Putting aside this week’s flat-footed G7 communique, the global policy response to the Coronavirus is beginning to unfold. The main short-run economic problem that governments will need to solve is getting cash to households and businesses that face a temporary but significant liquidity crunch. Central bank rate cuts can bolster confidence and support financial markets, but targeted lending programs can be more effective. In the United States, there is the very real possibility of a return to the effective lower bound on policy rates. In this event, expect the FOMC to commit to keep the policy rate at the lower bound until inflation is sustainably at two percent – an outcome that could take years.

This week the FOMC undertook its first intermeeting rate cut since the financial crisis, cutting the target range for the federal funds rate by 50 basis points. After briefly rising on the news, stock indices began to sell off during Chairman Powell's press briefing and closed sharply lower that day. I suspect markets were disappointed that the only immediate concrete policy action, on the monetary or fiscal front, to follow the joint communique from G7 finance ministers and central bank governors was the FOMC rate cut - an underwhelming response given significant downward revisions to global growth expectations. Powell’s press briefing comments were also not particularly helpful from a confidence perspective, as he implied that the Federal Reserve is doing no planning beyond rate cuts, which by his own admission are not an effective counter to a supply shock.

What happens next? Big picture, the global policy response is beginning to unfold. The Bank of Canada followed on the heels of the Fed with a rate cut today, and markets are now pricing in a rate cut from the Bank of England. The Fed move also opens the door for emerging market central banks to ease as well. The European Central Bank and the Bank of Japan are in a tougher spot, having few remaining policy rate or QE bullets but risk a confidence shock and tighter financial conditions the longer they remain on the sideline.

But the central bank policy response is somewhat of a side-show. What is needed sooner rather than later is clear evidence that elected officials understand and are actively working on measures to provide support to businesses and households. Economies experiencing local transmission of the coronavirus are at risk of a sharp drop-off in economic momentum as businesses and households curtail non-essential activity. This response to the coronavirus, while sensible on a case-by-case basis, can lead to an economy-wide cash flow crunch – business revenues and household incomes decline in the aggregate, but the clock does not stop on financial obligations and household necessities.

In the United States, there are some early signs of recognition of this problem. For example, this week Congress passed legislation that, among other things, earmarks funds to support an anticipated scaling-up of Small Business Administration (SBA) loan guarantees. The legislation demonstrates that Congress is beginning to recognize the scope of the crisis. The SBA funding, however, is just the tip of the iceberg of the types of economic support measures that may prove necessary, such as enhancements to unemployment benefit programs and a payroll tax cut. Unfortunately, given the length of time it might take to legislate, enact and implement such measures, the United States, like many other countries, risks falling behind in providing the necessary economic supports.

As for monetary policy, The FOMC is very likely to continue cutting rates, by another 50-75 basis points, over the next few months. This Committee firmly believes in an aggressive, front-loaded policy response when presented with risks of a protracted recession and limited policy space to respond.

Beyond additional rate cuts, should signs of a business and household cash crunch become evident, policy makers will need to consider a wide range of potential responses. Most of these fall under the category of the Federal Reserve’s bread and butter response, i.e., broad-based liquidity provision to the financial sector. But programs in coordination with Treasury that can directly support small businesses and households may also be necessary. For example, the Federal Reserve could resurrect the crisis-era Term Auction Facility to provide funds to banks for short-term loans to businesses and households. Other central banks, such as the European Central Bank, appear likely to move in a similar direction. In contrast to the financial crisis, banks are not experiencing funding shortages. But if Treasury is willing to provide a level of risk-sharing, such a facility can have the advantage of addressing banks’ likely reticence to increase loan exposure to cash-strapped households and businesses.

Finally, with risks of an outright contraction rising, much of the prior speculation about how the FOMC will act if the policy rate is back at the zero lower bound is no longer a far-off hypothetical. In this event, the FOMC would likely commit to keep the policy rate near zero until core PCE inflation is sustainably at two percent (i.e., for three to six months). This would bring down long-term interest rates even further as markets price in a near-zero policy rate potentially for a number of years. The FOMC could back up this commitment with asset purchases, targeting yield levels on shorter-dated Treasuries as opposed to a quantity of balance sheet expansion.