With Tuesday’s unprecedented decision to move the Fed funds rate in effect to zero, US monetary policy has entered a brave new world. Active fiscal policy will soon take the lead in stimulating the economy. But as the Federal Reserve’s bold statement indicates, it has both the means and the will to continue playing an integral role in combating the current crisis. The tools remaining at its disposal involve facilitating the flow of funds in credit markets. While many of these measures are new, they are all in keeping with the Fed’s traditional role as a lender of last resort and guardian against financial crises.

Despite using non-conventional tactics, the Fed’s basic strategy will remain the same. As in every postwar recession it will attempt to offset the weakness in the economy and seek to fuel recovery by reducing credit costs. In previous recessions it was able to accomplish this by dramatically reducing short-term interest rates. The current recession, however, is abnormal. Even though short-term nominal rates are near zero and real rates are slightly negative, credit costs remain high. The reason is that credit spreads are unusually elevated. These elevated spreads have raised borrowing costs and deepened the recession. They are also the main obstacle to recovery.