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Interest Rates During a Recession, What Happens, and What Not to Do

Updated on May 7, 2020 Updated on May 7, 2020
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Table of Contents  
  1. What Is a Recession?
  2. Expansionary Monetary Policy To the Rescue
  3. Recession Dos
  4. Recession Don’ts
  5. Be Smart, Be Safe

The economic news is grim at the moment, but we’ve been in this position before, many times throughout history. And looking back can give us some indicators of what is likely to happen during the next recession.

Even if the news is all bad, that doesn’t mean we can’t find opportunities amongst the chaos. Sometimes the best opportunities are borne of the ashes, be they personal or economic.

Many of us were not in a position to take advantage of the opportunities revealed during the last recession, the Great Recession.

The Great Recession began when the U.S. housing market went from boom to bust in 2007, and large amounts of mortgage-backed securities (MBS’s) and derivatives lost significant value.

Interest rates during a recession are typically lowered, the stock market drops, and real estate prices slump. All of these things create opportunities for us to make money or save money.

If we didn’t get to partake in any of the advantages during the 2007 financial crisis, now could be our chance to cash in.

Of course, there are also plenty of opportunities to make mistakes during a recession, mainly motivated by fear.

So let’s take a look at a few dos and don’ts during a recession.

What Is a Recession?

The textbook definition of a recession is:

Two consecutive quarters of negative economic growth as measured by the GDP or gross domestic product.

Gross domestic product is the total monetary value of all the goods and services produced by a country over a set period of time. GDP represents the health and size of the economy.

Other factors can be indications that a country is in a recession, including a high unemployment rate, trade wars, the stock market, industrial output, and credit availability.

Since 1900, America has averaged a recession every four years, and since World War II, the average recession has lasted about eleven months.

Eleven months is a misleading number. It’s skewed high due to the Great Recession, which lasted 18 months.

etfs-vs-mutual-funds

Are We In a Recession?

We are not yet in a recession; we’re in a correction.

A correction is a decline in the stock market of at least 10% from its 52-week high that stops an upward trend.

Like recessions, corrections are not uncommon. There have been 36 corrections in the S&P 500 since 1950 of at least 10%, or about one every two years.

Are we headed toward a recession? Probably. And even before the pandemic, there were signs a recession was looming.

But we’ve been through recessions before and come out the other side, so there is no need to panic. Expansionary monetary policy can help us through the coming recession.

Expansionary Monetary Policy To the Rescue

We know the government is often inept, but when it comes to something it really cares about, the economy, it can get things right through fiscal policy.

What is Expansionary Monetary Policy?

Expansionary monetary policy (EMP) occurs when a central bank uses its available monetary policy tools to stimulate a country’s economy. Doing so increases the supply of money, lowers interest rates, and increases aggregate demand.

Aggregate demand, also called domestic final demand, is the total demand for goods and services in an economy, the demand for a country’s real GDP.

EMP increases growth as measured by GDP. It devalues currency, which decreases the exchange rate.

This is the opposite of a contractionary monetary policy. Expansionary monetary policy curbs the contractionary phase of the business cycle.

But because central bankers don’t have a crystal ball, EMP is put into place only after a recession has started it; it’s a reaction, not a preemptive measure.

How Expansionary Monetary Policy Works

In the United States, the central bank is the Federal Reserve. One EMP tool that the Fed employs is open market operations.

It buys U.S. Treasury notes from member banks with credit created out of thin air. The Fed is increasing the money supply, by essentially printing money.

Replacing the banks’ Treasury notes with credit means the Fed has given the banks more money to lend out. To lend out the excess cash, banks lower interest rates.

Borrowing money for a mortgage, a car, or a student loan is now cheaper. The interest rates on credit cards are also reduced. These lower interest rates increase consumer spending and economic activity.

Business loans are cheaper, too, so companies can afford to hire additional employees, which lowers unemployment and puts money into these employee’s pockets, allowing them to spend more.

This tactic helps stimulate demand for goods and services and can increase economic growth.

The Federal Open Market Committee can also lower the fed funds rate, which is the rate banks charge one another for overnight deposits.

Banks are required by the Fed to hold a certain amount of their deposits in reserve at the local branch of their Federal Reserve office every night. Banks with more than they need lend the excess cash to banks that don’t have enough and charge the fed funds rate.

When the Fed lowers the target rate, it’s cheaper for banks to maintain their reserves, so they have more money to lend out. The result is lower interest rates for customers.

The Discount Rate

The next tool in the tool belt is the discount rate; the interest rate the Fed charges banks that borrow from its discount window. Banks don’t like to use the discount window.

They only do so when they can’t get loans from anywhere else. Kind of like if you or I had to go to a loan shark or a payday lender because no one else would lend us money.

The Fed is the last resort. The Fed lowers the discount rate when it lowers the Fed funds rate.

The fourth of the monetary policy tools is lowering the reserve requirement. This does increase liquidity immediately, but member banks must adhere to a lot of additional policies and procedures.

We can expect to see some of these tools deployed to prop up the economy and spur economic growth during the recession that’s probably heading our way. That’s what the Fed can do for us, let’s see what we can do for ourselves.

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Recession Dos

Some of us are scared to make any money moves when we’re in an economic downturn, but doing nothing can be the wrong decision if it means failing to take advantage of an opportunity.

Refinance

The Federal Reserve cut its benchmark interest rate to 0% in March. It lowered the federal funds rate by half a point to a range of 1% to 1.25%. Both of these moves were in response to the coronavirus threat to the economy.

When interest rates are low, it’s cheaper to borrow money, even money you’ve already borrowed. You can take advantage of lower interest rates by refinancing your mortgage rates, auto loans, and student loans.

When should you consider refinancing? If the rate you can get is half a point to one point lower than your current rate is the rule of thumb.

It might not sound like much, but when you’re talking about thousands of dollars over decades in the case of a mortgage, a 0.5% or 1% cut in your interest rate can save you thousands of dollars over time.

How do you know your new rate?

If you’re considering refinancing your student loans, Earnest allows you to enter in some basic information and check your rate without impacting your credit score.

Earnest refinance

Credible allows you to shop for rates from several different lenders who will refinance your student loans and mortgage without impacting your credit score.

Lending Club offers auto loan refinancing, and you can check your rate with no effect on your credit score.

There can be costs associated with some types of refinancing, so be sure to look at more than just the interest rates when you’re shopping around.

Pay Down Credit Card Debt

The annual percentage rate, APR on credit cards, is expected to decrease from 0.25% to 1.5%. It drops because most cards are variable rate and follow the prime rate. The prime rate follows the Fed’s rates, which were lowered in March as explained above.

It’s expected that the average rate will decrease from 17.35% to 16%. How aggressive should you be in paying off credit card debt to take advantage of these lower rates?

Credit card debt is always an emergency, but so is being out of a job, something many of us are at a heightened risk of right now.

If you have some measure of job security, now is the time to get aggressive with your credit card debt. At the very least, take the money you’re saving by not being able to go out and put it towards the credit card debt.

Invest

What does master investor Warren Buffett tell us about investing?

Be fearful when others are greedy and greedy when others are fearful.

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When the U. S. economy starts to tank, unwise investors panic and start selling their stocks. It’s a mistake because the only rule when it comes to investing is “buy low, sell high.”

You can profit from their fear now and their greed later.

Are prices going to drop further? I don’t know; no one does because that’s a crystal ball question.

You can’t time the market, but prices are lower now than they were six months ago. When you use dollar-cost averaging, you don’t have to time the market.

What should you invest in? If you’ve never bought individual stocks before, you don’t have to start now. You can invest in an ETF, so you’re investing in a wide swath of the total stock market.

But if you want to try your hand at buying individual stocks, start with what you know. Do you love Apple products? Start there.

And while there is no such thing as a 100% risk-free investment, we have some thoughts on what might be some good stocks to buy amid the pandemic.

Betterment interest rates during recession

Cut Back

In the past month, I have spent $480 outside of regular expenses like rent, utilities, and insurance. Nearly all of it is on groceries, and the number is that high because I buy enough to last for three weeks.

How much do I usually spend in a month? More than that, I can assure you.

All of you are probably in the same boat. We’re not spending money because there is nowhere to spend it during the COVID-19 lockdown.

We aren’t going out to dinner, out for drinks, to the movies, on vacation, or shopping. And that’s good because saving money is always a good thing.

But when things are uncertain, it’s a good idea to cut back even more.

Are you filling your time with online shopping? Are you still getting a fun subscription box or boxes? How many streaming services are you subscribed to?

When is the last time you comparison shopped for things like your car, home, and rental insurance or cell phone plan?

ways to make money trim app interest rates during recession

Trim can help you cancel unnecessary services and negotiate better rates on some essential expenses. Add all of the extra money you’re saving to your emergency fund or opportunity fund.

Prep Your Resume

Even if you still have your job, it could change. Or maybe a new opportunity will come your way in the aftermath of the current slowdown.

Either way, now is an excellent time to update your resume and reconnect with some professional contacts you might’ve lost touch with.

And it works both ways; when you reconnect, you might find that you’re in a position to help someone who needs it.

Recession Don’ts

There is a long list of things we can’t do right now, and we hate to pile on, but there are some things you definitely should not do during a recession.

Opt for Adjustable Rate Loans

What goes up must come down and vice versa. Interest rates are not going to stay this low forever. If you’re borrowing money or refinancing debt, now is not the time to gamble on an adjustable-rate mortgage.

When rates go up, you could get caught with your pants down.

Now, every rule has a workaround. If you do take a calculated risk and choose an adjustable-rate mortgage and rates go up, you could refinance or refinance again.

Take On Debt

Low-interest rates are an excellent reason to refinance existing debt, but they’re not a good reason to take on new debt in the current climate.

If you were planning on buying a home or a new car, put those plans on hold. Again, your current circumstances might be great, secure job, fully loaded emergency fund, plenty of retirement savings, but all of that could change.

You could lose your job, if you have a partner, he or she could lose their job. You or someone in your family could get sick.

And having health insurance is no guarantee that medical bills won’t ruin you financially.

Roughly 20% of people under age 65 with health insurance reported having problems paying their medical bills.

And of course, if you were to lose your job, it could mean losing your health insurance too.

Whatever plans you had, just hold on a little longer. You can buy a house or a car after this is all over and probably for considerably less than you would pay now.

And it goes without saying, stay out of credit card debt as much as you can. If you have lost your job, but you have a good credit score, consider a personal loan to pay your expenses (rather than charging everything on credit cards).

With the right credit score, a personal loan will have a much lower interest rate than credit cards.

Sell

We know that you might be obsessively checking your investment accounts, and the numbers don’t look good. Your portfolio may have lost a big chunk of its value.

But you haven’t lost any money, not yet. You only lose money when you sell.

Sit tight. This is why we always preach long-term investing. Unless you are near retirement, your money has time to ride this out. Don’t sell!

Risk the Rent Money

Yes, now is an excellent time to get some bargains in the stock market, and researching stocks will give you something productive to do while you’re under house arrest.

But now is not the time to invest money you can’t afford to lose or money you’ll need in the short or medium-term (less than ten years).

Panic

All of this is scary. We’re afraid of losing our jobs, our homes, our retirement funds, our family, friends, and way of life. And there are things we can’t control.

But there is plenty we can control. Focusing on those things is what we should do. Be smart with your money; be smart with your health. Don’t make rash decisions driven by fear.

In fact, don’t make any major decisions right now; things are too changeable and uncertain. Even relatively minor money decisions should be subject to at least a 24 hour waiting period.

Don’t read a scary headline, crazy rumor, or “insider tip” and act based on it.

Here’s what I’d do. If you’re about to do something really dumb, say the whole plan out loud and, at the end, add, “Your Honor.”

If you aren’t 100% sure the judge would agree your plan is indeed genius, don’t do it.

For example, I know a guy who can get a lot of hand sanitizer. I’m going to give him $10,000 from my emergency fund to buy his whole supply and then sell it on eBay for five times the cost, Your Honor.

Try it; it works.

Be Smart, Be Safe

Personal finance and health have a lot of parallels. Neither is easy, but both are simple. Motivation is not enough; you need discipline. It’s (almost) never too late to change bad habits and undo their damage.

During this pandemic, we need to take care of both, be smart and be safe with your money and your health.

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Candice Elliott - Senior Editor Candice Elliott is a substantial contributor to Listen Money Matters. She has been a personal finance writer since 2013 and has written extensively on student loan debt, investing, and credit. She has successfully navigated these areas in her own life and knows how to help others do the same. Candice has answered thousands of questions from the LMM community and spent countless hours doing research for hundreds of personal finance articles. She happily calls New Orleans, Louisiana home-the most fun city in the world.
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