Will The 35th Recession Bring A Swift Return To Zero Percent Interest Rates?

Many people view the seven years of zero percent interest rates experienced in the United States between 2008 and 2015 as being safely in the past, with normal times having returned.

As explored in this analysis, so long as the business cycle of expansions and recessions has not been repealed - then we are highly likely to see a swift return to a potentially protracted bout of zero percent interest rates with the next major downturn in the economy.

Indeed, even the staff of the Federal Reserve itself expects more frequent episodes of zero percent interest rates in the future, and for those episodes to be on a more protracted basis.

This just may change everything when it comes to the financial plans of retirement and other long term investors. Zero percent interest rates don't just eviscerate the ability of retirees to earn interest income, but they also fundamentally change stock, bond, housing and precious metals prices, moving them to places that are outside of the historical averages.

This analysis is part of a series of related analyses, an overview of the rest of the series is linked here.

A Change In The Cycles

As reviewed in the previous analysis in this series, which is linked here, the United States has experienced 34 cycles of expansion and recession since 1854. As explored in that analysis, the business cycle is an extremely reliable night and day cycle.

The sun has gone down 34 times, with those sunsets being the onsets of recessions. The sun has come up 34 times, with those sunrises being the beginnings of the expansions.

However, as can easily be seen - the left side of the graph is very different from the right side. There was a major change after the Great Depression and the end of World War Two: the recessions grew less frequent and less severe, and the expansions became longer.

What happened was not random, but has been the result of an ongoing series of Federal Reserve interventions, which have transformed the business cycle relative to what it was before the Great Depression and World War II.

The 100% Reliable Way In Which The Fed Responds To Recession

The business cycle has changed because the Fed uses modern monetary policy to actively intervene in the business cycle, with the attempt to shorten recessions and to extend the economic expansions. There's some different aspects to it but the core for how the Federal Reserve has been containing recessions in the modern era and how they change the cycle can be seen in the graph below.

The graph shows Fed Funds rates and recessions from 1977 to 2018, a period of a little over 40 years. There's a pattern that can be very easily seen: every single time that there is a recession, the Federal Reserve slashes interest rates.

The core of the policy is for the Federal Reserve to very rapidly force short term interest rates downwards in the attempt to jolt the economy out of recession. Now, the timing can be a little bit different because sometimes the Federal Reserve acts preemptively when they think a recession coming, but they turn out to be unable to prevent it. Sometimes they are a little bit late in the recognition that a recession has occurred - the starting dates of recessions are not known in real time but are assigned afterwards when all the data is available for study.

The Federal Reserve often continues the cycle of reducing interest rates well after the official end of the recession, first because they are not sure the recession has ended yet, and then more importantly, because they are trying to make sure the economy has reliably and robustly moved into the next expansion, so that there is no backsliding into recession.

When we review each one of these cycles of recession and the modern monetary response of Federal Reserve - which is to slash interest rates - then we can see how this has worked in process over the last four or so decades.

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