The Fed’s next big policy rethink needs rethinking

NEXT year, the US Federal Reserve will undertake an exercise with global implications: the periodic monetary policy framework review, at which it rethinks its approach to managing the world’s largest economy.

Although the central bank is planning to focus on some of the right things, it appears that important bits will be left out.

On the positive side, the Fed seems poised to scrap a regime aimed at preventing short-term interest rates from staying stuck at the zero lower bound. Adopted at the 2020 review, following the zero-interest-rate experiences of the 2008 financial crisis and the global pandemic, it committed the Fed to keep rates at the lower bound until three conditions had been met: employment had reached the highest level consistent with stable inflation; inflation had reached 2 per cent; and inflation was expected to climb above 2 per cent to offset past downside misses. This was supposed to keep inflation expectations more strongly anchored at 2 per cent, preventing an unintended tightening of policy if those expectations were to fall.