Rock-bottom interest rates before the pandemic made the coronavirus recession worse, Fed's Rosengren says

• The historically low interest rates seen before the coronavirus pandemic worsened the current recession by driving a wave of bankruptcies, Eric Rosengren, president of the Federal Reserve Bank of Boston, said Thursday.
• The central bank's benchmark rate sat at roughly 1.5% before the Fed dragged it near zero in March.
• The low-rate environment led investors to take on more risk for higher yields and encouraged businesses to offer up more debt.
• That build-up of risk "likely will make economic recovery from the pandemic more difficult," he said, as leverage throughout the virus-slammed economy fueled defaults and kept firms from tapping relief programs.
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Historically low interest rates in place before the coronavirus pandemic exacerbated the current economic slump, Eric Rosengren, president of the Federal Reserve Bank of Boston, said Thursday.

The central bank's benchmark rate sits near zero and is expected to stay there through 2024. Yet interest rates weren't much higher before the pandemic slammed the US economy and forced nationwide lockdowns. The federal funds rate hovered around 1.5% in late 2019 after three rate cuts through the second half of last year.

The pre-pandemic low-rate environment led investors to take on more risk in search of higher yields. Businesses met the demand with new debt offerings. That behavior is now coming back to bite all of the US, Rosengren said in prepared remarks for an online event with Marquette University.

"The slow build-up of risk in the low-interest-rate environment that preceded the current recession likely will make the economic recovery from the pandemic more difficult," he said.

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For reference, the rate stood at roughly 5.25% immediately before the Great Recession. The Fed slashed its rate close to zero during the financial crisis and maintained that level until late 2015.

A build-up in risk can intensify downturns, as levered businesses can more easily default on debt when facing a slowdown in business activity and, in turn, revenue. Greater leverage throughout the economy also kept many firms from participating in emergency lending programs. In all, risk-taking is "a contributing factor to the bankruptcies we have already seen, unfortunately with more quite likely in the coming months," Rosengren said.

The US lacks the regulatory tools needed to moderate risk build-ups down the road, he added. Failing to research risk-taking behaviors threatens an even worse wave of bankruptcies down the road.

"If we expect to remain in a low-interest-rate environment for a protracted period of time, we need to take more precautions against financial stability risks for when the next economic shock hits," Rosengren said.

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