Inflation, recession and the banks
Government spending can have both positive and negative effects on inflation, depending on various factors. When the government increases spending, it creates more demand for goods and services in the economy. If the supply of goods and services does not increase at the same rate as demand, this can lead to an increase in prices and therefore inflation.
When the government spends more money, it injects more money into the economy, increasing the money supply. If the supply of goods and services does not increase at the same rate as the increase in the money supply, the government will cause inflation.
The federal government can use fiscal and monetary policies to control inflation. Fiscal policy involves changing government spending and taxation, while monetary policy involves changing interest rates and the money supply. If the government increases spending while the central bank tightens monetary policy, it can help to control inflation.
The Federal Reserve has been increasing the interest rate. When the Federal Reserve raises interest rates, it increases borrowing costs, such as mortgage rates. Higher interest rates increase the cost of borrowing money, making it more expensive for businesses and individuals to take out loans. This can lead to a decrease in borrowing and investment, which can slow down economic growth, which is normally a significant driver of the economy.
Higher interest rates can make the currency more attractive to foreign investors, leading to an increase in demand for the currency and an appreciation in its value. This can make exports more expensive and imports cheaper, potentially leading to a decrease in net exports and a decrease in economic growth. This will cause the U.S. to lose more jobs and increase unemployment.
Higher interest rates can help to control inflation by reducing the money supply and decreasing cumulative demand in the economy. Increasing interest rates can help to prevent prices from rising too quickly. The Federal Reserve just increased the interest rate another 0.25%. The Fed has raised interest rates five times this year for an increase of 1.25% in just three months. They expect to further make more increases, which will not only affect consumers but also the banks. So far, increasing the interest rates has done little to slow inflation.
Some economists think that we are facing a recession. A recession is generally defined as a significant decline in economic activity that lasts for a sustained period, typically two consecutive quarters or more of negative Gross Domestic Product growth. Gross Domestic Product is the monetary value of all finished goods and services. GDP provides an economic snapshot of the U.S., used to estimate the size of its economy and growth rate.
The calculation of a country’s GDP encompasses all private and public consumption, government outlays, investments, additions to private inventories, paid-in construction costs, and the foreign balance of trade. Of all the components that make up our GDP, the foreign balance of trade is especially important. Right now, this is a negative because of our trade with
China. The U.S. exported a record $153.8 billion worth of goods to China last year. Yet, the gap between exports and imports in trade with China was $382.9 billion in 2022, which was also the second bilateral trade deficit highest on record. Because of this, the GDP of the U.S. tends to decrease.
When the price of assets, such as real estate or stocks, become overvalued and then abruptly drop, it can cause a ripple effect in the economy and lead to decreased investment and consumer spending. Economists at Goldman Sachs expect home prices to decline by around 5% to 10% from the peak in June 2022. Wells Fargo has recently forecasted that national median single-family home prices will drop by 5.5% year-overyear by the end of 2023.
With mortgage rates more than doubling since the start of this year, the calculations for a homebuyer have changed considerably. The monthly principal and interest mortgage payment on the median priced home is up $930 from a year ago, a 73% increase, according to Black Knight, a mortgage data company.
A decrease in consumer and business confidence can lead consumers and businesses to cut back on spending and investment. This decreases economic activity and leads to a recession. Recessions are complex and there may be multiple causes that contribute to their occurrence.
Inflation and high interest rates can have both positive and negative effects on banks, depending on various factors, such as increased net interest margins. When interest rates are high, banks can earn more money on loans, as they can charge higher interest rates on loans. This can increase their net interest margins, which is the difference between the interest earned on loans and the interest paid on deposits.
High inflation can lead to an increase in default risk, as borrowers may find it more difficult to repay their loans due to the higher cost of borrowing. This can lead to an increase in non-performing loans and decrease the profitability of banks.
When interest rates are high, banks have to pay higher interest rates on their own borrowing, such as through bonds or deposits. This can increase their cost of funding and decrease their profitability.
High interest rates can also decrease the demand for loans, as borrowers find it more expensive to borrow money. This can decrease the loan portfolio of banks and reduce their profitability.
Overall, the impact of inflation and high interest rates on banks depends on various factors such as the state of the economy, the level of competition in the banking sector, and the ability of banks to manage their risk effectively. This is what caused Silicon Valley Bank and others to fail, as they did not have enough available cash to handle withdrawals; and they had to sell bonds for a loss to cover the negative cash availability.
The financial health of America is a delicate balance, which needs to be watched closely or we will see more inflation, a recession or more bank failures.