What Happens to Interest Rates During a Recession? During a recession, interest rates are fallen. But the year 2022 and 2023 buck the normal trend a bit. Although there is a global recession, many countries increase interest rates.
Firstly, let’s discuss what is the recession.
What Is a Recession?
Recession means the period of negative or very weak economic growth.
It is very important to define recession technically. When we technically define the recession, “it is the period of minimum two consecutive quarters of negative economic growth rate”. Here usually economic growth is determined by the growth of the Gross Domestic Product (GDP).
You may be interested to read more about,
But some well reputed organizations have defined the recession differently. As examples, according to the National Bureau of Economic Research (NBER), recession means the period of minimum more than few consecutive months with significant economic decline.
When an economy with the recession, its aggregate production is declined or increased very slow, unemployment is increased significantly. Because output level of the business organizations is decreased and then they have to lay off employees. As results of losing employments, people reduce their private consumption expenditures such as buying a car, house.
Recessions are part of the economic cycle. There are 4 phases of the business cycle. They are expansion, peak, recession and trough. Among them, recession is the period where economy moving from a peak to a trough.
What happens to interest rates during a recession?
During a recession, interest rates are fallen. Because when economy is in a recession, the central bank (Ex: Federal Reserve Bank, Bank of England) apply expansionary monetary policy.
This was shown during the financial crisis of 2008 and the beginning of COVID 19 pandemic in 2020. You can notice that the FED fund’s rate decreased around 2008 and then again around 2020, if you look at the rate graph over time.
What Happens to Fed Interest Rates During a Recession?
FED fund’s rate decreased around 2008
FED fund’s rate decreased in beginning of COVID 19 pandemic
When interest rates are fallen, investors borrow more money. Because it becomes cheaper to do so. They invest these money on businesses. Increasing investment level to stimulate the economic growth of a country.
There is an inverse relationship between the interest rates and investment level as graphed in follows.
Interest rates are increased to reduce inflation
According to the historical examples, economies have been grown until interest rate are increased. Interest rates have been increased to slow down the inflation and to reduce the cost of living.
Increasing interest rates decreases the loan demand since credit is more expensive. On the other hand money savers receive higher interest income. Finally money supply is decreased. Within the period of 2015 – 2018, USA economy has gown very fast. So, FED has increased interest rate as follows.
What Happens to Interest Rates During a Recession of 2022- 2023?
During a recession, interest rates are fallen. But the year 2022 and 2023 buck the normal trend a bit. Although there is a global recession, many countries increase interest rates.
According to IMF global recession prediction, global growth will remain at 3.2 percent in 2022, but that it will decline to 2.7 percent in 2023.
To read more, kindly click on “Global Recession Prediction by IMF and World Bank”
A recession is generally defined as two consecutive quarters of declining gross domestic product (GDP), which would indicate that the United States has fallen a recession in the summer of 2022. But the target federal funds rate range was recently increased by the Federal Reserve to 4.25% – 4.50%. The rate rises by 50 basis points to its highest level since December 2007. Furthermore, it is the eighth straight increase in rates for 2022. The Fed quickly moved to increase the fed funds rate by three percentage points in approximately six months after deciding it was time to act against inflation. According to the median prediction of policymakers, the Fed now anticipates that the rate will end in 2023 in a range of 5% to 5.25%.
To read more, kindly click on “Fed interest rate 2023: will be in the range of 5% to 5.25%”
The Monetary Policy Committee (MPC) of the Bank of England stated on December 15 that it has increased bank rate (interest rate) to 3.5%, up 0.5 percentage points. Bank of England interest rate will be 5.2% in the fourth quarter of 2023.
To read more, kindly click on “Bank of England interest rate will be 5.2% in 2023”
As inflation continues to be a problem in many major economies, other central banks throughout the world have also increased interest rates.
We are not in a recession. We a in a stagflation
Although there is a recession, central banks increase the interest rates. Why is that?
Because we are not in a recession. We a in a stagflation (inflationary recession). Stagflation is the situation both inflation and unemployment are increasing simultaneously. In other words, even though there is a recession, inflation also increasing. The COVID-19 outbreak, the conflict in Ukraine, the energy shock, and years of historically low interest rates all contributed to the current economic situation. It is acceptable to say that these circumstances aren’t usual.