Inflation fight may get help from banking woes, less lending
WASHINGTON — The Federal Reserve is getting some unwanted help in its drive to slow the U.S. economy and defeat the worst bout of inflation in four decades: a cutback in bank lending.
The upheaval in the financial system that has followed the collapse of two U.S. banks is raising the likelihood that lending standards will become more restrictive. Fewer loans would mean less spending by consumers and businesses. That, in turn, would make it harder for companies to raise prices, thereby reducing inflationary pressures.
At the same time, some economists worry that the slowdown might prove so severe as to send the economy sliding into a painful recession.
On Wednesday, the Fed raised its benchmark interest rate for the ninth time in just over a year. The central bank’s policymakers are struggling with a persistently high inflation rate that has bedeviled American households and heightened the uncertainties overhanging the economy. At roughly 6 percent, U.S. inflation remains well below last year’s peak yet is still far above the Fed’s 2 percent annual target.
But the Fed also signaled that it might be nearing the end of its rate hikes. In part, that is because a decline in bank lending could help the central bank achieve its goal of slowing the economy and taming inflation.
Speaking at a news conference Wednesday after the Fed’s announcement, Chair Jerome Powell suggested that stricter lending standards, resulting in a pullback in loans, could have the same slowing effect on inflation that a Fed hike can.
“It doesn’t all have to come from rate hikes,” Powell said. “It can come from tighter credit conditions.”
Gregory Daco, chief economist at the consulting firm Ey-parthenon, said he thinks a significant credit squeeze would have “slightly more” of an economic impact than the quarter-point rate hike the Fed announced Wednesday.
Edward Yardeni, an independent economist, said he would estimate that the impact would be even larger — the equivalent of a full percentage point hike by the Fed.
Inflation could slow as a result, helping the central bank accomplish its goal. But the toll on economic growth could be substantial, too. Most economists have said they expect a recession to occur in the United States by the second half of this year. The main question is how severe it might be.
Signs of a possible credit crunch in the United States had begun to emerge even before Silicon Valley Bank collapsed on March 10, raising worries about the stability of the financial system. In the face of rising rates and a deteriorating economic outlook, banks were becoming stingier about approving loans to businesses at the end of 2022, according to a Fed survey of bank lending officers.
And bank “commercial and industrial” loans to businesses dropped last month for the first time since September 2021, according to the Fed.
Powell declared Wednesday that the banking system is “sound” and “resilient.” Yet fear remains that more depositors will pull their money out of all but the biggest American banks, intensifying pressure on financial institutions to lend less and conserve cash to meet withdrawals.
Cash-short banks were still lining up this week to borrow money from the Fed. The Fed said Thursday that emergency lending to banks fell slightly in the past week — to $164 billion — but remained high.
More than $110 billion in borrowing went through a program called the “discount window.” That was down from a record $153 billion the week before. Banks can borrow from the discount window for up to 90 days. In a normal week, they only borrow about $5 billion that way.
The Fed also lent nearly $54 billion over the past week from a special facility it set up two days after the Silicon Bank failure. That was up from nearly $12 billion the week before — when the program was just getting set up.
Banks with less than $250 billion in assets account for about half of all business and consumer lending and two-thirds of home mortgages, noted Mark Zandi, chief economist at Moody’s Analytics.
A tightening of bank credit, he said, “noticeably increases the risk of a recession.”