The active Federal Reserve returns to calm, Powell may make U.S. monetary policy "boring"

According to the Zhitong Finance APP, for most of the past 17 years, the Federal Reserve has been a core participant in U.S. economic policy, injecting trillions of dollars into the financial system as a safety net, providing nearly a decade of ultra-cheap funding, crossing red lines during the COVID-19 pandemic, and increasingly studying areas such as stocks and climate change. Now, the Fed's work has once again become mundane.

This expansive role has now shrunk to a brief policy statement, a substantive debate about interest rates, a reduction in bond reserves, and the growing likelihood that Federal Reserve Chairman Jerome Powell will be remembered both as the person who led the U.S. through the economic crisis triggered by the pandemic and as the one who made the Fed's work boring again.

The decision-making team that includes former St. Louis Fed President James Bullard witnessed the Fed's role expand during the 2007-2009 financial crisis, saw its role rapidly expand again during the pandemic, and now witnesses the Fed gradually returning to normal.

Bullard stated that in recent years, "we had to return to that strong anti-inflation approach, which reminds us of the past when you didn't have to worry about the zero lower bound on interest rates or about balance sheet policies." "In this regard, it is a kind of normalcy. Times have changed."

Bullard, who is currently the dean of the Mitch Daniels School of Business at Purdue University, will deliver the opening remarks at a conference in Washington on Monday, focusing on the Fed's monetary policy framework and strategies for achieving its mission of promoting price stability and maximum employment.

Despite the potential controversies brought to the Fed by Donald Trump's victory in the November 5 election—such as indications that the president-elect may attempt to fire or undermine Powell, reigniting his discord with Powell from his first term—the framework discussion highlights another possibility: as inflation is brought under control, economic growth continues, and interest rates remain within a longer-term historical range, the Fed may retreat somewhat into the background, with its focus on stabilizing inflation now being an important matter for the next administration to maintain.

Ultra-low interest rates are no longer needed

The economic team members initially chosen by Trump are relatively traditional. This conference, organized by the American Institute for Economic Research in Washington, includes a keynote speech by Federal Reserve Governor Christopher Waller. Waller was appointed by Trump during his first term in the White House, and along with Federal Reserve Governor Michelle Bowman, will provide an internal option for new leadership after Powell's term ends in May 2026 Consistent with Powell, Waller has been a major force against inflation and has guided the Federal Reserve system away from issues like climate change, which are not directly affected by monetary policy, leading to tensions with some Republican members of Congress.

Waller may also voice strong opinions on reforming the Fed's current policy framework. The policy framework adopted in 2020 brought the Fed into a new realm, which many now believe is out of sync with the current economic environment.

The outbreak of the pandemic that year led to widespread unemployment and made the recovery of the labor market a top priority for Fed officials, who were determined not to let the slow employment recovery after the 2007-2009 crisis repeat itself. Many believe that crisis resulted in a lost decade, traumatizing a generation of workers. Long-term weak inflation and historically low interest rates have also raised concerns about economic stagnation.

The 2020 framework attempted to address all these issues by committing to "broad and inclusive" employment, as interest rates were expected to remain low and "more frequently" approach zero levels than in the past.

The "zero lower bound" is a dilemma faced by Fed officials: once interest rates fall to zero, the options for further supporting the economy are limited to poor and politically difficult choices. Rates could be lowered to negative values, which effectively taxes people's savings, or other unconventional measures could be taken, such as large-scale bond purchases to suppress long-term rates and a commitment to keep rates low for an extended period.

The Fed's solution in 2020 was to commit to high inflation periods to offset periods of weak price growth, with policymakers hoping this would keep inflation around the Fed's average target of 2%. For various reasons, this was followed by the worst inflation in 40 years, prompting the Fed to raise interest rates significantly in 2022 and 2023. Regardless of what this means for the economic and political outlook in the U.S., it may also have pulled the entire economy out of stagnation and allowed fiscal and other policies to regain dominance.

David Russell, global market strategist at TradeStation, said, "The economy and the stock market no longer need ultra-low interest rates." "In the future, trade and tax policies may be more important than monetary policy."

Preemptive Action is "Necessary"

Currently, Fed officials believe that inflation pressures will remain elevated compared to pre-pandemic levels, and interest rates will be well above zero, allowing them to achieve their goals by raising and lowering rates, similar to what central bank officials did before the unconventional measures triggered by the Great Recession 17 years ago.

If a sufficiently large shock occurs, these tools remain at hand and may return. For example, some economists believe that the policies of the incoming Trump administration, which aim to raise import prices through tariffs, stimulate spending through tax cuts, and limit the number of available workers by restricting immigration, could shake the Fed's perception of the economy as currently healthy and balanced However, more and more people believe that the Federal Reserve's current framework is too adapted to the environment and risks of the 10 years following the 2007-2009 crisis and the pandemic period, and that it needs to return to a more cautious stance on inflation issues.

Research by Federal Reserve staff indicates that this stance can lead to better outcomes for the labor market, and the old-fashioned idea of suppressing inflation before it becomes entrenched has regained favor.

Economists Christina Romer and David Romer wrote in a research report for the Brookings Institution conference in September, "Proactive monetary policy actions are not only appropriate but necessary." They stated that the Federal Reserve "should not deliberately seek a hot labor market," as rigid monetary policy tools "cannot... reduce poverty or address the growing inequality."

Powell seems to have anticipated future changes, and these changes are not unwelcome, as they indicate that the U.S. no longer needs the Federal Reserve's special support. In the early years of his tenure as central bank chairman, Powell was not entirely satisfied with the Federal Reserve's special support.

After pushing the Federal Reserve's powers to the limit during the pandemic, he may leave his successor with a more focused and concentrated institution.

Last month, Powell stated in Dallas, "The 20 years of low inflation ended a year and four months after we established our framework," referring to a return to a more "traditional" central bank style, and he asked, "Should we change the framework to reflect the now higher interest rates, so that some of the adjustments we made in the past... should no longer be the baseline?"