Monetary policy

Rising rates and financial stability

Less than 48 hours since my last note where I said I was reading “A History of the Federal Reserve”, Silicon Valley Bank (SVB) collapsed and is now under FDIC control. SVB has asset of $200B and its failure is the largest since the 07/08 US financial crisis and the second biggest in US history. The impact on tech companies and the other US banks is yet to unfold and to be seen, though I believe the damage will be limited and contained thanks to the quick actions taken by the FDIC.

The failure of SVB may be attributed to many reasons but I think by large this is induced by the faster and higher interest rate hikes by the Fed in the past year. The Fed is narrow minded on inflation control at the prices of economic recession and financial stability.

  1. In my view, inflation is a natural phenomenon from the pandemic. The pandemic caused severe damages to our society, one of the terms is that our money should not be as value as before. We should understand and allow a one time inflation. The Fed should have stick to its thinking of transitory nature of inflation dynamics and allow time to settle its internal dynamics, and should have avoided excessive responses by hiking rates so aggressively.
  2. The Fed failed to understand the employment dynamics. The hot labor market is only part of whole picture of the labor market. The tight labor condition is only in a few areas such a leisure and hospitality, health care where labor supplies were severely impacted by the pandemic, and it’s a process to return to normalcy and really nothing like a hot market. The demand of quality jobs with higher pays have been shrinking. Major tech companies have cut average 5% work forces and more cuts are likely.
  3. Maintaining price stability is a mandate assigned to the Fed, but that does not mean only Fed has the responsibility in inflation control. Government and their agencies have their roles as well. The price of natural gas is now down to $2.5/btu from $9.0/btu, why my heating bill remains the same? What the government regulators are doing to reduce my gas bill? I hope the government can do their jobs to ease inflation.