For much of the last 17 years, the Federal Reserve (Fed) has been central to US economic policy, throwing multi-trillion-dollar safety nets under the financial system, offering nearly a decade of ultra-cheap money and jumping red lines during the Covid-19 pandemic, too, delving into areas such as equity and climate change.
But that expansionary role has been reduced to terse policy statements, debate over interest rates, a declining bond stockpile and a growing possibility that Fed Chairman Jerome Powell will be remembered as much as the man who led the country out of economic crisis due to the pandemic like the one that made central banking boring again.
Former St. Louis Fed President James Bullard was part of the team that saw the central bank’s role expand during the 2007-2009 financial crisis, watched it grow again during the pandemic, and sees how it is now transformed back into something more normal.
In recent years, “we’ve had to go back to fighting inflation, which is reminiscent of the old days when you didn’t have to worry about the zero lower bound or balance sheet policy,” Bullard said. “In that sense, it is something simple. Times have changed.”
Bullard, now dean of Purdue University’s Mitch Daniels School of Business, will deliver the keynote address Monday at a conference in Washington on the Federal Reserve’s monetary policy framework and its strategy for fulfilling its mandate of fostering price stability and maximum employment.
Despite all the potential controversy surrounding the Fed raised by Donald Trump’s victory in the November 5 election – hints, for example, that the US president-elect could rekindle his first-term feud with Powell by trying to fire him or undermine him – there is an alternative possibility that the debate on the framework highlights.
It is that with inflation under control, the economy growing and interest rates at their long-term historical range, the central bank may be moving a little out of the picture, with its constant focus on inflation now as what is important to the incoming administration.
Super-low rates are no longer necessary trump’s first choices for his economic team were conventional.
The Washington conference, hosted by the American Institute for Economic Research, includes a keynote address by Fed Governor Christopher Waller, an appointee of Trump’s first term in the White House who, like the Fed governor, Michelle Bowman, would offer an internal option for new leadership when Powell’s term as central bank chief expires in May 2026.
With Powell, Waller was a leading force in navigating the fight against inflation and steering the Fed system away from issues like climate change that are outside the direct influence of monetary policy and that had raised tensions with some Republicans in Congress.
Waller is also likely to have an important voice in reforming the Fed’s current policy framework, which at the time of its adoption in 2020 took the central bank into new territory that many now consider out of step with the current economic environment.
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The outbreak of the pandemic that year caused widespread unemployment and made the recovery of the labor market a top priority for central bankers, determined not to see a repeat of the slow employment recovery after the 2007-2009 crisis, which many consider it caused a lost decade, marking a generation of workers.
Chronically weak inflation and historically low interest rates also raised concerns about stagnation.
The 2020 framework sought to address all of those issues with a new commitment to “broad-based and inclusive” employment amid expectations that interest rates would remain low and end up near zero “more often than in the past.” ”.
The “zero lower bound” is the bane of a central banker’s existence: once interest rates hit zero, there are only bad and politically difficult options left to continue supporting the economy. Interest rates can be pushed into negative territory, effectively taxing people for saving, or other unconventional measures can be taken, such as large-scale bond purchases to suppress long-term rates and promises to keep them there for a long time.
The Fed’s solution in 2020 was to promise periods of higher inflation to offset periods of weak price growth, with which policymakers hoped to keep inflation at the central bank’s 2% average target.
What followed, for various reasons, was the worst inflation in 40 years, prompting the Fed to aggressively raise rates in 2022 and 2023. Whatever this meant for the US economic and political landscape , may also have brought the entire economy out of its slumber and returned fiscal and other policies to the driver’s seat.
“The economy and the stock market no longer need super-low rates,” said David Russell, global head of market strategy at TradeStation. “Trade and fiscal policy will probably matter more than monetary policy in the future”
With necessary preventative actions, Fed officials now see that inflation pressures remain higher than before the pandemic, with rates staying far enough above zero that they can achieve their goals by raising and lowering them, just as they did. central bankers before the “great recession” unleashed the use of unconventional methods 17 years ago.
Those tools are still close at hand, and a big enough jolt can bring them back.
Some economists argue, for example, that the policies of the incoming Trump administration, by simultaneously raising the price of imports with tariffs, stoking spending through lower taxes and restricting the pool of available workers by limiting immigration, could shake up an economy that The Fed currently considers itself healthy and in balance.
But there is growing consensus that the central bank’s current framework became too adapted to the circumstances and risks of the decade after the 2007-2009 crisis and the pandemic era, and needs to return to a more prudent stance in matter of inflation.
Fed staff research suggested that stance provides better labor market outcomes anyway, and a return to the old-school philosophy of suppressing inflation before it takes hold has regained favor.
Powell seems to have anticipated the coming changes, and not unwelcome ones, since they indicate that the United States has freed itself from the need for extraordinary support from the Fed, something with which he was not entirely comfortable in his first years as governor of the Fed. central bank.
After pushing the Fed’s power to the limit during the pandemic, he may leave his successor a much more focused institution.
“Twenty years of low inflation ended a year and four months after we did the framework,” Powell said last month in Dallas, where he spoke of a return to a more “traditional” style of central banking. “Shouldn’t we change the framework to reflect that interest rates are higher now, so some of the changes we made…should no longer be the base case?”
With information from Reuters
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