Federal Reserve Hikes Interest Rates Again, Despite Bank Failures

One analyst said this interest rate increase, the ninth in the past year, shows the Fed's "willingness to roll the dice" with the economy.
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WASHINGTON ― The Federal Reserve on Wednesday continued to ramp up its efforts to slow the economy, despite recent bank failures caused partly by rising interest rates.

The central bank announced it is raising interest rates by another quarter of a percentage point, the ninth rate hike since the Fed kicked off its battle against inflation in March 2022.

Even as he said the banking system remains resilient, Federal Reserve chair Jerome Powell also noted Wednesday that the recent instability in it would actually help the Fed in its mission to fight inflation.

“The events of the last two weeks are likely to result in some tightening of credit conditions for households and businesses and thereby weigh on demand on the labor market and on inflation,” Powell said.

“You can think of it as being the equivalent of a rate hike, or perhaps more than that. Of course, it’s not possible to make that assessment today with any precision whatsoever.”

While Powell said bankers becoming more choosy in their lending may help the central bank’s efforts to fight inflation, one economist said the decision to hike rates may hurt its efforts to stabilize the banking system.

“The Fed’s decision to raise rates is incongruous with efforts to reestablish the stability of the financial system,” Mark Zandi, chief economist with financial analysis firm Moody’s Analytics told HuffPost in an email.

“It shows a willingness to roll the dice with the financial system and economy to get inflation down more quickly,” he said.

“The last few weeks of financial turmoil have shown that interest rate hikes are wreaking havoc on our financial system. Adding more fuel to the fire will only exacerbate the instability that is of the Fed's own making.”

- Rakeen Mabud, chief economist with Groundwork Collaborative

Higher interest rates make money more expensive to borrow, causing people to spend less. The Fed is hoping the economy will cool off just enough that businesses set lower prices for goods and services.

But another potential consequence of higher rates is financial instability ― not to mention potentially massive layoffs.

Policymakers at the Fed, including Powell and other members of the central bank’s board of governors, indicated they expect the national unemployment rate to rise to 4.5% this year, a tenth of a percentage point less than they expected when they last released an estimate in December.

“That’s an estimate of what will happen as demand slows, and as conditions soften in the labor market, and it’s just ― it’s a highly uncertain estimate,” Powell said. “There are real costs to bring it down to 2%, but the costs of failing are much higher.”

Overall annual inflation has fallen from its peak of 9.1% last summer to 6% in February, but the recent pace of decline has been too slow for the Fed’s liking.

The Fed’s strategy has been controversial from the start, with progressives calling on the central bank to lay off the rate hikes so as to avoid causing a recession. After all, the higher prices resulted partly from supply chain problems ― such as factories shutting down in China because of COVID ― that are entirely outside the Fed’s control.

But the recent failure of Silicon Valley Bank in California illustrated another way that interest rates can cause economic turmoil ― by making investors complacent about the risk of interest rates rising after a long period of cheap money.

Customers and bystanders form a line outside a Silicon Valley Bank branch location on March 13. The bank's failure sent shock waves throughout the U.S. and global banking systems.
Customers and bystanders form a line outside a Silicon Valley Bank branch location on March 13. The bank's failure sent shock waves throughout the U.S. and global banking systems.
via Associated Press

Silicon Valley Bank invested depositors’ money in low-yield government bonds that lost value when interest rates rose last year. When panicky depositors started withdrawing their money last month, the bank couldn’t pay them. (BuzzFeed, HuffPost’s parent company, banked with SVB.)

“Today’s rate hike is a reckless move by Chair [Jerome] Powell and the Fed,” Rakeen Mabud, chief economist with Groundwork Collaborative, a group of progressive economic experts, said Wednesday. “Chair Powell knows that his aggressive rate-hiking campaign has the potential to cause mass unemployment and economic devastation for millions across the country.”

“The last few weeks of financial turmoil have shown that interest rate hikes are wreaking havoc on our financial system,” she said. “Adding more fuel to the fire will only exacerbate the instability that is of the Fed’s own making.”

In addition to overseeing the money supply, one of the Fed’s jobs is supervising banks ― which it seemingly failed to do in Silicon Valley Bank’s case, after Congress passed a law in 2018 telling regulators to go easy on regional financial institutions.

The Federal Reserve, the U.S. Treasury Department and the Federal Deposit Insurance Corporation swooped in to guarantee deposits at SVB and to make loans available to other regional banks with antsy depositors. Some Republican lawmakers decried the moves as a “bailout,” but officials insisted they had to make depositors whole in order to prevent a broader financial crisis.

Powell blamed Silicon Valley Bank’s failure on a run by panicky depositors, but he suggested the Fed deserved some blame as well.

“Clearly we do need to strengthen supervision and regulation,” Powell said.

He added that while there were factors that made Silicon Valley Bank “an outlier” in terms of risk, the speed with which depositors attempted to withdraw their money showed potential systemic changes need to be looked at too.

“It’s very different from what we’ve seen in the past, and it does kind of suggest that there’s a need for possible regulatory and supervisory changes, just because supervision and regulation need to keep up with what’s happening in the world,” he said.

On Capitol Hill, the Fed’s move drew criticism from lawmakers in both parties. Rep. Brendan Boyle (D-Penn.), the top Democrat on the House Budget Committee said, “Raising rates too high and too fast — especially in this moment — could jeopardize the record recovery Americans have enjoyed under President Biden.”

“Higher interest rates mean more Americans unable to buy a home, small businesses can’t get a line of credit, and families buried in credit card debt they’ve taken on just to get through these last two years,” said Rep. Jason Smith (R-Mo.), chairman of the House Ways and Means Committee.

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