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How the Fed responds to economic downturns

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Since the 1970s, the Federal Reserve has relied on manipulating expectations of short-term interest rates through cuts in its overnight policy rate in response to economic and manufacturing slowdowns. Reducing interest rates is thought to facilitate investment, which is necessary for economic growth and full employment.

Traditionally, the Fed has cut interest rates during downturns…

These cuts are meant to spur growth…

A cut in the Fed Funds rate has an effect on the entire yield curve by changing the market’s expectations for the path of short-term rates and the risk built into holding long-term securities.

The cuts affect the entire yield curve for Treasuries…

… by changing expectations among investors…

Because recoveries from financial crises have historically been long and arduous, the Fed turned to unconventional policies to drive long-term interest rates lower. The Fed began purchasing long-term bonds, a program known as quantitative easing, adding them to its balance sheet and in the process, reducing the supply of bonds. The effect was to drive up price of bonds and lower market yields.

Investors and policymakers should expect the Fed to reduce rates and possibly resume its quantitative easing program if the coronavirus has a sustained impact on domestic and global production and economic growth.

But with the financial crisis, the Fed needed new tools…

…so it bought bonds in an effort to lower yields and spur borrowing

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About Joseph Brusuelas

@JoeBrusuelas

Joe Brusuelas, “chief economist to the middle market,” is the preeminent voice championing issues and policies facing midsize companies in the United States and around the world. An award-winning economist, Brusuelas has more than 20 years’ experience analyzing U.S. monetary policy, labor markets, fiscal policy, international finance, economic indicators and the condition of the U.S. consumer.

A member of the Wall Street Journal’s forecasting panel and the UCLA Anderson School of Management's Board of Directors, Brusuelas regularly briefs members of Congress and other senior officials regarding the impacts of federal policy on the middle market and the factors by which middle market executives make business decisions. He also frequently offers his insights on the U.S., Canadian and global economies in the financial media. In 2020, he was named one of the 100 most influential economists by Richtopia. In December 2023, Brusuelas and the economics team were recognized on Bloomberg's list of Best Bond Forecasters after correctly predicting where the benchmark Treasury would end the year.

Before joining RSM in 2014, Brusuelas spent four years as a senior economist at Bloomberg L.P. and the Bloomberg Briefs newsletter group, where he co-founded the award-winning Bloomberg Economic Brief. Earlier in his career, he was a director at Moody's Analytics covering the U.S. and global economies for the Dismal Scientist website. He also served as chief economist at Merk Investments L.L.C. and chief U.S. economist at IDEAglobal.

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