How Would The Fed Help During A Recession?

Congress has given the Federal Reserve a dual duty to preserve full employment and price stability in the US economy.
During recessions, the Fed uses a variety of monetary policy tools to assist lower unemployment and re-inflate prices.
Open market asset purchases, reserve regulation, discount lending, and forward guidance to control market expectations are some of these strategies.
The majority of these measures have previously been used extensively in response to the economic hardship created by current public health limitations.

During a recession, what does the federal government do?

To impact economic performance, the US government employs two types of policies: monetary policy and fiscal policy. Both have the same goal in mind: to assist the economy in achieving full employment and price stability.
It is carried out by the Federal Reserve System (“the Fed”), an independent government institution with the authority to control the money supply and interest rates.
When the Fed believes inflation is a problem, it will employ contractionary policy, which involves reducing the money supply and raising interest rates. It will utilize expansionary policies to boost the money supply and lower interest rates in order to combat a recession.
When the economy is in a slump, the government will either raise spending, lower taxes, or do both to stimulate the economy.
When inflation occurs, the government will either cut spending or raise taxes, or both.
A surplus occurs when the government collects more money (via taxes) than it spends in a given year.
When the government spends more money than it receives, we have a budget deficit.
The national debtthe total amount of money owed by the federal governmentis the sum of all deficits.

In the case of a recession, what is the Fed most likely to do?

In the case of a recession, what is the Fed most likely to do? They might offer more money to citizens by lowering taxes, which would increase consumption. Fiscal policy is essentially expansionary. The Federal Reserve System’s actions to increase or decrease the money supply in order to influence the cost and availability of credit.

What has the Federal Reserve done in response to the Great Recession?

The Great Recession lasted from December 2007 to June 2009, making it the longest downturn since World War II. The Great Recession was particularly painful in various ways, despite its short duration. From its peak in 2007Q4 to its bottom in 2009Q2, real gross domestic product (GDP) plummeted 4.3 percent, the greatest drop in the postwar era (based on data as of October 2013). The unemployment rate grew from 5% in December 2007 to 9.5 percent in June 2009, before peaking at 10% in October 2009.

The financial repercussions of the Great Recession were also disproportionate: home prices plummeted 30% on average from their peak in mid-2006 to mid-2009, while the S&P 500 index dropped 57% from its peak in October 2007 to its trough in March 2009. The net worth of US individuals and charity organizations dropped from around $69 trillion in 2007 to around $55 trillion in 2009.

As the financial crisis and recession worsened, worldwide policies aimed at reviving economic growth were enacted. Like many other countries, the United States enacted economic stimulus measures that included a variety of government expenditures and tax cuts. The Economic Stimulus Act of 2008 and the American Recovery and Reinvestment Act of 2009 were two of these projects.

The Federal Reserve’s response to the financial crisis varied over time and included a variety of unconventional approaches. Initially, the Federal Reserve used “conventional” policy actions by lowering the federal funds rate from 5.25 percent in September 2007 to a range of 0-0.25 percent in December 2008, with the majority of the drop taking place between January and March 2008 and September and December 2008. The significant drop in those periods represented a significant downgrading in the economic outlook, as well as increasing downside risks to output and inflation (including the risk of deflation).

By December 2008, the federal funds rate had reached its effective lower bound, and the FOMC had begun to utilize its policy statement to provide future guidance for the rate. The phrasing mentioned keeping the rate at historically low levels “for some time” and later “for an extended period” (Board of Governors 2008). (Board of Governors 2009a). The goal of this guidance was to provide monetary stimulus through lowering the term structure of interest rates, raising inflation expectations (or lowering the likelihood of deflation), and lowering real interest rates. With the sluggish and shaky recovery from the Great Recession, the forward guidance was tightened by adding more explicit conditionality on specific economic variables such as inflation “low rates of resource utilization, stable inflation expectations, and tame inflation trends” (Board of Governors 2009b). Following that, in August 2011, the explicit calendar guidance of “At least through mid-2013, the federal funds rate will remain at exceptionally low levels,” followed by economic-threshold-based guidance for raising the funds rate from its zero lower bound, with the thresholds based on the unemployment rate and inflationary conditions (Board of Governors 2012). This forward guidance is an extension of the Federal Reserve’s conventional approach of influencing the funds rate’s current and future direction.

The Fed pursued two more types of policy in addition to forward guidance “During the Great Recession, unorthodox” policy initiatives were taken. Credit easing programs, as explored in more detail in “Federal Reserve Credit Programs During the Meltdown,” were one set of unorthodox policies that aimed to facilitate credit flows and lower credit costs.

The large scale asset purchase (LSAP) programs were another set of non-traditional policies. The asset purchases were done with the federal funds rate near zero to help lower longer-term public and private borrowing rates. The Federal Reserve said in November 2008 that it would buy US agency mortgage-backed securities (MBS) and debt issued by housing-related US government agencies (Fannie Mae, Freddie Mac, and the Federal Home Loan banks). 1 The asset selection was made in part to lower the cost and increase the availability of finance for home purchases. These purchases aided the housing market, which was at the heart of the crisis and recession, as well as improving broader financial conditions. The Fed initially planned to acquire up to $500 billion in agency MBS and $100 billion in agency debt, with the program being expanded in March 2009 and finished in 2010. The FOMC also announced a $300 billion program to buy longer-term Treasury securities in March 2009, which was completed in October 2009, just after the Great Recession ended, according to the National Bureau of Economic Research. The Federal Reserve purchased approximately $1.75 trillion of longer-term assets under these programs and their expansions (commonly known as QE1), with the size of the Federal Reserve’s balance sheet increasing by slightly less because some securities on the balance sheet were maturing at the same time.

However, real GDP is only a little over 4.5 percent above its prior peak as of this writing in 2013, and the jobless rate remains at 7.3 percent. With the federal funds rate at zero and the current recovery slow and sluggish, the Federal Reserve’s monetary policy plan has evolved in an attempt to stimulate the economy and meet its statutory mandate. The Fed has continued to change its communication policies and implement more LSAP programs since the end of the Great Recession, including a $600 billion Treasuries-only purchase program in 2010-11 (often known as QE2) and an outcome-based purchase program that began in September 2012. (in addition, there was a maturity extension program in 2011-12 where the Fed sold shorter-maturity Treasury securities and purchased longer-term Treasuries). Furthermore, the increasing attention on financial stability and regulatory reform, the economic consequences of the European sovereign debt crisis, and the restricted prospects for global growth in 2013 and 2014 reflect how the Great Recession’s fallout is still being felt today.

Is the Fed to blame for recessions?

Since the 1970s, there has been a widespread belief that fast spikes in oil prices cause recessions. Today, many pundits are resurrecting this incorrect notion as a probable result of higher oil prices caused by the Ukrainian conflict. This will not happen, if historical evidence is any guide. Only one recession in the United States has been triggered by quickly rising oil prices; for the most part, our recessions have been driven by Federal Reserve actions, which were in response to other economic conditions.

Economists have conventional theoretical models, which can be found in many textbooks, that represent the effect of rising oil prices. The assumption is that rising oil prices and lower oil supplies generate an economic shock, raising the cost of production and reducing the supply of goods in the economy. Concurrently, customers will reduce their demand for goods as a result of increasing prices. These findings, either separately or in combination, point to a drop in economic production, possibly a recession.

Quiz: In the case of a recession, what is the Fed most likely to do?

In the case of a recession, what is the Fed most likely to do? On the open market, purchase government bonds.

Easing Monetary Policy

Federal funds rate: At its March 3 and March 15, 2020 meetings, the Fed decreased its target for the federal funds rate, which is the rate banks pay each other to borrow money overnight, by a total of 1.5 percentage points. The funding rate was reduced to a range of 0% to 0.25 percent as a result of these cuts. The federal funds rate serves as a standard for other short-term rates and has an impact on longer-term rates, thus this decision was intended to boost expenditure by cutting borrowing costs for consumers and companies.
The Fed issued forward guidance on the future direction of interest rates, using a method developed during the Great Recession of 2007-09. Initially, it stated that rates will be kept close to zero “until it is satisfied that the economy has weathered recent events and is on track to meet its maximum employment and price stability objectives.” The Fed strengthened that guidance in September 2020, reflecting its new monetary policy framework, by stating that rates would remain low “until labor market conditions are consistent with the Committee’s estimates of maximum employment, and inflation has risen to 2% and is on track to moderately exceed 2% for some time.” By the end of 2021, inflation had risen well over the Fed’s 2% target, and labor markets were approaching full employment “The Federal Reserve’s “maximum employment” goal. The Federal Open Market Committee (FOMC) of the Federal Reserve signaled at its December 2021 meeting that most of its members expected the Fed to raise interest rates in three quarter-point increments in 2022.
The Federal Reserve began acquiring enormous volumes of debt securities, a key instrument it used during the Great Recession. The Fed’s actions in response to the acute dysfunction of the Treasury and mortgage-backed securities (MBS) markets following the outbreak of COVID-19 were initially aimed at restoring smooth functioning to these markets, which serve as benchmarks and sources of liquidity for the flow of credit to the broader economy. The Fed switched the goal of QE to boosting the economy on March 15, 2020. It said it would buy at least $500 billion in Treasury bonds and $200 billion in government-backed mortgage-backed securities over the next few years “in the months ahead.” It made the purchases open-ended on March 23, 2020, saying it would buy securities indefinitely “in the amounts required to support smooth market functioning and effective transmission of monetary policy to broader financial conditions,” broadening the stated goal of bond purchases to include economic stimulus. The Fed announced in June 2020 that it will buy at least $80 billion in Treasuries and $40 billion in residential and commercial mortgage-backed securities per month until further notice. In December 2020, the Fed updated its guidance, indicating that it would reduce these purchases once the economy had recovered “The Fed’s aims of maximum employment and price stability have achieved “much more progress.” The Fed began decreasing its asset purchases by $10 billion in Treasuries and $5 billion in MBS per month in November 2021, after determining that the condition had been met. At the following FOMC meeting in December 2021, the Fed quadrupled the rate of tapering, cutting monthly bond purchases by $20 billion in Treasury bonds and $10 billion in MBS.

Supporting Financial Markets

Lending to securities firms: The Fed granted low-interest loans up to 90 days to 24 large financial organizations known as primary dealers through the Primary Dealer Credit Facility (PDCF), a program resurrected after the global financial crisis. Commercial paper and municipal bonds were among the securities offered by the dealers as collateral to the Fed. The purpose was to assist these dealers in continuing to play their part in keeping credit markets afloat during a difficult period. Institutions and individuals were prone to avoid riskier assets and hoard cash early in the epidemic, and dealers faced challenges in financing the swelling inventories of securities they accumulated as they created deals. To re-establish the PDCF, the Fed needed Treasury Secretary approval to use Section 13(3) of the Federal Reserve Act’s emergency lending authority for the first time since the 2007-09 financial crisis. On March 31, 2021, the program came to an end.
Backstopping money market mutual funds: The Fed also re-launched the Money Market Mutual Fund Liquidity Facility, which was created during the financial crisis (MMLF). This facility lends money to banks in exchange for collateral purchased from prime money market funds, which invest in Treasury securities and commercial paper from companies. Investors withdrew en masse from prime money market funds at the start of COVID-19, questioning the value of the private securities these funds held. To counteract the outflows, funds tried to sell their securities, but market disturbances made it difficult to find buyers for even high-quality, shorter-maturity securities. These attempts to sell the securities only served to lower prices (in a negative way) “companies rely on to raise capital (“fire sale”) and closed off markets As a result, the Fed established the MMLF “help money market funds meet redemption demands from households and other investors, improving overall market functioning and credit availability to the broader economy.” Treasury granted the Fed permission to operate the scheme under Section 13(3), and also committed $10 billion from its Exchange Stabilization Fund to cover potential losses. The MMLF was set to expire on March 31, 2021, due to its minimal use.
The Fed’s repurchase agreement (repo) operations have been considerably extended in order to channel liquidity to money markets. Firms borrow and lend cash and securities in the repo market for a short period of time, usually overnight. The Fed’s repo operations make cash accessible to main dealers in return for Treasury and other government-backed securities, because disturbances in the repo market can affect the federal funds rate. The Fed was issuing $100 billion in overnight repo and $20 billion in two-week repo before the coronavirus crisis hit the market. Throughout the epidemic, the Fed considerably increased the program, both in terms of the amount of money available and the length of time that the loans were available. The Fed established a permanent Standing Repo Facility in July 2021 to help stabilize money markets during times of crisis.
Foreign and International Monetary Authorities (FIMA) Repo Facility: Foreigners seeking dollars sold U.S. Treasury assets, putting pressure on money markets. The Fed launched a new repo facility dubbed FIMA in July 2021 to ensure foreigners had access to dollar finance without selling Treasuries in the market. FIMA provides dollar funding to the large number of foreign central banks that do not have established swap lines with the Fed. The Fed lends these central banks overnight dollars in exchange for Treasury securities as collateral. The central banks can then lend dollars to their own financial institutions in their home countries.
International swap lines: During the global financial crisis, the Fed made U.S. dollars accessible to other central banks in order to increase the liquidity of global dollar funding markets and to assist those authorities in supporting their domestic banks that needed to raise dollar funding. The Fed received foreign currencies in exchange and levied interest on the swaps. The Fed cut its interest rate and extended the maturity of the swaps for the five central banks that have permanent swap lines with the Fed: Canada, England, the Eurozone, Japan, and Switzerland. The central banks of Australia, Brazil, Denmark, Mexico, New Zealand, Norway, Singapore, South Korea, and Sweden were also given temporary swap lines. The Fed extended these temporary swaps through December 31, 2021 in June 2021.

Encouraging Banks to Lend

Direct lending to banks: The Federal Reserve dropped the rate it charges banks for loans from its discount window by two percentage points, from 2.25 percent to 0.25 percent, the lowest rate since the Great Recession. These loans are usually overnightthat is, they are taken out at the end of one day and returned the nextbut the Fed has extended the durations to 90 days. Banks pledge a variety of collateral (securities, loans, and so on) to the Fed in exchange for cash at the discount window, thus the Fed has little (or no) risk in making these loans. Banks can continue to operate because depositors can withdraw money and banks can create new loans with cash. Banks, on the other hand, are occasionally hesitant to borrow from the discount window because they are concerned that if word gets out, markets and others may assume they are in trouble. In March 2020, eight major banks decided to borrow from the discount window to combat this reputation.
Temporarily reducing regulatory requirements: During the epidemic, the Fed urged banks, both large and small, to dig into their regulatory capital and liquidity buffers to increase lending. To avoid repeat collapses and bailouts, post-financial-crisis reforms require banks to retain extra loss-absorbing capital. These changes do, however, include provisions allowing banks to use their capital buffers to support lending during downturns. The Fed aided this lending by making a technical tweak to its TLAC (total loss-absorbing capacity) criterion, which covers both capital and long-term debt, to phase in restrictions associated with TLAC deficiencies over time. (In order to protect capital, large banks likewise halted share buybacks.) The Fed also abolished banks’ reserve requirement, which was a percentage of deposits that banks had to retain as reserves to fulfill cash demand, albeit this was essentially immaterial because banks had significantly more reserves than were required. During the pandemic, the Fed banned bank holding company dividends and share buybacks, but these limits were repealed for most corporations on June 30, 2021, based on stress test findings. These stress tests revealed that banks have sufficient capital to support lending even if the economy did not perform as well as expected.

Supporting Corporations and Businesses

On March 23, 2020, the Fed announced two new facilities to promote the flow of credit to major corporate employers, taking a considerable step beyond its crisis-era programs, which focused primarily on financial market functioning. The Primary Market Corporate Credit Facility (PMCCF) enabled the Federal Reserve to lend directly to businesses by purchasing new bond issuance and making loans. Borrowers were allowed to postpone interest and principal payments for at least the first six months in order to pay staff and suppliers (but they could not pay dividends or buy back stock). The Fed might also buy existing corporate bonds and exchange-traded funds that invest in investment-grade corporate bonds through the new Secondary Market Corporate Credit Facility (SMCCF). A well-functioning secondary market was viewed as assisting enterprises in obtaining new loans in the primary market. The Fed stated that these facilities gave “businesses access to finance so that they can better maintain company operations and capacity during the period of dislocations associated to the epidemic.” The Fed stated on April 9, 2020, that the facilities will be expanded to cover a total of $750 billion in new corporate debt, up from $100 billion before. The Fed also used Section 13(3) of the Federal Reserve Act and gained approval from the US Treasury, which committed $75 billion from its Exchange Stabilization Fund to cover potential losses, as it had done with prior facilities. Despite the Fed’s reservations, Treasury Secretary Steven Mnuchin concluded that the final bond and loan purchases for the corporate credit facilities would take place no later than December 31, 2020, after the epidemic had passed. The Federal Reserve objected to the stoppage, preferring to keep the facilities open until there was more certainty that financial circumstances would not worsen. On June 2, 2021, the Fed announced that it will progressively sell off its $13.7 billion corporate bond portfolio, which it finished in December 2021.
The Commercial Paper Funding Facility (CPFF) is a $1.2 trillion market where businesses issue unsecured short-term loans to fund their day-to-day operations. The Fed bought commercial paper through the CPFF, a crisis-era initiative that allowed the Fed to lend directly to firms for up to three months at a rate 1 to 2 percentage points higher than overnight lending rates. “By removing much of the risk that eligible issuers may be unable to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to engage in term lending in the commercial paper market once again,” the Fed stated. “A stronger commercial paper market will help firms preserve employment and investment as the country struggles with the coronavirus outbreak,” says the report. The Fed invoked Section 13(3) and gained authorization from the US Treasury, which placed $10 billion into the CPFF to cover potential losses, as it did with other non-bank lending facilities. On March 31, 2021, the Commercial Paper Funding Facility expired.
Supporting small and medium-sized company loans: The Federal Reserve’s Main Street Lending Program, which began on April 9, 2020, was designed to help businesses that were too big for the Small Business Administration’s Paycheck Protection Program (PPP) but too small for the Fed’s two corporate credit facilities. Following that, the program was enlarged and broadened to accommodate additional potential borrowers. The Fed was prepared to fund up to $600 billion in five-year loans through three facilities: the New Loans Facility, Expanded Loans Facility, and Priority Loans Facility. Businesses with up to 15,000 workers and yearly revenue of up to $5 billion are eligible to apply. The Fed reduced the minimum loan amount for New Loans and Priority Loans in June 2020, raised the maximum loan size for all facilities, and prolonged the payback period. The Fed invoked Section 13(3) and got approval from the US Treasury, which deposited $75 billion into the three Main Street Programs through the CARES Act to compensate losses, as it had done with other facilities. Stock buybacks, dividends, and executive compensation are all restricted for borrowers. (More operating information can be found here.) Over the Fed’s protests, Secretary Mnuchin decided that the Main Street facility would stop accepting loan applications on December 14, 2020, and make its final purchases on January 8, 2021. The Fed also established a Liquidity Facility for the Paycheck Protection Program, which facilitated PPP loans. Banks that lend to small firms could use PPP loans as collateral to borrow from the facility. On July 30, 2021, the PPP Liquidity Facility came to an end.
Supporting non-profit loans: In July 2020, the Federal Reserve expanded the Main Street Lending Program to include non-profits, such as hospitals, schools, and social service groups, that were in good financial standing before to the epidemic. Borrowers had to have at least ten workers and an endowment of little more than $3 billion, among other requirements. The loans were for five years, but the first two years’ principal payments were postponed. Lenders kept 5% of the loans, just like they did with corporate loans. On January 8, 2021, this extension to the Main Street program, along with the rest of the building, expired.

Supporting Households and Consumers

The Term Asset-Backed Securities Loan Facility (TALF) is a short-term loan facility for asset-backed securities. The Fed helped individuals, consumers, and small businesses through this facility, which was reinstated on March 23, 2020, by lending to holders of asset-backed securities that were collateralized by new loans. Student loans, vehicle loans, credit card loans, and SBA-guaranteed loans were among the loans. The Fed went above and beyond the crisis-era program by expanding eligible collateral to include existing commercial mortgage-backed securities and freshly issued high-quality collateralized loan obligations. The TALF, like the corporate lending programs, will initially support up to $100 billion in additional loans, according to the Fed. The Fed used Section 13(3) and got clearance from the Treasury to relaunch the program, which was funded with $10 billion from the Exchange Stabilization Fund. On Secretary Mnuchin’s instruction, this facility halted making acquisitions on December 31, 2020, if there was no extension.

Supporting State and Municipal Borrowing

Direct lending to state and local governments: During the financial crisis of 2007-09, the Fed refused to backup municipal and state borrowing, believing that this was the administration’s and Congress’s obligation. The Federal Reserve, on the other hand, lent directly to state and municipal governments during this crisis through the Municipal Liquidity Facility, which was established on April 9, 2020. On April 27 and June 3, 2020, the Federal Reserve enlarged the list of eligible debtors. In March 2020, the municipal bond market was extremely stressed, and state and local governments were finding it increasingly difficult to borrow as they battled COVID-19. The Fed’s facility provided loans to states in the United States, as well as the District of Columbia, counties with populations of at least 500,000 people, and cities with populations of at least 250,000 people. In exchange for notes connected to future tax collections with maturities of less than three years, the Fed made $500 billion accessible to government organizations with investment-grade credit ratings as of April 8, 2020. Illinois became the first government agency to use the facility in June 2020. Governors in states with cities and counties that did not match the population criterion could nominate up to two communities to participate, according to modifications published that month. Governors could additionally select two revenue bond issuers to be eligible: airports, toll facilities, utilities, and public transportation. In August, the New York Metropolitan Transportation Authority (MTA) used this clause to borrow $451 million from the facility. The Fed employed Section 13(3) with the Treasury’s agreement, and the CARES Act was used to give $35 billion to cover any potential losses. (For further information, see here.) As a result of Secretary Mnuchin’s decision, the Municipal Liquidity Facility’s purchases ceased on December 31, 2020. On December 10, 2020, the New York MTA received a second loan from the facility, borrowing $2.9 billion before lending was discontinued.
Municipal bond liquidity was also supported by the Fed, which used two of its credit facilities to backstop muni markets. It added municipal variable-rate demand notes and highly rated municipal debt with maturities of up to 12 months to the list of suitable collateral for the MMLF. The Fed also added high-quality commercial paper backed by tax-exempt state and municipal securities to the CPFF’s list of eligible collateral. Banks were able to channel cash into the municipal debt market, which had been experiencing stress due to a shortage of liquidity.

In reaction to the Great Recession, what did the Federal Reserve do?

What did the Fed do in the aftermath of the Great Recession? It bought bonds on the open market to lower interest rates.

How did the Fed respond to the financial crisis that began in 2007 using the major tools of monetary policy?

Beginning in late 2007, the Fed began using the principal tool of traditional monetary policy, interest rate decreases, to combat increasing unemployment.

The Fed stimulates the economy by lowering the federal funds rate, which is the interest rate that banks pay each other for overnight loans. Cuts in the federal funds rate are supposed to lead to lower interest rates across the economy. Low interest rates encourage businesses to make new investments, people to buy homes or renovate them, and big durable products like cars to be purchased. When the economy is weak and there is a lot of excess capacity unemployed people, empty offices and storefronts, idle factories all that extra spending leads to an increase in employment and output.

Greater spending, on the other hand, merely leads to more inflation if the economy isn’t in a slump. When inflation becomes uncontrollable, the Federal Reserve raises the federal funds rate, resulting in higher interest rates and less expenditure across the economy.

The Federal Reserve began gradually lowering interest rates in September 2007 and continued to do so until June 2008. Despite the fact that the economy was still worsening at the time, the danger of growing inflation fueled by high energy and agricultural commodity prices prompted them to halt the rate-cutting process. The Federal Reserve kept its policy rate at 2% for its June, August, and September 2008 meetings, all conducted the day after Lehman Brothers went bankrupt.

In the months that followed, the economy deteriorated dramatically, and by mid-December 2008, the Federal Funds Rate had dropped to virtually 0% and couldn’t go any lower.

What role did the Fed play in the 2008 financial housing crisis?

The Term Asset-Backed Securities Loan Facility provided loans to qualified investors to help them buy asset-backed securities.

The Fed unveiled the $200 billion TALF in November 2008.

This program facilitated the issuing of asset-backed securities (ABS) secured by vehicle, credit card, education, and small business loans.

This move was taken to alleviate concerns about liquidity.

The Fed stated in March 2009 that the TALF program would be expanded to accept loans against other types of collateral.