In the aftermath of two failed banks, the crypto-focused Signature Bank and the 16th largest U.S. depository Silicon Valley Bank (SVB), economists are questioning the role of the Federal Reserve in the banking crisis.
Former economic adviser to President Ronald Reagan, Steve Hanke believes that the Fed’s contractionary policies have contributed to the current situation and that the central bank is poised to bring more pain.
Hanke, a professor of applied economics at Johns Hopkins University, emphasized the importance of money supply (M2) and its impact on the economy and inflation. In his view, the Federal Reserve needs to pay more attention to this economic indicator.
“Monetary policy is not about interest rates. It is about the growth in the money supply,” he told The Epoch Times. “Right now, the Fed is excessively contracting the money supply.
“The Fed seems unlikely to ease off contractionary policies—in part because the central bank wrongly focuses on the Phillips curve, which portrays inflation and unemployment as contrary forces.”
The Phillips curve, first proposed by economist A.W. Phillips in the 1950s, suggests an inverse relationship between inflation and unemployment. According to the theory, when unemployment is low, inflation tends to rise, and when unemployment is high, inflation tends to fall.
The Fed has traditionally used this theory to guide its monetary policy decisions. But Hanke argues that it is faulty and the Fed’s fixation on it does more harm than good.
Current unemployment levels lead the monetarist to conclude that more central bank tightening is still to come.
“Seeing a tight labor market, the Fed says it anticipates upward inflation pressures to persist through 2023, so quantitative tightening and high-interest rates will remain in place until further notice,” Hanke said.
The Fed’s policy of quantitative tightening involves reducing the size of its balance sheet by selling off assets, which reduces the amount of money in circulation. This policy is intended to curb inflationary pressures, but Hanke thinks it has gone too far.
“As I anticipated, this slowdown in the money supply growth has been so massive that it has caused significant problems in the banking sector,” he told The Epoch Times. “However, the Fed will pivot if it sees a crisis.
“If the Fed doesn’t adjust to this reality, it will greatly increase the chances of a recession or banking bloodbath.”
Government Intervention
According to the economist, such a crisis and pivot may soon occur, judging by what he sees in the markets.“On Friday, investors with skin in the game believed there was a 40 percent probability of the Fed hiking the Fed funds rate by 50 basis points,” Hanke said. “Today, that probability stands at 0 percent.”
The SVB collapse is just the latest example of the problems that arise in an environment of scarce liquidity. The tech sector, one of the main drivers of the economy in recent years, has been hit particularly hard by the downturn. Many startups and smaller companies are struggling to stay afloat, and some are even closing their doors for good.
Financial regulators have promised to assist the failed banks “in a manner that fully protects all depositors, both insured and uninsured.”
Professor Hanke deemed this course of action unwise, arguing that society should not be forced to subsidize the financial risks assumed by others.
“Depositors with over $250,000 on deposit thought that they were uninsured, and they were willing to take the risk,” he said.
“Why should they now be rewarded with a bailout gift from the government?”
