May 6, 2020

In the wake of the economic meltdown caused by the government’s dramatic measures to halt the spread of the corona virus the Fed has leaped into action.  It boosted its balance sheet by $2.2 trillion primarily via purchases of U.S. government securities.  When it purchases government securities the proceeds of the transaction are put into a bank’s “reserves” account at the Fed.  Think of this as that bank’s checking account.  Excess reserves in the banking system have jumped from $1.5 trillion in February to $2.9 trillion.  This measures the ability of the banking system to make additional loans.  Banks are awash in funds just waiting to be lent to needy businesses.

Banks have already been busy.  Their loan portfolios have increased by $800 billion in the past two months.  To put that in perspective, total bank loans increased $450 billion in 2019.  In two months they have lent almost double they did all last year.  The recent increase in lending has been almost exclusively to businesses.  Commercial and industrial loan growth has climbed at annualized growth rates of 115% in March and 191% in April.

When banks lend to consumers and businesses, they put the proceeds into a checking account.  At that point the money supply begins to grow.  In March M-2 grew at a 21.0% annual rate.  In April it climbed by 46%.  Those are funds that businesses can use to pay their workers, pay the rent, and keep the lights on.

The point of all this is that, to its credit, the Federal Reserves has stepped into the credit void to make sure that banks have adequate funds to lend to businesses to keep the economy functioning – however slowly – for a while.  If the virus begins to show signs of slowing down, some businesses will be permitted to re-open and the economy can begin a gradual recovery.

Stephen Slifer


Charleston, SC