LESSONS FOR THE FED FROM THE PANDEMIC.

• Author: Allison, John A.

The COVID-19 pandemic greatly increased the scope and power of the Federal Reserve. The Fed created a number of new emergency lending facilities, which allowed it to make off-balance sheet loans and buy the debt of corporations and municipalities through special purpose vehicles backstopped by the Treasury under the CARES Act. Meanwhile, the Fed's large-scale asset purchase program, known as quantitative easing (QE), was put on steroids after the pandemic struck in March 2020. The Fed has been purchasing longer-term Treasuries and mortgage-backed securities amounting to $120 billion per month, pushing the size of its balance sheet to an astonishing $7 trillion.

Of course, the pandemic and lockdowns, which put the economy in a downward spiral, justified pumping liquidity into the financial system. But the shift toward allocating credit and the drift into fiscal policy have put the Fed's independence and credibility at risk. Indeed, those actions have set a precedent for the future, making it difficult for the Fed to normalize monetary policy and adhere to its primary function of providing sound money and a stable growth of nominal income.

This conference's focus is on digital currency. In my remarks today, I will paint with a broader brush and briefly discuss the lessons I think the Fed can learn from the pandemic, including why it is important to leave entrepreneurs free to experiment with digital currencies and why any credible monetary system ultimately needs to be based on a genuine rule of law. I shall begin by arguing that while COVID-19 has been costly, both in terms of human and economic losses, it has provided for deregulation and innovation that wall benefit society.

The Pandemic's Costs and Opportunities

The human costs of the pandemic have been high, with more than 550,000 deaths in the United States alone, a huge disruption to family life and schooling, and a sharp rise in uncertainty. Economic costs are evident in high unemployment, the closing of tens of thousands of small businesses, the loss of human capital in terms of lost or delayed schooling, and the major disruption to the travel industry. While the growth of output and income will resume, the level of real income per capita will take some time to recover. In part, because the massive debt incurred by the federal government is not a free lunch.

In 2020, the federal government borrowed more than $4 trillion compared to about $1 trillion in 2019. More importantly, the...