Financial or price stability? Fed faces calls to pause

With the recent banking crisis causing disruption in global markets, some financial industry executives are urging the Federal Reserve to pause its monetary policy tightening for the moment and resume raising rates later as necessary. Currently, investors predict a 60% probability that the Fed will raise interest rates by 25 basis points during their upcoming meeting on Wednesday. However, some suggest that the central bank should prioritize financial stability over price stability at present.

Peter Orszag, Lazard Ltd.’s Chief Executive of Financial Advisory, suggests going fast and hard on financial stability while going gradual and slow on price stability. The Fed has increased interest rates rapidly over the past year, with the European Central Bank following suit by raising rates by 50 basis points earlier this week. This rise in rates has triggered significant global market responses, including bank failures and fluctuations in asset prices.

While some market observers note a sustained pause could lead to concerns over a consumer price rebound, others suggest that the current banking difficulties are only liquidity issues that the Fed can successfully handle with its lending facilities. However, they note that the real “wild card” is the market reaction. James Tabacchi, CEO of broker-dealer South Street Securities, feels that the Fed should pause to see the market stabilize.

In addition, Orszag, who served as Director of the U.S. Office of Management and Budget during the Obama administration, argues that there are disinflationary trends resulting in the current economic conditions. Orszag and co-author Robin Brooks, Chief Economist at the Institute of International Finance, believe that delivery time lagged effects explain between 30%-70% of elevated core PCE inflation during Q4 2022. Such effects of pandemic supply chain disruptions and the limited demand for travel and entertainment will turn into disinflationary forces this year.

Torsten Slok, Chief Economist at Apollo Global Management, thinks the recent banking crisis disruptions have already tightened financial conditions. Monetary conditions have tightened to a degree where there’s a higher risk of a potential economic slowdown. BlackRock Inc. strategists believe the gyrations of the past week indicate the damage done by quick rises in interest rates and the markets are already pricing in a recession.

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