Indonesia has little exposure to SVB. Nevertheless, vigilance must still be increased by continuing to pay close attention to various domestic and foreign micro-banking and macroeconomic indicators.
By
ARI KUNCORO
·6 minutes read
SALOMO TOBING
Ari Kuncoro
The Phillips curve is a visualization of the inverse relationship between unemployment and inflation discovered by Phillips (1958) and refined by Samuelson and Solow (1960). This concept later became the basis for monetary policy by the United States Federal Reserve.
If the economy experiences a recession, expansionary policies are implemented. Conversely, if inflation is too high (overheating), the economic growth should be slowed by raising the benchmark interest rate. Friedman (1967) and Phelps (1968) then argued that the monetary authority cannot simply use the trade-offs in the Phillips curve to manage the economy.
This idea developed into the non-accelerating inflation rate of unemployment (NAIRU). In NAIRU, the unemployment rate can change according to the situation and economic conditions. To determine the ideal inflation rate, unemployment should be actual, not a statistical fiction, which is called natural unemployment.
Their argument is based on the labor market, which has a rational expectation that will bring real wages into initial equilibrium. Nominal wages and inflation may be higher, changing according to circumstances and economic conditions, but real wages remain the same.
Confusion occurred when the 2 percent inflation rate was used as a dogma. Due to the COVID-19 pandemic, the labor market became a hybrid between at home and in the office. The Ukrainian-Russian conflict was also followed by a war of sanctions, and the Western allies and Russia isolated themselves from globalization. So far, economies of scale from collaboration have played a key role in reducing production costs and world inflation. The trend of deglobalization is intensifying as US and China relations worsen, impacting world supply chains.
The impact on the US was the acceleration of the inflation rate from 1.7 percent in March 2021 to as high as 9.1 percent in June 2022. Inflation then declined to 6 percent in February 2023 after the Fed raised its benchmark interest rate several times from June 2022. The question is whether the 2 percent inflation rate is achievable in today's global situation? Has the Phillips curve shifted to higher inflation, at least for the next few years?
Observations show that the inflation rate has fallen in the US, but the decline has slowed down, perhaps it will not return to 2 percent in as short a time as expected. In fact, it may even stay at the 4 percent level (Schrager; Bloomberg, April 2022). The same thing happened in the United Kingdom, and the central bank was even advised to begin accepting a new normal of life with higher inflation (Ward; Financial Times, December 2022).
SVB collapse
The overly aggressive increase in the Fed's benchmark interest rate carries a high risk. Since the 2008 global financial crisis, the benchmark interest rate had been set at near zero to maintain economic growth.
This policy created a bubble in the property sector as the cost of owning a home became too low. Housing loan-based securities (mortgage-based securities or MBS) became attractive financial investment instruments.
The situation reversed in mid-2022 when the Fed's benchmark interest rate rose rapidly in an effort to reduce inflation. Property asset prices then fell by about 20 percent. The combination of higher living costs due to the pandemic and geopolitical tensions reduced people's purchasing power. The ability to repay home loans also dropped dramatically. This has had an impact on MBS, which are a significant part of the portfolios of regional banks in the US.
The bubble burst when Silicon Valley Bank (SVB) collapsed after a bank run. This panic spread to three other regional banks, namely First Republic, Signature Bank and Silvergate Bank. SVB has been a system integrator between investors and innovators dominated by technology start-ups.
The signs began to appear following the layoffs of tens of thousands of employees in the technology sector, which started in late 2022, including established technology companies. The macroeconomic situation worsened due to the pandemic, and the Russia-Ukraine conflict caused their market to shrink. The need for working capital to survive caused it to borrow funds more often. Meanwhile, investors became more selective in financing start-ups.
This situation led to liquidity problems at SVB. SVB securities consisted mostly of MBS whose selling price in the secondary market had fallen due to the decline in property asset values. At the same time, the selling price of government bonds also fell due to the increase in the Fed's interest rate.
SVB was also working on a bridging fund to increase funds from the sale of securities. The goal was to switch to financial assets with higher yields. This news was leaked, causing panic among depositors resulting in a bank run, which led to the collapse of SVB. The Federal Deposit Insurance Corporation soon announced that SVB was in the hands of regulators.
Without regulatory intervention, the SVB collapse had the potential to spread to other medium and small size banks in the US, making it even more difficult for the Fed to find a balance between controlling inflation and maintaining financial stability. The Fed finally announced a "compromise" increase of 25 basis points at its March 21-22 meeting. The increase was lower than the initial estimate of 50 basis points, but came with high risk because the Fed continued to raise interest rates while regional banks were still hit by a crisis of confidence. The US benchmark interest rate is expected to be in the range of 4.75-5 percent, the highest since 2007.
Indonesia has little exposure to SVB. Even if there was, the impact in the short term would be through the exchange rate. The US dollar index weakened to near 102 due to shifts to safe assets, both in the US itself and abroad. It sounded like a paradox, the rupiah, which previously weakened, started to strengthen to reach Rp 15,000 per US dollar, last week.
The SVB collapse raises the issue that there is a greater chance of a recession in the US. As a result, the price of WTI oil fell below US$70 to close to $65 per barrel. However, oil prices then moved to a new balance in the range of $70-75 per barrel and Brent in the US$76-79 range due to an increase in demand from China. This can widen the corridor of mobility-based policy options to maintain domestic growth momentum.
Nevertheless, vigilance must still be increased by continuing to pay close attention to various domestic and foreign micro-banking and macroeconomic indicators.
ARI KUNCORO, Rector of the University of Indonesia.
(This article was translated by Hendarsyah Tarmizi)
