Power & Market

Banking Crisis (Not the Fed) To Cause Recession?

One of the most dishonest headlines of the week goes to CNBC:

Fed expects banking crisis to cause a recession this year, minutes show

CNBC absolves themselves by citing that this was said in the Fed minutes, yet it does raise some interesting considerations, the idea that the upcoming recession will be due to a banking crisis.

Market contacts observed that the recent developments in the banking system will likely result in a pullback in bank lending, which would not be reflected in most common financial conditions indexes.

How much a bank “should” lend is anyone’s guess, but with rates on the rise and the Fed’s Quantitative Tightening of last year, it’s understandable lending activity would decrease. Anecdotally, other than mortgage loans, small business owners can attest that banks haven’t been lending to main street for a long time, save for government backed programs.

The Fed continues to place fault on the banking sector, as explained:

Given their assessment of the potential economic effects of the recent banking-sector developments, the staff’s projection at the time of the March meeting included a mild recession starting later this year, with a recovery over the subsequent two years.

An irreconcilable turn follows, with the prediction that:

In 2024 and 2025, both total and core PCE price inflation were expected to be near 2 percent.

On one hand the Fed thinks a recession will happen this year, with a recovery to happen in 2024 and 2025, but on the other hand, inflation will remain at 2% during this time.

Unfortunately, last month gave the world a glimpse of what is to come in the next recovery. It happened fairly quickly, but over the course of one week in March, the Fed expanded its balance sheet by $300 billion, and then $100 billion the following week.

If the Fed created a few hundred billion dollars to save a few troubled banks, imagine the response they’ll give once larger banks fall on hard times. Even worse, should the banking crisis be only a small part of the problem, the Fed’s desire to intervene will be even greater. And never forget that $5 trillion was required to fix the last crisis; they’ve given us nothing to believe that next time will be different.

No one knows how bad it will get, and how large the Fed response will be, but don’t expect a mild response any more than a soft landing. The March monetary inflation event reaffirmed this. Nonetheless, the meeting closes.

Members concurred that the U.S. banking system is sound and resilient.

And so, members of the Fed’s inner circle deem the banking system both sound and resilient but warn that a banking failure is ahead. They expect a recession this year and 2% inflation during the period of recovery. While they’re not wrong about the upcoming recession, they might be overly optimistic about their response to the recession. All they have is the ability to print more money and lower rates, so it’s difficult to imagine "low" inflation during any alleged recovery. Lucky for the Fed, they’ll suffer no adverse consequences for their actions because according to them, the crisis won’t be their fault.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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