How The Federal Reserve Fights Recession

By Marc Davis | September 05, 2012 AAA
How The Federal Reserve Fights Recession

America's central bank, the Federal Reserve, has several methods by which to fight recession. Among other measures, the Fed can raise or lower interest rates as economic circumstances require; it can sell and buy U.S. government debt - Treasury bills and notes - and it can extend cash and or credit to various financial institutions. In its ongoing effort to fight the recession and stimulate the economy, the Fed has used all of those measures.

SEE: The Federal Reserve: Introduction

Here's a closer look at what the Fed has done:

Help for Unemployment
In the third week of June, the Fed announced that it would continue its "Operation Twist" program to reduce long-term interest rates until year's end. The program is designed to make borrowing cheaper for businesses and consumers when the Fed sells short-term U.S. debt and takes the cash to buy long-term U.S. debt. Fed Chairman, Ben Bernanke, said that additional Fed action may be required if unemployment doesn't fall below 8.2%. The labor market showed signs of modest improvement in the early months of 2012, but had slowed through the spring and early summer.

Money for Mortgages
Throughout the years of America's recent recession and subsequent slow recovery, the Fed, under chairman Bernanke, has been actively attempting to restart the faltering economy. In recent years, the Fed announced it was to buy a significant amount of mortgages.The money would be used to buy mortgage debt and government bonds, a move designed to stimulate spending, reduce long-term interest rates and fire up the stock market. This Fed action was known as quantitative easing, or QE for short.

Lending for Banks
In 2008 and 2009, as the nation's economic problems became severe, the Fed provided lines of credit to financial and lending institutions. This cash infusion provided funds for consumer loans and consequent consumer buying - the engine that drives the economy. A follow-up effort to pull down long-term interest rates was initiated in 2010, with an additional $267 billion earmarked by the Fed for bond buying.

Besides these actions by the Fed, America's central bank loaned money to J.P. Morgan Chase to help the banking giant takeover the failing investment bank, Bear Stearns. The Fed also established a line of credit and financing for the government's acquisition of American International Group (AIG), one of the largest global insurance firms. By mid-June this year, these loans had been totally repaid, according to the Federal Reserve Bank of New York.

SEE: When The Federal Reserve Intervenes (And Why)

Beginning in 2008, the Fed has also provided cash to some central banks of foreign countries so that loans could be made to local banks with liquidity problems and for lending purposes to businesses and consumers. The loans were made by the Fed to protect U.S. markets that relied, in part, on these foreign economies.

The Bottom Line
The results of all this effort by the Fed have only been partially successful. The economy enjoyed a somewhat faster growth rate in early 2012, but has since slowed. The extended "Operation Twist" program, with its projected sales of $267 billion of short-term debt and the purchase of an equal amount of long-term securities, is hoped to ignite the economy and create more jobs for millions of currently unemployed Americans.

SEE: The Treasury And The Federal Reserve

Prospects for a quick recovery seem dim, however. Fed Chairman Bernanke cited the European debt crisis as a contributing factor to the struggling U.S. economy. Fed officials forecast an unemployment rate of at least 7.5% for the next 18 months or so. If "Operation Twist" has limited results, Bernanke stated at a Federal Open Market meeting in June that he is prepared to take additional steps.

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