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The Federal Reserve got an unwanted help in its bid to slow the US economy and beat the worst inflation in four decades: a reduction in bank lending.
The turmoil in the financial system that followed the collapse of two major US banks raised the possibility that lending standards could become even tighter. Fewer loans mean less spending by consumers and businesses. That, in turn, makes it harder for companies to raise prices, thus reducing inflationary pressures.
At the same time, some economists worry that the slowdown could prove severe enough to send the economy into a painful recession.
On Wednesday, the Fed raised its benchmark interest rate for the ninth time in just one year. Central bank policymakers are grappling with a persistently high rate of inflation that has angered American households and raised uncertainty overhanging the economy. At about 6%US inflation remains well below last year’s peak but well above the Fed’s 2% annual target.
But the Fed has also signaled that its rate hikes may be nearing an end. In part, that’s because reducing bank lending helps the central bank achieve its primary goal of slowing the economy and controlling inflation.
Speaking at a news conference on Wednesday after the Fed’s announcement, Chair Jerome Powell suggested that stricter lending standards, resulting in a withdrawal of loans, could have the same dampening effect on inflation that a Fed hike would.
“Not everything has to come from rate hikes,” Powell said. “This could be from tighter credit conditions.”
Similarly, after the European Central Bank raised its own benchmark rate by a substantial half a percentage point last week, its president, Christine Lagarde, says the ECB has not locked itself into a preset plan for rate hikes and that future rate decisions will be made on a meeting-by-meeting basis.
Concerns surrounding the European banking system “may have an impact on demand and may actually do some of the work that monetary policy can do,” Lagarde said just days after the collapse of the two major US banks and the Swiss banking giant Credit Suisse needed a rescue from its rival UBS.
Indeed, if Europe experiences a credit crunch, analysts say, the ECB’s rate hike last week could be its last for a while.
ECB officials said their banks are “resilient” and have strong enough capital and cash buffers to cover any deposit withdrawals they face. European supervisors apply international standards, which require more ready money. In contrast, US regulators have bailed out all but the largest US banks. Silicon Valley Bank one of the exempted banks.
And when loans are more expensive and harder to qualify for, consumers, who drive much of the U.S. economy’s growth, are less likely to spend.
Gregory Daco, chief economist at consulting firm EY-Parthenon, said he thought a significant credit squeeze would have “less impact” on the economic impact than a quarter-point rate hike. the Fed announced on Wednesday.
Edward Yardeni, an independent economist, said he estimated the impact would be greater – the equivalent of a full percentage point increase in the Fed.
Inflation may slow as a result, helping the central bank meet its long-term goals. But the increase in economic growth can also be substantial. Most economists say they expect a recession to occur in the United States in the second half of this year. The main question is how bad it is.
Signs of a possible credit crunch in the United States had begun to emerge even before Silicon Valley Bank collapsed on March 10, raising concerns about the stability of the financial system. Faced with rising rates and a worsening economic outlook, banks have become stingier about approving loans to businesses by the end of 2022, according to a Fed survey of lending officials. in the bank.
And “commercial and industrial” bank loans to businesses fell last month for the first time since September 2021, according to the Fed.
Since then, the stress on the banks has only grown. Silicon Valley Bank, which was the 16th largest bank in the country, failed after accumulating huge losses in his bond portfolio which caused worried depositors to withdraw their money. Two days later, the regulators were shut down New York-based Signature Bank.
The Federal Deposit Insurance Corporation, which insures bank deposits up to $250,000, said banks were sitting on $620 billion in paper losses in their investment portfolios at the end of last year. That’s because higher interest rates have greatly reduced the value of their holdings in the bond market.
Powell declared Wednesday that the banking system is “good” and “stable.” Yet fears remain that many depositors will pull their money out of all but America’s biggest banks, intensifying pressure on financial institutions to lend less and save money to meet the deficit. withdraw.
Cash-short banks are still lining up this week to borrow money from the Fed. The Fed said Thursday that emergency lending to banks fell slightly last week – to $164 billion – but remained high.
More than $110 billion in borrowing went through a long-standing program called the “discount window.” That was down from a record $153 billion last week. Banks can borrow from the discount window for up to 90 days. In a normal week, they only borrow about $5 billion like that.
The Fed also lent nearly $54 billion last week from a special lending facility it set up two days after Silicon Bank failed. That’s up from nearly $12 billion last week — when the program was just set up.
Banks with less than $250 billion in assets account for nearly half of all business and consumer lending and two-thirds of home loans, said Mark Zandi, chief economist at Moody’s Analytics.
“Credit is really the grease that drives the US economy and allows it to operate and grow at a steady pace,” Daco said. “With no credit — or with slow credit growth — we’re likely to see businesses become more hesitant when it comes to investment decisions, when it comes to hiring decisions.”
The tightening of bank credit, he said, “significantly increases the risk of an economy.” ____
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