The Federal Reserve got some unexpected help to stimulate the US economy and beat the worst inflation in four decades: reducing bank lending.
The upheaval in the financial system that followed the collapse of two major US banks raised the possibility that credit defaults would become more restrictive. Fewer loans mean less consumer and business spending. That, will make it more difficult for companies to raise prices, thereby reducing inflationary pressure.
At the same time, some economists worry that the slowdown could prove too severe to plunge the economy into a painful recession.
On Wednesday, the Fed raised its benchmark interest rate for the ninth time in more than a year. Central bank policymakers are grappling with persistently high inflation rates that have strained American households and added uncertainty beyond the economy. At around 6%, US inflation remains below last year’s peak but still well above the Fed’s annual target of 2%.
But the Fed has also signaled that it may be close to a rate hike. In part, this is because the decline in bank debt can help the central bank achieve its primary goal of slowing the economy and reducing inflation.
Speaking at a press conference on Wednesday after the Fed’s announcement, Chairman Jerome Powell suggested that tighter credit standards, which lead to loan withdrawals, could have the same slowing effect on inflation that Fed hikes can have.
“Not everything has to come from rate hikes,” Powell said. “You can come from tighter credit conditions.”
Also, after the European Central Bank raised its own benchmark rate by half a percentage point last week, its president, Christine Lagarde, said the ECB was not locking itself into a preset plan for rate hikes and that future rate decisions would follow. meeting-to-meeting basis.
Concerns about the European banking system “might have an impact on demand and maybe do some work that can be done with monetary policy,” Lagarde said just days after two major US banks collapsed and Swiss banking giant Credit Suisse required a rescue by rival UBS.
Indeed, if Europe is in a credit crunch, analysts say, the ECB’s rate hike last week could be the end of it.
ECB officials said the banks were “resilient” and had strong enough capital and cash buffers to cover any deposit withdrawals. European supervisors have adopted international standards, requiring more ready cash. By contrast, US regulators exempted all of the largest US banks. Silicon Valley Bank is one of the exempted banks.
And when loans are more expensive and harder to qualify for, consumers, who drive most of the US economic growth, are less likely to spend.
Gregory Daco, chief economist at the consulting firm EY-Parthenon, said he thinks the significant credit squeeze will have a “slightly greater” economic impact than the quarter-point increase the Fed announced Wednesday.
Edward Yardeni, an independent economist, said he would have thought the impact would have been larger — the equivalent of a full percentage point hike by the Fed.
Inflation could slow as a result, helping the central bank meet its long-held goals. But the toll on economic growth could be substantial. Most economists say they expect a recession in the United States in the second half of this year. The main question is how heavy 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. In the face of rising rates and a worsening economic outlook, banks have become more stingy about approving loans to businesses by the end of 2022, according to a Fed survey of bank lending officials.
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 banks has only increased. Silicon Valley Bank, which had been the nation’s 16th largest bank, failed after racking up huge losses on its bond portfolio that left depositors worried about withdrawing their money. Two days later, regulators 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 paper losses of $620 billion in investment portfolios at the end of last year. That’s largely because higher interest rates have reduced the value of holdings in the bond market.
Powell declared on Wednesday that the banking system is “sound” and “resilient”. But fears remain that more depositors will pull money from all but America’s biggest banks, increasing pressure on financial institutions to lower prices and save cash to meet withdrawals.
Cash-strapped banks are still lining up this week to borrow money from the Fed. The Fed said on Thursday that emergency loans to banks fell last week – to $164 billion – but remained high.
More than $110 billion in loans through a long-standing program called the “discount window.” That was down from a record $153 billion the previous week. Banks can borrow from the discount window for up to 90 days. In a normal week, they only borrow $5 billion that way.
The Fed also lent nearly $54 billion over the past week from a special lending facility it created two days after the failure of Silicon Bank. That’s up from nearly $12 billion the week before – when the program was just set up.
Banks with assets of less than $250 billion account for about half of all business and consumer loans and two-thirds of home mortgages, noted Mark Zandi, chief economist at Moody’s Analytics.
“Credit is really the lubricant that fuels the U.S. economy and allows it to function and grow rapidly,” Daco said. “Without credit – or with slower credit growth – we will see businesses more hesitant when taking investment decisions, when taking decisions.”
A tightening of bank credit, he said, “actually increases the risk of recession.” ____