The banking crisis increases the risk of recession, the Fed should not raise its rates

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Paul Krugman warned that the banking chaos has increased the risk of a US recession. The Nobel Prize-winning economist advised the Fed to halt interest rate hikes again. Krugman warned that falling rates could signal to investors that regulators are panicking. Something is loading.

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The US banking turmoil has increased the odds of a recession, so the Federal Reserve should stop turning the screws on the economy for now, Paul Krugman said.

“Everyone is wondering what other landmines might explode,” the Nobel Prize-winning economist wrote in his New York Times column on Tuesday.

He was referring to the sudden collapse of Silicon Valley Bank and Signature Bank, the government-backed takeover of Credit Suisse by UBS, and mounting pressure on First Republic Bank. Fears of further chaos have rattled financial markets in recent days.

Krugman dismissed “doomsday warnings about hyperinflation and the impending collapse of the dollar,” noting that depositors withdrawing their money from banks generally alleviate upward pressure on prices.

He explained that people transferring their money to bigger banks and money market funds should tighten economic conditions. Tighter regulations and stricter capital and liquidity requirements mean that these institutions engage in less business lending than small and medium banks.

Additionally, Krugman noted that the threat of further bank runs could spook lenders, prompting them to lend money more cautiously.

“We’re probably looking at a serious credit squeeze,” he said, equating the economic impact of a lending crunch with the Fed’s interest rate hike.

“It is clear that the risk of recession has increased and the risk of inflation has decreased,” he continued. As a result, he suggested the Fed refrain from further rate hikes until the fallout from the banking fiasco becomes clearer.

In response to historic inflation, the US central bank raised interest rates from near zero to over 4.5%. Wall Street analysts widely expect it to approve a further 25 basis point hike on Wednesday, despite the current turmoil in the banking sector.

Unlike Elon Musk, Krugman did not go so far as to support an immediate rate cut. The former Princeton and MIT professor warned that “could convey a sense of panic”, although going ahead with new hikes would signal “a sense of ignorance”.

Krugman praised regulators’ handling of the banking mess so far, especially their swift action to protect depositors at SVB and Signature. He also brushed aside concerns about the systemic risks posed by the chaos.

“It doesn’t look like a full-fledged financial crisis,” he said. “Stay tuned, though.”

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