Stay informed with our free updates from the Federal Reserve. Sign up now to receive a daily email digest, myFT Daily Digest, that compiles the latest news on the Federal Reserve every morning.
Don’t miss out on important updates from the Federal Reserve. Subscribe to our newsletter today!
The writer is a former chair of the US Federal Deposit Insurance Corporation and a senior fellow at the Center for Financial Stability
The decision of the US Federal Reserve to pause rate rises at its previous policy-setting meeting was a wise move. However, it appears that the Fed is now considering raising rates again. This decision could potentially undermine the progress made. It would be prudent for the Fed to maintain its current rates and refrain from further increases.
Although climate change may be causing extreme temperatures, inflation in the US is actually cooling down. In June, the consumer price index only increased by 3%, a significant drop from its peak of 9.1% in June 2022. The rate of producer price increases also slowed down.
The rising costs of housing and services have significantly slowed, and data from new leases indicates that residential rents are decreasing in some cases. Meanwhile, the economy remains strong, with an unemployment rate of 3.6% and the addition of 200,000 new jobs in June.
These positive trends suggest that inflation can be effectively controlled without adversely affecting the economy, as long as the Fed exercises caution.
Over the past 15 months, the Fed has implemented rapid and significant rate hikes, raising rates from near zero to over 5%. Additionally, the M2 money supply has experienced its largest decline since 1959, dropping by 4.6% year over year by April. Given that the Fed maintained near-zero rates for 14 years, the economy needs time to adjust to these drastic changes in monetary conditions.
While the economy has shown signs of adjusting, there are still potential challenges ahead. Trillions of dollars in corporate and commercial real estate have yet to be refinanced at higher rates, which will need to be addressed in the coming years. Households, although benefiting from savings accumulated during the pandemic, will face higher borrowing costs once those funds are depleted. Private sector job growth has also slowed down, posing risks to the labor market and small businesses.
Rapid rate increases could further distress the banking system, particularly regional and community banks. The Fed’s focus on raising short-term rates has resulted in a yield curve inversion, where short-term borrowing costs exceed long-term rates. This poses a threat to smaller banks that rely on higher rates for longer-term loans using short-term deposits.
If the Fed decides to raise rates again at this week’s meeting, it could mitigate the impact by only raising rates on bank reserves while maintaining rates for non-bank financial intermediaries. The Fed has the authority to adjust the interest it pays banks on their reserve accounts, incentivizing banks to keep their reserves with the Fed unless they can achieve higher returns by lending them out.
Furthermore, the Fed can lower the yield on the overnight reverse repo facility (ONRRP), which serves as a reserve account for non-bank intermediaries, such as money market funds. Currently, the ONRRP drains deposits from banks and contributes to financial instability. By reducing the yield on the ONRRP relative to the Fed’s target rate, money market funds would be encouraged to invest in creditworthy assets, stimulating the economy and improving bank stability.
The Fed is faced with difficult choices, but it must carefully consider the risks of further tightening, which could potentially lead to a recession and financial instability. If the Fed chooses to proceed with rate hikes, it should explore measures to mitigate the impact. Just as the Fed miscalculated the inflation risks of loose money policies, it should not underestimate the consequences of rapidly tightening monetary conditions. The safest option for now is to maintain the current rates.
Denial of responsibility! VigourTimes is an automatic aggregator of Global media. In each content, the hyperlink to the primary source is specified. All trademarks belong to their rightful owners, and all materials to their authors. For any complaint, please reach us at – [email protected]. We will take necessary action within 24 hours.
