The Week Ahead: The Federal Reserve’s dual mandate balancing act with its other big responsibility

The Federal Reserve’s dual mandate for monetary policy says nothing explicit about stabilizing the banking system or shoring up Americans’ confidence in their financial institutions. The central bank has two goals when setting interest rates: maximum employment and stable prices.

Lots of jobs and low inflation. That’s it.

One of those objectives – inflation – has been the Fed’s sole focus for the past year. That concentration will be tested in the week ahead.

The dramatic actions last weekend by the central bank and other financial regulators to protect depositors of two failed banks and assure bank depositors en masse have recalibrated market expectations for Fed action when it announces its latest interest rate decision on Wednesday. Aggressive action in the agency’s year-long fight to bring down inflation was a casualty, as Americans were reminded just how fast a once stable and respected bank can collapse. Silicon Valley Bank’s downfall may have been its own mistakes, but make no mistake: the Fed’s own inflation fight was a factor.

This month marks one year since the Federal Reserve Open Market Committee began raising its target short-term interest rate. After months of describing inflation as “transitory,” the policymakers finally acted. It was the first rate hike in an economy fast recovering from COVID-19. The Fed’s borrowing cost has gone from nothing to 4.5% in the past year – a historic move that until this month was seen as having little noticeable impact beyond higher mortgage rates and other consumer borrowing costs. Sure, the stock market has been having a rough time, but that’s not the economy, right?

Job growth has continued, consumers kept spending, home prices remained stable. Then Silicon Valley Bank shattered the facade that the Fed’s inflation fight with higher interest rates had very little cost.

SVB’s and any other bank’s inability or unwillingness to adjust its assets to the central bank’s inflation fight is its responsibility. The aftermath, though, is the Fed’s.

This week, Fed policymakers now must balance its dual monetary mandate with its duties “to establish a more effective supervision of banking in the United States,” as was pledged in its founding 1913 law. Striking the balance may have the central bank sway away from efforts to steady prices with higher interest rates in favor of steadying confidence by slowing or pausing its rate hikes.

Buttressing trust in banks may come at the cost of higher and longer inflation.

Tom Hudson is a financial journalist and chief content officer at WAMU public radio in Washington, D.C. Follow him on Twitter @HudsonsView.