Fed’s challenge: Confront inflation, ease bank jitters
Economists signal central bank will raise rates quarter-point to tackle problems
WASHINGTON — Still grappling with persistently high inflation, the Federal Reserve faces an entirely new — and in some ways conflicting — challenge as it meets to consider interest rates this week: How to restore calm to a nervous banking system.
The two problems would normally push the Fed in different directions: To fight elevated inflation, it would raise its benchmark rate, perhaps substantially, for the ninth time in the past year. But at the same time, to soothe financial markets, the Fed might prefer to leave rates unchanged, at least for now.
Most economists think the Fed will navigate the conundrum by raising rates by just a quarter-point when its latest policy meeting ends Wednesday. That would be less than the half-point hike that many economists had expected before the recent collapse of two large banks. But it would still mark another step by the Fed in its continuing drive to tame inflation.
If the Fed were instead to leave rates alone, which some analysts last week had suggested it might do given the banking turmoil, it could alarm Wall Street traders by suggesting that significant problems remain in the banking system.
Vincent Reinhart, a former top Fed economist now at the investment bank Dreyfus-mellon, noted that the central bank prefers to manage financial stability issues separately from its rate decisions. One goal of a series of emergency steps the Fed announced Sunday to bolster the banking system is to allow it to separately address inflation through its rate policies.
“If you are obviously seen as adjusting your monetary policy because of concerns about financial strain, then you’re admitting you’re not (successfully) doing ... crisis management,” Reinhart said.
Last week, the European Central Bank imposed a half-point rate hike to try to reduce an 8.5% inflation rate despite jitters caused by the struggles of Switzerland’s second-largest lender, Credit Suisse. ECB
President Christine Lagarde said she saw “no tradeoff ” between fighting inflation and preserving financial stability.
The Fed intervened in the banking emergency a little over a week ago by joining with the Treasury Department and the Federal Deposit Insurance Corporation to announce that the government would protect all of the banks’ deposits. It also unveiled an expansive emergency lending program to provide ready cash for banks and other financial institutions. And it sweetened the terms for the banks to borrow from a long-standing Fed facility known as the “discount window.”
On Thursday, the Fed said it had lent nearly $300 billion in emergency funding to banks, including a record amount from the discount window.
Assuming that those programs work as intended, the Fed can focus on its ongoing campaign to cool inflation.
Most recent economic reports point to a still-hot economy with strong hiring, steady consumer spending and persistent inflation.