The US Fed must rethink the way it exercises its authority

Clarify quantitative tools and shift the rate targeted by Fed policy

- BILL DUDLEY

Next year, the US Federal Reserve will undertake an exercise with global implications: its periodic monetary policy framework review, at which it rethinks its approach to managing the world's largest economy. Although the Fed plans to focus on some of the right things, it appears important bits will be left out.

On the positive side, the US central bank 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%; and inflation was expected to climb above 2% to offset past downside misses. This was supposed to keep inflation expectations more strongly anchored at 2%, preventing an unintended tightening of policy if those expectations were to fall.