Interest rates typically decline during recessions as loan demand slows, bond prices rise, and the central bank eases monetary policy. During recent recessions, the Federal Reserve has cut short-term rates and eased credit access for municipal and corporate borrowers.

Interest Rates and Supply and Demand

Loan demand can be an early casualty of a recession. As economic activity falters, companies shelve expansion plans they otherwise would have financed with borrowings. As layoffs spread, consumers worrie🌟d about their jobs start spending less and saving more.

It’s possible for lenders to pull back in a financial crisis as well, subjecting the economy to the additional pain of a 澳洲幸运5官方开奖结果体彩网:credit crunch and🔴 forcing a central bank with the mandate to address such systemic threats to intervene. Absent a credit crunch, interest rates fall in a recession because the downturn suppresses loan demand while stimulating the supply of savings.

In fact, that tendency precedes recessions, as shown by an 澳洲幸运5官方开奖结果体彩网:inverted bond yield curve that frequently foreshadows a downturn. A yield inversion occurs when the yield on a longer-dated Treasury note falls below that on a shorter-dated one.

If the 10-year Treasury note’s yield falls below that of the two-year Treasury note, for example, it typically signifies that investors are already anticipating economic weakness and opting for the longer-dated fixed-income 澳洲幸运5官方开奖结果体彩网:maturities that tend to outperform in downturns.

Can Interest Rates Cause a Recession?

In certain cases, central banks may be compelled to raise interest rates to fight inflation. Most central banks have a mandate to maintain price stability. If an economy runs hot, price-push inflation (where too much money is chasing not enough goods) may see the costs of goods and services rise at a rate higher than the central bank’s policy mandate, usually around 2%.

The other type of inflation is wage-push inflation, where the hot economy compels employers to raise wages to entice workers to stay with them or to attract new workers. The wage increase ca💛n translate into increased consumer demand, resulti💎ng in a price-push scenario. In both cases, high or rising inflation may appear on the central bank’s radar screen, compelling them to raise interest rates to combat inflation.

When both inflation scenarios are in play, as they were in 2022 and most of 2023, central banks are forced to take extreme action on interest, raising rates.

The Role of the Central Bank

Central banks practice , easing the money supply in rece♌ssions as economic activity💜 and inflation slow and tightening it as necessary during recoveries.

The primary tools available to the Federal Reserve are its 澳洲幸运5官方开奖结果体彩网:target federal funds rate range and 澳洲幸运5官方开奖结果体彩网:balance sheet. And while those tools have an eff🐬ect over time, they’re not instant remedies.

The target federal funds rate range governs the rates banks charge each other for reserves lent overnight. The Fed lowers the rate range to ease 澳洲幸运5官方开奖结果体彩网:financial conditions at the margin, hoping that consumers and businesses begin borrowing again to stimulate the econom♊y. It ra🅠ises the rate range to tighten conditions and reduce spending.

Its balance sheet reflects the value of its💫 assets, which it adjusts to 𒀰control the amount of currency in circulation.

Quantitative Easing

Following the 澳洲幸运5官方开奖结果体彩网:2008 financial crisis, central banks in the United States, Europe, and Japan kept short-term interest near zero for years to contain downside risks to economic growth. When that proved insufficient, they engaged in large-scale asset purchases, also known as 澳洲幸运5官方开奖结果体彩网:quantitative easing. The asset purchases increased the amount of money in circulation, giving banks more 澳洲幸运5官方开奖结果体彩网:liquidity and the ability to issue more loans.

Additionally, demand for the assets—usually government bonds and Treasuries—purchased by the central bank increased, thereby raising coupon rates, which are the i🍃nterest rates for fixed-income securities.

As expectations for a recovery begin to be reflected in inflation and asset prices, the central bank can raise its target rate and reduce its balance sheet by selling the assets it previous🌜ly purchased.

The Bottom Line

Interest rates usually fall in a recession, reflecting reduced credit demand, increased savings, and an investor flight to "safe" Treasuries. The decline also anticipates a central bank's likely response to the economic downturn, which can include cuts in short-term interest rates and large-scale asset purchases of debt securities with extended maturities.