Will Bank Turmoil Tank the Economy?

"One Federal Reserve official has suggested the trouble that Silicon Valley Bank touched off makes a recession more likely.

As government officials testify before congressional committees on the fallout from recent banking collapses, a major question looms: What will this mean for the economy?

Federal Reserve officials have been clear that they expect a slowdown in bank lending tied to the tumult to weigh on economic growth this year, but the magnitude is uncertain. And much of the potential fallout depends on what comes next.

If the banking turmoil blows over in the coming weeks, lending and financing standards could return to something like normal — and the economic fallout might not be substantial.

But if the upheaval continues, or if it creates knock-on effects in other parts of financial markets and the economy, the hit could be meaningful. If the banking trouble makes it harder to take out loans or issue debt, it means fewer businesses can expand and hire staff, among other troubles. Those problems could even be enough to push America toward a recession.

“It definitely brings us closer” to a downturn, Neel Kashkari, the president of the Minneapolis Fed, said on CBS News’s “Face the Nation” this weekend. “Right now what’s unclear for us is how much of these banking stresses are leading to a widespread credit crunch.”

Mr. Kashkari noted that some capital markets have been largely closed for weeks, and that if “capital markets remain closed because borrowers and lenders remain nervous, then that would tell me, OK, this is probably going to have a bigger imprint on the economy.”

The riskiest companies have been mostly frozen out of debt markets since early this month. At the same time, some of the healthiest corporate borrowers have managed to issue bonds again this week — a hopeful sign — though their borrowing costs were unusually elevated.

Investors and economists are watching for other risks, like the effect of banking turmoil on commercial real estate, which was already confronting pandemic-spurred office vacancies and which has traditionally relied on small and midsize banks for loans.

With the scope of the fallout so unpredictable, Fed officials have been hesitant to react too decisively.

Central bankers raised interest rates by a quarter-point last week as they continued their fight against inflation, while also suggesting that they did not know what would come next.

“Events in the banking system over the past two weeks are likely to result in tighter credit conditions for households and businesses, which would in turn affect economic outcomes,” Jerome H. Powell, the Fed chair, said at a news conference after the rate increase. “It is too soon to determine the extent of these effects and therefore too soon to tell how monetary policy should respond.”"