The Federal Reserve raised its benchmark interest-rate target by another quarter percentage point this week, bringing the federal funds range to 4.75% to 5% even as the collapse of two large regional banks forced policymakers to weigh financial stability against inflation that remains well above the central bank’s 2% goal. The Federal Open Market Committee voted unanimously Wednesday for the increase, its ninth consecutive rate move since tightening began a year ago.

The decision came less than two weeks after federal authorities intervened following the failures of Silicon Valley Bank and Signature Bank. In its statement, the Fed said the U.S. banking system is “sound and resilient,” while also warning that recent developments are likely to produce tighter credit conditions for households and businesses and could weigh on economic activity, hiring and inflation. That formulation placed the banking shock directly into the central bank’s economic calculus without declaring that the inflation fight is finished.

A smaller rate increase, but no retreat

The quarter-point increase was smaller than the 0.50- and 0.75-point steps used earlier in the tightening cycle, but it still pushed policy into territory designed to restrain demand. The Fed’s accompanying implementation note directed the New York Fed to maintain the new target range and raised the interest rate paid on reserve balances to 4.9%.

New economic projections released alongside the decision show officials still expect rates to remain elevated. The median participant in the Fed’s Summary of Economic Projections sees the federal funds rate at 5.1% at the end of 2023, only modestly above the new range. The same projections put 2023 real GDP growth at just 0.4%, the unemployment rate at 4.5%, headline personal-consumption-expenditures inflation at 3.3% and core PCE inflation at 3.6%.

Chair Jerome Powell said at his post-meeting press conference that policymakers had considered a pause because of the banking turmoil but concluded that the committee could continue tightening while financial authorities used separate tools to stabilize the banking system. He also emphasized that the economic effect of tighter bank lending is uncertain and could, in principle, substitute for some additional rate increases.

Inflation is slowing, but remains broad

The inflation backdrop gives the Fed little room to declare victory. The Labor Department reported this month that the consumer price index rose 0.4% in February and 6.0% from a year earlier. The February CPI report showed shelter costs were the largest contributor to the monthly increase, accounting for more than 70% of it, while core prices excluding food and energy rose 0.5% for the month and 5.5% over 12 months.

Those figures represent a meaningful slowdown from last year’s peak inflation rates, but they remain far above the pace consistent with the Fed’s price-stability objective. The labor market also remains unusually tight, giving officials reason to worry that service-sector inflation could prove persistent even as goods-price pressures ease.

The policy problem is now more complicated because rate increases themselves can expose weaknesses in institutions holding long-duration securities or dependent on concentrated, mobile deposits. Silicon Valley Bank’s failure showed how quickly unrealized losses and deposit flight can become a liquidity crisis when confidence breaks.

Bank rescues shift the credit channel

On March 12, the Treasury Department, Federal Reserve and Federal Deposit Insurance Corporation invoked a systemic-risk exception that allowed depositors at Silicon Valley Bank and Signature Bank to be made whole beyond the standard $250,000 insurance limit. The joint announcement stressed that shareholders and certain unsecured debtholders would not be protected and that losses to the Deposit Insurance Fund would be recovered through a special assessment on banks.

Days later, 11 large banks placed $30 billion of uninsured deposits into First Republic Bank in an effort to reinforce confidence in another lender facing heavy withdrawals. Treasury Secretary Janet Yellen, Powell, FDIC Chairman Martin Gruenberg and Acting Comptroller Michael Hsu welcomed the move in a March 16 statement, calling it a demonstration of support for regional banks and the broader financial system.

Yellen told the American Bankers Association this week that federal actions were designed to stop contagion rather than shield bank investors. Her March 21 remarks said aggregate deposit outflows from regional banks had stabilized and that the government would be prepared to take additional steps if smaller institutions suffered deposit runs that posed contagion risks.

The following day, in Senate testimony, Yellen reiterated that the banking system remained sound while acknowledging the need to review whether supervisory and regulatory changes are warranted. That leaves the Fed operating on two tracks: raising the price of money to reduce inflation while simultaneously supplying liquidity and supporting confidence so that monetary restraint does not become an uncontrolled banking contraction.

Credit conditions may do part of the Fed’s work

The most important economic question now is not simply how high the policy rate rises, but how sharply banks tighten standards in response to funding stress, deposit competition and balance-sheet losses. A meaningful pullback in lending could slow business investment, commercial real estate activity and household borrowing even without many additional Fed increases. If that happens, the banking shock could function like an additional dose of monetary tightening.

That mechanism also carries risk. Credit contraction is difficult to calibrate and can move faster than an interest-rate policy that is adjusted at scheduled meetings. The Fed therefore has to assess whether inflation requires further restraint while watching for signs that bank caution is producing a sharper downturn than intended.

For now, officials have chosen to keep raising rates rather than pause. The quarter-point move, the 5.1% year-end median projection and Powell’s emphasis on incoming data signal that the Fed still sees inflation as an active threat. But the change in the statement’s language—from anticipating “ongoing increases” to saying that “some additional policy firming may be appropriate”—also reflects a more uncertain path. The next phase of the tightening cycle will depend not only on prices and jobs, but on whether the banking system transmits policy through orderly restraint or destabilizing stress.