Former Treasury Secretary Lawrence Summers believes the probability of the United States entering a recession has spiked, pointing to tightening credit conditions.
Now, the data is less relevant due to the prospects of a credit tightening, he said. “We’re getting a sense that there is some substantial amount of constriction in credit.”
After the collapse of Silicon Valley Bank (SVB) in March, almost $174.5 billion in deposits left the banking system the following week, according to data from the Federal Reserve. Most of the money went into money market funds. The banking crisis triggered by SVB’s collapse has raised concerns about access to credit.
Business activity is indicating a slowdown, adding to worries of recession. In March, the Institute of Supply Management’s manufacturing activity gauge fell to its lowest level since May 2020. This is also the lowest reading since 2009 once the pandemic is excluded.
Meanwhile, venture capital funding for start-ups declined by 55 percent in the first quarter of 2023 compared to the same period a year ago. This is the lowest level in over five years.
The Conference Board Leading Economic Index (LEI) for the United States fell for the 11th straight month in February, which is the longest slump since the collapse of Lehman Brothers in 2008.
Fed Rate DecisionThe Federal Reserve had raised its benchmark interest rates multiple times in the past year, pushing it up from around 0.5 percent to a range of 4.75 to 5 percent. However, the current banking crisis poses a challenge to this policy of rate hikes.
“I think the Fed’s got very, very difficult decisions ahead of it—with very much two-sided risk,” Summers said. These two-sided risks are a reflection of the consequences of the American economy overheating, he added.
The former Treasury Secretary pointed out that the Fed’s internal models failed to anticipate the rising inflation which kicked off in 2021 as well as risks emerging in the banking system as a result of SVB’s collapse.
“Business as usual at the Fed has not been successful over the last two and a half years.”
Some Fed officials, like St. Louis Fed President James Bullard, are pushing the central bank to continue the policy of rate hikes. Summers is not sure about the Fed continuing such a policy. “What’s pretty clear is that we’re in the very late innings of the current tightening cycle,” he said.
“Whether there’s going to be another move necessary or not, I think that’s a judgment they should be holding off on until the very last kind of moment,” he said about the Fed policymakers. The upcoming Fed meeting to decide interest rates is scheduled for May 3.