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Fed struggles to balance growth, stability amid inflation surge

US banking crisis sparks recession fears: Fed minutes
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March 23, 2023 (MLN): The Federal Reserve, the central bank of the United States, is facing a delicate balancing act as it tries to manage both the financial system and the macroeconomy.

On Wednesday, the Fed increased interest rates by a quarter-percentage point and signaled that another rate hike was likely in the future, in an effort to cool growth and bring down high inflation rates.

However, at the same time, the Fed has been lending generously to banks through its discount window to contain the damage caused by the failure of Silicon Valley Bank.

This highlighted the challenge the Fed faces in separating its two jobs, as higher interest rates can cool growth and inflation but also cause financial institutions to lend less, potentially leading to failures or a credit crunch.

The Fed's actions on Wednesday reflect its recognition that something was breaking, as recent data had indicated economic growth was accelerating and underlying inflation was stubbornly high.

Fed Chairman Jerome Powell indicated to Congress earlier this month that these trends would likely require rates to rise above 5.25%, but the projections released on Wednesday showed that the Fed had abandoned those plans and still saw the target range for the federal-funds rate topping out between 5% and 5.25% this year, unchanged from December's meeting.

The Fed's decision was influenced by concerns over a potential credit crunch, with officials nudging expected growth down to 0.4% this year from 0.5% in their December projections and 1.2% next year from 1.6%. However, there are concerns that the Fed may have overreacted or made the financial system more fragile by raising rates, potentially setting back the fight against inflation.

Despite these risks, the Fed's balancing act has been successful so far, with a systemic financial crisis avoided at a relatively low cost. However, there are still concerns over the fragility of the financial system and the potential for unforeseen risks to emerging.

As the Fed continues to navigate these challenges, it remains to be seen whether it can successfully manage both the financial system and the macroeconomy without causing unintended consequences.

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Posted on: 2023-03-23T13:00:34+05:00