Of course, this is political lending, but the government’s entry contract into these lenders should also include a sharp exit date, so that government control of bank lending is not normalized.
In any event, without decisive government action, research from the Great Depression suggests that this crisis could fundamentally alter the US economy for decades, as population movements as well as firm and bank failures can transform whole regions of the country. The experience from 2008-2009 also shows that government action is needed to avoid an even sharper increase in the concentration of wealth, as fortunate cash-rich big investors could buy up liquidity constrained businesses at big discounts and make huge profits once a vaccine is found.