Following the turmoil that started with a run on Silicon Valley Bank, there is uncertainty about whether the Fed will raise rates again—or pause
actions work through financial conditions.” So said Jerome Powell, chairman of the Federal Reserve, late last year, referring to the causal chain of monetary policy. As interest rates rise, tighter financial conditions lead companies and consumers to cut spending, prompting economic slowdown and lower inflation. The past ten days have illustrated a less desirable causal chain: from higher rates to aThese stormy financial conditions pose a dilemma for the Fed.
Second, instability is itself a drag on the economy. As confidence cracks, firms try to preserve capital. Banks lend less and investors pull back. Measures of financial conditions—which include interest rates, credit spreads and stock values—have tightened sharply in the past ten days. Eric Rosengren, a former president of the Fed’s Boston branch, has compared it to the aftermath of an earthquake.
A rate rise would also demonstrate that the Fed can chew gum and walk at the same time. In an ideal world officials should be able to manage financial stability while keeping inflation in check. With a combination of deposit guarantees, a new liquidity facility and support from bigger banks, a framework is now in place to shore up America’s financial institutions.
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