The U.S. central bank, the Federal Reserve, has a dual mandate: to work to achieve low unemployment and to maintain stable prices throughout the economy.
During a recession, unemployment rises, and prices sometimes fall in a process known as deflation.
The Fed, in the case of steep economic downturns, may take dramatic steps to suppress unemployment.
And bolster prices both to fulfill its traditional mandate and also to provide emergency support to the U.S. financial system and economy.
At the onset of a recession, some businesses begin to fail typically due to some combination of real economic shocks or economic bottlenecks.
That result from the incompatibility of production and consumption activities that results from previously distorted interest rate and credit conditions.
These businesses lay off workers, sell assets, and sometimes default on their debts or even go bankrupt.
All of these things put downward pressure on prices and the supply of credit to businesses in general, which can spark a process of debt deflation.
The Great Recession and Its Aftermath
The period known as the Great Moderation came to an end when the decade-long expansion in US housing market activity peaked in 2006 and residential construction began declining.
In 2007, losses on mortgage-related financial assets began to cause strains in global financial markets, and in December 2007 the US economy entered a recession.
That year several large financial firms experienced financial distress, and many financial markets experienced significant turbulence.
In response, the Federal Reserve provided liquidity and support through a range of programs motivated by a desire to improve the functioning of financial markets and institutions.
And thereby limit the harm to the US economy.1 Nonetheless, in the fall of 2008, the economic contraction worsened, ultimately becoming deep enough and protracted enough to acquire the label “the Great Recession.”
While the US economy bottomed out in the middle of 2009, the recovery in the years immediately following was by some measures unusually slow.
Conclusion
The coronavirus crisis in the United States—and the associated business closures, event cancellations, and work-from-home policies—triggered a deep economic downturn.
The sharp contraction and deep uncertainty about the course of the virus and economy sparked a “dash for cash”
A desire to hold deposits and only the most liquid assets—that disrupted financial markets and threatened to make a dire situation much worse.
The Federal Reserve stepped in with a broad array of actions to keep credit flowing to limit the economic damage from the pandemic.
