Federal Reserve Facing Trilemma Challenge – Will It Win?

The Federal Reserve is currently facing a trilemma challenge with limited tools to deal with inflation, job market, & bank failure simultaneously. The article examines each of these challenges in detail & analyzes why Federal Reserve Facing Trilemma Challenge and the Fed’s response to it.

Introduction

Trilemma is familiar concept for many economic background people. For people of other backgrounds just to understand the basic concept here is the definition “A trilemma is a difficult choice from three options, each of which is unacceptable or unfavourable.” (Source: Wikipedia). Federal Reserve is facing three challenges with its limited tool. 

Federal Reserve Facing Trilemma Challenge

With the Federal Reserve facing Trilemma Challenge – What is Federal Reserve going to do? Will it emerge as a winner? We need to wait and watch. This article we are going to see all the three challenges that is Inflation, Job Market and Bank Failure – which the Federal Reserve is facing now. This article ends with our perspective. Let’s delve into the subject now.

Inflation

According to the U.S. Bureau of Labour Statistics (BLS) the All Urban Consumers Index (CPI-U) inflation, Seasonally Adjusted, rose by 0.4% in February – this is a decrease 0.1% compared to January’s (0.5%) data. For the last 12 months, the all item index rose by 6% before seasonal adjustment. This is the marginal 12-month increase since September 2021.

The food index also increased by 0.4% over the month with the food at home index rising 0.3%. Energy index decreased by 0.6% over the month – this is due to decline in fuel oil and natural gas index. 

The core index (i.e. all items less food and energy) inflation increased by 0.5% in February (compared to 0.4 increase in January). The 12-month core index inflation increased by 5.5% – this is smallest increase since December 2021. The energy index increased by 5.2% for the 12-moth and food index increased by 9.5% over the last year.

Job Market

In February, the Job Market data showed that Employers added 311,000 jobs. The unemployment rate rose to 3.6% last month because more people look for Job – a sign of economic strength (in a way). This actively seeking employment rate has increased from 62.4% to 62.5%; this is the highest level of labour-force participant rate since March 2020. However, in February, the wage growth moderated despite strong labour demand. This shows that job market is still tighter even though relaxed a bit. 

Fed’s Battle against Inflation

In February, the Fed officials slowed their leap of rate raise while they have increased its benchmark rate by 0.25% to a range between 4.5% and 4.75%. In December 2022, there was increase of a larger 0.5% and an increase of 0.75% in November (same in the 3 previous meetings). This is first time since the 1980s, the Federal Reserve has raised the interest rate at the fastest pace ever – from near zero to more than 4.5%. 

Federal Reserve is still on hiking spree and it has many times reiterated that it will not stop the goal is achieve (i.e. to bring inflation to its 2% target). 

So far so good but what will happen now? What will happen now, will there be another interest rate hike? Well, here is another headache and problem to handle for Federal Reserve. 

Bank Failure

On Friday (i.e. 10^th March 2023), Silicon Valley Bank (SVB) Collapsed. This is the second-biggest bank failure in U.S. history. It happened after the SVB – tech-based lender’s plans to raise fresh capital got failed/doomed.  The reason for the failure is mainly attributed to rising interest rates as that hurt the value of bond that bank had them in their portfolio.

According to Federal Reserve, the assets of the SVB is some $209 billion and it is the 16^th largest bank in U.S. This is the second biggest bank to fail after Washington Mutual Inc. 

Another two banks Silvergate and Signature has went out of business last week. 

Federal Reserve in War Front (Our Perspective)

One side inflation is not in control, on another front the Job Market is not tighter yet, and above all there are Bank Failures. Second-Biggest Bank Failure in U.S. history – Silicon Valley Bank.

By seeing the Job Market data, Federal Reserve will not be convinced at all to put brakes on Interest Rate hikes. It is because Job market is still tighter. Inflation data is showing a marginal sign of decrease which is okay for Federal Reserve to consider slowdown in hiking the pace of interest rates. 

What now the major concern is Bank failures. The trouble (or) problem of such bank failure is it may spread across the financial spectrum/ sector. Therefore, now, Fed has to consider whether it should go for rate hike. 

As we reiterated in our earlier article that Fed is trying to slow down investment, spending, and hiring, to control inflation. We also stated in the same article that “Any policy measure has a certain time lag to see its results or response from the economy”. Now, the economy is showing some sign of resistance and breakdowns, What Fed is going to do now? We feel (actually reiterate) that a Pause for now (if not decreasing the interest rates) will save the economy from the ongoing distress instead of Fed going for the kill.

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