As we head into what could be the worst global recession in almost a century, it is interesting to understand how one of the global financial superpowers helps to stem the tide.
Role Of The Fed
The Central Bank of America, the Federal Reserve, uses a dual mandate as damage limitation to an economic downturn by minimizing unemployment and stabilizing prices.
The knock-on effect of a recession will be an increase in unemployment; it will also cause prices to decrease, which in turn causes deflation.
Deflation is a less obvious aspect of economic instability but it causes a reduction in the price of goods and services.
This causes a loss in income for many people as well as the equity secured on their home.
The decrease in the value of people’s property, in line with the loan they used to buy it, can see an increase in defaulted payments which also hurts the banks as well.
Deflation can also make recessions worse by causing people to spend less, which causes businesses to decrease prices and in turn staff wages. This vicious cycle of reduction in prices due to lack of demand is known as a deflationary spiral.
Here are 3 ways the Fed helps to alleviate the damage done by a recession.
Reducing Interest Rates
By lowering their fund rates, the Fed reduces the interest rates the banks use to borrow from each other.
This makes it easier for companies to borrow money to keep their business afloat, potentially holding on to their employees and keeping the economy ticking over.
It also allows consumers to get credit to buy products and services which creates demand and keeps the economy moving.
Quantitative Easing
If it’s not a viable option to lower interest rates any further, then quantitative easing is another way the Fed can stem an economic downturn.