AP
- Paul Krugman has warned the banking chaos has increased the risk of a US recession.
- The Nobel Prize-winning economist advised the Fed to hold off on hiking interest rates again.
- Krugman cautioned that cutting rates could signal to investors that regulators are panicking.
The US banking turmoil has boosted the odds of a recession, so the Federal Reserve should stop turning the screws on the economy for now, Paul Krugman has said.
"Everyone is wondering what other landmines may be about to go off," 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 pressures on First Republic Bank. Fears of further mayhem have rattled financial markets in recent days.
Krugman dismissed "apocalyptic warnings about hyperinflation and the imminent collapse of the dollar," noting that depositors pulling their money out of banks typically relieves upward pressure on prices.
He explained that people moving their cash to bigger banks and money market funds should tighten economic conditions. More stringent regulations and stricter capital and liquidity requirements mean those institutions engage in less business lending than small and mid-sized banks.
Moreover, Krugman noted the threat of further bank runs might spook lenders, spurring them to loan out money more cautiously.
"We're probably looking at a serious reduction in credit," he said, equating the economic impact of tighter lending to the Fed lifting interest rates.
"Clearly the risk of a recession has gone up and the risk of inflation has gone down," he continued. As a result, he proposed 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 has raised interest rates from nearly zero to upwards of 4.5%. Wall Street analysts largely expect it to approve another 25-basis-point increase on Wednesday, despite the current upheaval in the banking sector.
Unlike Elon Musk, Krugman didn't go as far as supporting an immediate rate cut. The former Princeton and MIT professor cautioned that "might convey a sense of panic," although forging ahead with further hikes would signal "a sense of cluelessness."
Krugman praised regulators' handling of the banking mess so far, particularly their swift intervention to protect SVB and Signature's depositors. He also brushed off concerns about systemic risks posed by the chaos.
"This doesn't look like a full-blown financial crisis," he said. "Stay tuned, though."