Goldman Sachs Raised the probability of a recession from 25% to 35% given the SVB-related turmoil (although their guess is still below consensus). This leads me to wonder what the net effect on economic activity is of the turmoil and the Fed’s response (easing tightening).
First, the path of Fed funds – as the market perceives it – on Sunday compared to a few weeks ago.
figure 1: Federal funds in effect (black) as of March 19 at 4:30CT (red square), March 14 at 1:30CT (pink square), March 8 (sky blue inverted triangle) and February 15 (green triangle) ), implied federal funds. Source: Federal Reserve via FRED, CME Fedwatch and author’s calculations.
By the end of the year, implied federal funds were about 180 basis points below where they were nearly two weeks ago. Ball and Swanson (air energy 2023) A shock of 100 basis points is estimated to reduce growth by 0.24 to 0.60 percentage points. Of course, a 180bp cut in interest rates is not really the “shock” considered in the VAR literature (the reduction is based on an inferred reaction function that takes into account the darker growth outlook), but let’s take that number as a ballpark. This would imply a less pronounced tightening adding about 0.4 to 1 percentage point to growth. Saying half of 180 basis points is a “shock” because it’s driven by concerns about the banking system. And then this has a positive impact of between 0.2 and 0.5…
Conversely, a shock to the banking system could reduce bank lending and thus growth. Luzetti et al. Deutsche Bank (“(Credit) Processing Figures”, March 20, 2023) estimates that a 10 percentage point increase in loan conditionality in the Senior Loan Officer Survey (SLoOS), which was typical in the recessions of the 1990s and early 2000s, would lead to Growth in the fourth quarter was reduced by 0.4 percentage points.
notes: A 10-point increase in SLoOS is approximately equal to a 1 standard deviation shock to FCI. source: Luzetti et al. (2023).
I wouldn’t take these as rough calculations, but it does serve as a reminder that recent developments can have offsetting effects.
