How Can The Fed Control Inflation Without Endangering More Banks?

A delicate balancing effort can be seen in the Federal Reserve's decision to increase borrowing costs by a quarter of a percent on Wednesday while also indicating that the rate hike cycle is about to come to an end. The Fed wants to keep fighting inflation without making matters worse for the struggling banking sector.

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It's unclear how much longer banking issues will continue to impede the Fed's ability to act. That was the consequence from the Federal Open Market Committee’s up in the previous statement & Chairman Jerome Powell’s following press conference.

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Take the Fed's policy statement, for instance, where a formerly clear assertion that "ongoing hikes" in the federal-funds rate would've been appropriate was replaced with more ambiguous language acknowledging that "some" further tightening "may" be required.

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The Summary of Economic Projections, too, reflected divisions over the way forward. The median rate projection for 2023 remained at 5.1% from the last Fed meeting, but the range revealed that projections varied widely: some Fed officials see no additional rate hikes this year, whereas others are asking for a full point of additional tightening.

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In his press conference, Powell highlighted numerous times that the Fed would have to wait to observe how much lending is being affected by the banking crisis—and consequently, how much the economy is being slowed—before deciding what to do next.

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Powell told reporters that it was "very unknown" how long the scenario would last or how substantial any of the impacts would be. So we'll just have to wait and see.

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For the Fed, which is attempting to calm both financial unrest and high inflation without sending the economic recession, the shift in language marks a difficult new chapter. Also, even though the central bank has already been increasing interest rates to slow the economy, the financial crisis, which is likely to limit growth—although no one is certain by how much or for how long—is now complicating efforts to slow inflation.

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Ian Shepherdson, senior economist of Pantheon Macroeconomics, summarized the situation as follows: "In short, the statement, policy interventions, and dots signal plainly that the Fed is anxious."

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Powell, for his part, tried to reduce some of the anxiety on Wednesday by restoring trust in the US banking system after escaping deposits caused both Silicon Valley Bank and Signature Bank to fail. He stressed that problems at the two failing banks aren't widespread throughout the banking sector, characterizing the past two weeks of banking instability as "severe difficulties at a limited number of banks." He also informed the media that "all savings of depositors in the financial system are safe."

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Nonetheless, many economists are now predicting a recession in the wake of the banking issues. Furthermore, the Fed itself revised its growth projections downward for each of the following two years.

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According to Tiffany Wilding, a North American economist with PIMCO, "the odds of a sooner, deeper recession have grown, as financial stress has increased at a time while economic circumstances were already tight."

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However, there are currently more inquiries than responses for economists and investors. Has the rate of interest peaked? What would happen if the banking system remained unstable as inflation rose once more? What is the Fed do in the event that another bank fails?

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The Fed of 2022 was heavily foreshadowing its next movements and let investors know what to anticipate, so the current dynamic marks a substantial change from that time period. In which the Fed of 2023 will just go next can only be predicted with time.

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