History of Banking Crises Holds a Warning for Jay Powell

Central banks have always struggled with striking a balance between financial stability and price stability. Raising short-term interest rates to maintain price stability can create problems for financial intermediaries like banks. The recent failure of Silicon Valley Bank, and the fear of a wider bank run in the United States, have led to emergency measures by the US financial and monetary authorities.

Last week’s events

Last week, regulators released their three-part plan to avoid a banking crisis. First, with the help of the Treasury Department and the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC) invoked the “systemic risk exception” to protect uninsured deposits at SVB and Signature. The Fed and the Treasury used the Federal Reserve Act’s 13(3) emergency authority to create a Bank Term Funding Program (BTFP) to lend against Treasuries and Agencies at par. Access to this program is anonymous.

The President of the United States, Joe Biden, announced that the banking system is safe and promised to do whatever is necessary to maintain financial stability. However, it remains to be seen how the recent measures will impact the effort to bring down inflation from 6% to the Federal Reserve’s target of 2%. Fed Chair Jerome Powell might have to consider this as the Federal Open Market Committee’s meeting approaches this Wednesday.

The risks of bank runs

The recent events highlight the risks of bank runs, which can affect individual and regional banks. Emergency measures may help to contain the risks of bank runs, but they come with a cost. For example, the Fed’s measures to expand its balance sheet may contradict its efforts to shrink it.

Lessons from history

The history of banking crises tells us that applying brakes to the economy can be risky, even if investors and policymakers expect a soft landing. The recent events in the United States and Europe show that financial stability can be fragile and that unforeseen circumstances can lead to emergency measures. Central banks should be prepared to act quickly and recognize the tradeoffs between financial and price stability.

Related facts

• Some economists argue that central banks should focus solely on maintaining price stability and allow other institutions to deal with financial stability.
• The recent events in the United States and Europe highlight the interconnectedness of the global financial system.
• The COVID-19 pandemic has created unprecedented challenges for central banks and has forced them to adopt unconventional monetary policies.

Key takeaway

Central banks must strike a delicate balance between financial and price stability. Recent events in the United States and Europe show that even the most robust financial systems can face unexpected challenges. As a result, central banks should be prepared to act quickly and recognize the tradeoffs between financial and price stability.

Conclusion

Jay Powell and other central bankers worldwide must be mindful of the lessons of history when it comes to maintaining financial stability. While emergency measures may be necessary in times of crisis, they come with costs that must be carefully weighed. The recent events in the United States and Europe serve as a timely reminder that the global financial system remains vulnerable and that the actions of central banks can have far-reaching consequences.