What Happens to Interest Rates during a Recession?

The condition of the economy is the main driver of interest rates. On one hand, interest rates drop when the economy declines. Borrowers pay less interest on credit card debt, their adjustable rate mortgage, and other interest-bearing loans like credit lines, business loans, and personal loans.

When economic growth booms and stocks soar, interest rates tend to rise due to higher borrower demand.

As more businesses and individuals seek loans to fund their latest ventures, this puts more pressure on interest rates, so the Fed typically raises them in response.

The Truth about Recessions & How They Affect the Economy

Entering into a recession seems like it happens swiftly, but it usually takes place over a period of six months. In the United States alone, we’ve experienced 47 recessions in our country’s history.

The current Coronavirus-inspired recession is much different than anything we’ve ever seen before. The US government is forced to slow down the economy in an effort to stop the spread of this deadly virus.

When economic activity slows down to a grinding halt, there is less demand to borrow money. With low demand from borrowers, the lenders are forced to lower interest rates with the intent to stimulate borrowing once again.

Additionally, the Fed normally intervenes during a recession with monetary policy. They will intentionally lower interest rates and increase the supply of money to create more of a demand for economic activity.

It makes perfect sense. When entrepreneurs can borrow money at bargain basement extremely low interest rates, they’ll feel empowered to take a chance. The financial ramifications aren’t nearly as severe if they fail. Plus, with interest rates so low it’s much easier to pay back the money they borrow.

Why Lowering Interest Rates on an Adjustable Rate Mortgage, Credit Card Debt, and Business Loans Makes Perfect Sense

Besides stimulating the economy, lowering interest rates also serves another purpose. By lowering rates on loans, it’s easier for borrowers stay current while they struggle to survive during less prosperous economic times.

Life can get really tough for millions of Americans during an economic recession. Businesses fail because customers are afraid to spend their money. Swarms of people lose their jobs because companies downsize or shut down because they can’t weather the economic storm. And paying everyday bills becomes difficult to put it mildly.

Lowering interest on credit cards, adjustable rate mortgages, business loans, and other loans is the sensible thing to do during a recession. People need help any way they can get it.

By paying less interest, they’ll have a better chance of making their regular monthly payments for a while. But the longer they stay out of work, the harder it will be.

Lenders realize the situation borrowers end up in. They want their customers to succeed and stay current. So, the Fed mandates lower rates to give regular people a better chance to overcome their dismal financial situation when the economy bounces back.

Bottom Line

Living through an economic recession is scary for many of us. The uncertainty creates lasting fear and panic. Many Americans tighten their belts and only buy the essentials.

This ends up having an even greater negative impact on the overall economy because no one is spending money. That’s when the Federal Reserve steps in and lowers interest rates in an effort to stimulate growth and get the US back on strong economic footing.