The failure of the Silicon Valley Bank, the second-largest bank failure in US history, crippled the financial system and distracted attention from another problem: very high inflation.
Two economic challenges pose a dilemma for the Fed. Because the Fed’s most powerful tool, the benchmark interest rate, is the main cause of the financial crisis and the main solution to high prices.
The central bank has aggressively raised interest rates over the past year, bringing inflation down significantly from its summer peak, while still remaining more than three times the Fed’s 2% target.
However, a sharp rise in interest rates caused the value of bonds held by Silicon Valley Banks to plummet, spurring their collapse.
If interest rates continue to rise, there is a risk of further intensification of the banking crisis, putting more financial institutions at risk of failure. But a moratorium on rate hikes could undermine the Federal Reserve’s fight against inflation, keeping prices high and eating into household budgets, economists said.
“It’s a very delicate balance,” Andrew Levin, an economics professor at Dartmouth College and a former Fed economist, told ABC News. “If the Fed is too concerned about the stability of the banking system to make sure prices are stable, it would be a very unfortunate situation,” he said.
Still, the Fed can avoid choosing between the two ends. Because the tougher lending practices adopted by commercial banks in response to the financial crisis could themselves cool the economy, allowing the Fed to refrain from cutting rates without raising them. It’s from Inflation, economists said.
Zip Recruiter chief economist Julia Pollak told ABC News, “In any case, it looks like the financial woes can deal with inflation.”
Last year, the Federal Reserve raised its benchmark interest rate by 4.5%. This is his fastest pace since the 1980s.
The Federal Reserve (Fed) has proposed a series of borrowing cost hikes in an attempt to keep prices from rising by slowing the economy and dampening demand. But this approach risks sending the U.S. economy into recession and putting millions out of work.
But so far, the economy has proven fairly resilient, Levin said, citing a strong job market.
“If the economy remains strong, inflation could stay well above the Fed’s target,” Levin said. “We may need to raise interest rates significantly to keep inflation under control.”
In early March, Fed Chairman Jerome Powell told Congress that there was “a long and likely bumpy road ahead” for inflation, and the central bank expected benchmark rates to “continue to rise.” He said that
However, sustained interest rate hikes also threaten the stability of the banking system.
A sharp rise in interest rates over the past year has devalued Silicon Valley banks’ government and mortgage bonds, creating holes in their balance sheets, causing some depositors to flee and leading to a disastrous 48-hour bank run. caused
Silicon Valley Bank faced unique and serious risks, but it was not the only vulnerable bank.
At the end of last year, US banks had $620 billion in unrealized losses, holdings that had fallen in value but were not yet sold. found.
Swiss banking giant UBS bought ailing rival Credit Suisse for $3.2 billion on Monday.
The largest US financial institution took action on Friday to stabilize the financial sector, injecting $30 billion into the First Republic bank, one of the regional lenders.
Bank of America, Citi, JPMorgan Chase, Wells Fargo, Goldman Sachs and many others have joined the effort. But the bank’s shares continue to plummet, dropping 47% on Monday.
Such financial turmoil, which plagues many, could be the expected result of rapid interest rate hikes, Pollack said, rather than undermine the fight against inflation. , the banking crisis is part of it, she added.
“Normally, the Fed will raise rates until something breaks,” Mr. Pollack said.
“The immediate effect of the tightening of credit is that households will buy less homes and invest less in businesses, which will affect demand for the goods,” she added, lowering prices. perpetuate.”
Meanwhile, some forecasters expect the Fed to forgo another rate hike at Wednesday’s meeting, citing vulnerabilities in the financial system.
In a research note, Goldman Sachs told investors on Monday it expected the Fed to “suspend its March meeting this week due to stress in the banking system.”
Dartmouth’s Levin said he thinks the Fed should take a cautious approach to rates this week.
“In addition to this, we should try to reassure the market that we are carefully monitoring it,” he said.
He added that prices could fall anyway if the financial crunch continues.
“People aren’t going to buy that refrigerator,” he said. “Upward pressure on inflation could subside really quickly.”