Andrew MacKinlay
Andrew MacKinlay

The economic shock caused by the coronavirus pandemic has been dramatic in both the speed and intensity with which it has hit the United States and other economies throughout the world.

In late March, the Federal Reserve announced extensive new measures geared to support the economy. These measures include near-zero short-term interest rates, unlimited large-scale purchases of U.S. Treasury securities and mortgage-backed securities (MBS), and new credit facilities designed to stabilize markets for consumer debt, corporate, and municipal bonds, and commercial paper. As stated in its March 23 press release, the Federal Reserve intends these actions to “support smooth market functioning and effective transmission of monetary policy to broader financial conditions.”

Many of these actions, collectively referred to as quantitative easing or “QE,” received their first trial during the financial crisis and recession of 2008-09. Assistant Professor Andrew MacKinlay of the Finance Department at the Pamplin College of Business, an expert in how banks respond to monetary policy actions, has studied their efficacy. His paper, “Monetary Policy and Bank Lending,” recently published in the Journal of Financial Economics, considers how the Federal Reserve’s large-scale securities purchases affected the broader economy through bank behavior.

“As banks play the primary role in many of the markets targeted by parts of the Federal Reserve’s policy, understanding how they respond is critical,” explained MacKinlay.

Focusing on the QE actions related to mortgages, MacKinlay and his co-authors found that different banks were more or less able to take advantage of the program. The best-positioned banks took advantage of the Fed’s MBS purchases and increased their mortgage activity the most, according to the research.

At the same time, MacKinlay and his co-authors found a surprising distortion. “These same banks cut back on commercial lending compared to other banks, hurting companies that borrow from these banks,” MacKinlay said. “The affected companies received less capital, paid higher interest rates, and ultimately invested less.”

In short, the improved profitability from mortgage lending “crowded-out” commercial lending, which was not as directly supported by the Federal Reserve. This effect on commercial lending was a significant negative consequence of the QE policy and impacted its overall efficacy.

Today, as the Federal Reserve implements new purchases of MBS and additional related policies, MacKinlay believes this distortion is particularly relevant. A hallmark of the current economic crisis is the damage occurring to small businesses and other commercial enterprises.

“The Fed should remain mindful that policies aimed at supporting other vital markets – such as the housing market – do not accidentally detract from the goal of helping the broader economy through altering banks’ incentives to lend to businesses,” MacKinlay added.