Abstract

Views expressed do not necessarily reflect official positions of the Federal Reserve System. Increasing—yet still much-debated—evidence indicates the worstof the recent financial crisis is behind us. This marks the first pay-off of a series of aggressive and coordinated steps by the Federal Reserve, Treasury, FDIC, and Congress to (i) stem the financial panic following the Lehman Brothers ’ bankruptcy and (ii) restore the flow of credit. Additional payoffs in the medium term are expected from the Fed’s decision to cut its key policy rate to near zero and greatly expand the monetary base. One of the most popular indicators of financial stress are yield spreads—both default risk spreads (e.g., between Baa- and AAA-grade corporate debt) and liquidity spreads (e.g., between interbank deposits and Treasury bills). Low bond yields are instrumental to the goals of an expansionary policy: They stimulate growth by reducing costs of capital to firms and households.1 Yields on T-bills and notes have decreased notably in response to a number of the Fed’s credit-easing policies. However, transmission of monetary impulses from Treasur