The recent severe turmoil in the international banking system confirms that efforts by central banks to curb inflationary expectations are costly and time consuming. Spending or employment may not be as tight as predicted, and the economy may be remarkably resilient for the time being, but so-called “precision” for households and businesses is not the only collateral damage needed in the short term to curb inflation.

Monetary policy has an obligation to protect the financial stability of the system, in addition to inflation. In America, the Fed’s interest rate hike may have been extraordinarily harsh – after being slowly correctly diagnosed with inflation – and contributed to the solvency crisis of the non-systemic SVB and FS banks, but the problem lies in the weakening of supervision, which led to an extremely low “resolved” diversification of loans, as well as investment portfolios without insurance. But apart from assets on the balance sheet, as well as liabilities, the list of contributors was just as undifferentiated, $74 billion of startups, top managers, etc. When the latter decide to withdraw deposits, selling assets at a discount involves a loss that requires an injection of capital. Problems of solvency and liquidity reinforce each other in the face of the loss of perhaps the most important intangible asset, which is “trust”.

This banking system, although non-systemic, is to some extent internationally distributed, from Asia to Europe. However, the loss of “trust” worries ordinary people, and the drastic development raises suspicions of further problems. Logically, the weakest links should suffer. Credit Suisse has been facing mismanagement for about 15 years, with billions of dollars in fines for money laundering, tax evasion, etc. Despite capital injections and a relatively good liquidity situation, the new management is facing deposit runs. The intervention of the Swiss central bank with an open credit line of 50 billion restores liquidity after an earlier statement about the withdrawal of capital support by a major shareholder signaled imminent danger.

In this context, the ECB has decided to stick to its guidance of raising interest rates by 50 basis points to 3%, but without further guidance, saying it has all the funds (LTRO) to support the banking system if needed. I can say that such a movement was taken into account by the markets, but from now on it is impossible to be sure of the consequences of further tightening of monetary policy. We are clearly approaching the limits of this policy.

* Mr. Theodoros Pelagidis is Deputy Governor of the Ministry of Finance, Professor of Economic Analysis at the University of Piraeus.