A:

Interest rates rarely increase during a recession. Actually, the opposite tends to happen; as the economy contracts, interest rates fall in tandem.

The Federal Reserve has tools to control interest rates. During a recession, the Fed usually tries to coax rates downward to stimulate the economy. When a recession is on, people become skittish about borrowing money and are more apt to save what they have. Following the basic demand curve, low demand for credit pushes the price of credit—meaning interest rates—downward.

The Federal Reserve

The Federal Reserve exerts major influence on interest rates. It can push rates upward or downward by adjusting the federal funds rate, which is the interest rate at which banks lend money to each other to meet overnight reserve requirements, and by buying or selling Treasury bonds (T-bonds). When a recession hits, the Federal Reserve prefers rates to be low. The prevailing logic is low interest rates encourage borrowing and spending, which stimulates the economy.

Supply and Demand

In a bad economy, consumers tend to become more fastidious with household finances. They are more careful about borrowing and more motivated to save the money left over after meeting expenses. This supply and demand dynamic creates an environment for low interest rates to thrive. When everyone wants to borrow money, interest rates tend to rise; the high demand for credit means people are willing to pay more for it. During a recession, the opposite happens. No one wants credit, so the price of credit falls to entice borrowing activity. 

(For related reading, see: How Banks Set Interest Rates on Your Loans.)

RELATED FAQS
  1. What are the implications of a low federal funds rate?

    Find out what a low federal funds rate means for the economy. Discover the effects of monetary policy and how it can impact ... Read Answer >>
  2. What are some examples of expansionary monetary policy?

    Learn about expansionary monetary policy and how central banks use discount rates, reserve ratios and purchases of securities ... Read Answer >>
  3. How do central banks impact interest rates in the economy?

    Learn how central banks such as the Federal Reserve influence monetary policy in the economy by increasing or decreasing ... Read Answer >>
  4. Market operation and its effect on Money Supply

    Understand how open market operations affect the supply of money in the economy and learn the specific ways the Federal Reserve ... Read Answer >>
Related Articles
  1. Insights

    How Interest Rates Affect the U.S. Markets

    Interest rates can have both positive and negative effects on U.S. stocks, bonds, and inflation.
  2. Financial Advisor

    Implications of the Federal Reserve's Impending Rate Hike

    The Federal Reserve begins its two-day meeting on Wednesday, September 16, and everyone is watching to see if the central bank will raise the United States target interest rate for the first ...
  3. Investing

    Investment Portfolio Strategy in Recession

    Do you know what to do when recession hits? Learn these recession-proof strategies that help your portfolio to endure the economic downturn.
  4. Insights

    How the Federal Reserve Affects Individual Investors

    The Federal Reserve's decision on interest rates affects the whole economy.
  5. Personal Finance

    How the Federal Reserve Affects Your Mortgage

    The Federal Reserve can impact the cost of funds for banks and consequently for mortgage borrowers when maintaining economic stability.
  6. Insights

    How US Interest Rates Move the World Economy

    Because the US has the world's largest economy, fluctuations in America's interest rates affect much more than domestic growth
  7. Managing Wealth

    Buying a House Before an Interest Rate Hike

    Find out how a Fed rate hike would impact aspiring homebuyers, why rates increase, and whether now is the right time to buy a house.
  8. Insights

    Industries that thrive on recession

    Recessions are hard on everyone – aren't they? Actually, just as wars have their war babies, recessions have their tough offspring as well.
  9. Insights

    5 Things To Do Before Interest Rates Go Up

    It is inevitable that interest rates will go up, but what should investors do to prepare themselves?
RELATED TERMS
  1. Growth Recession

    Growth recession describes an economy that is growing at such ...
  2. Recession

    A recession is a significant decline in activity across the economy ...
  3. Recession Resistant

    Recession resistant refers to an entity such as stocks, companies, ...
  4. Federal Discount Rate

    The federal discount rate allows the central bank to control ...
  5. Interest

    Interest is the charge for the privilege of borrowing money, ...
  6. Cheap Money

    Cheap money is a loan or credit with a low interest rate, or ...
Trading Center