Fed is doing too much, all at once

People wait in Santa Clara to get into a Silicon Valley Bank branch on March 13, 2023. By Jeff Sommer

Published:
Sun 2 Apr 2023, 7:51 PM

The Federal Reserve is committed to reducing inflation. Promoting full employment is equally important. Each one of these goals is an example for others. The Fed has caused a wave of bank failures by tightening financial conditions in order to reduce inflation. In a Tuesday conversation, Mark Zandi (chief economist at Moody's Analytics) stated that "This is a very uncomfortable time." Zandi remains cautiously optimistic about the strength of the economy and the Fed's fight against inflation. If you're a long-term investor, it may be best to stick with your plans as long as you feel confident you can weather any difficulties. There are likely to be more unpleasant surprises. Silicon Valley Bank in California, which was a large clientele of the tech community, went bankrupt on March 10, in the worst US bank failure since 2008. It was a bank run with a 2023 twist: Social media fueled panic and involved billion-dollar depositors. Both banks were regulated by regulators. They invoked emergency authority to ensure that depositors had easy access to their money, even if they had more than $250,000 worth of deposits. This is the FDIC standard limit. The stress has been caused by the Fed's monetary policies. The Bank Term Funding Program is a new money channel that the Fed created in the current bailouts. Do not let the name fool you. Anybody who has ever owned a bonds fund will know that the last year was one of the worst for bonds. When interest rates were low, banks bought a lot of long-term bonds. These banking problems are fascinating because they were partially caused by the Fed and they are a boon to it right now. They will continue to be so long as they can be contained. The Fed's goal is to stifle inflation. A credit crunch caused by bank failures could quickly make it happen. He said that, "In principle," he stated, "as a matter fact, it can be thought of as the equivalent of a rate increase or possibly more." What is the impact on the financial system? The Fed's limited control over so-called'shadow banks' is one reason for the imprecision. These include money market funds whose almost 5% interest rates have attracted billions of dollars from traditional banks; large swathes of the economy controlled by private equity firms; and mortgage-issuing businesses that finance most private homebuying. It is also difficult at this stage to evaluate the effects of financial tightening upon important sectors of economy like commercial real estate. These areas have been severely hurt by rising interest rates and the unwillingness of many workers to return the office. It is also amazing that the Fed could help ease many of these problems by flooding the economy with money as it did during previous crises. The Fed's plans would be changed if there was a significant financial crisis and an accompanying economic downturn. It is possible to have luck and achieve something similar. Perhaps the Fed can beat inflation without changing course too early. This article first appeared in The New York Times