Weening a country, or market, off easy money is tricky, even when it’s done slowly, as the Federal Reserve is doing. The removal of monetary accommodation is not made any easier by protectionist threats and counter threats that complicate the macroeconomic mix, roil markets and tighten financial conditions.
A reconstituted Federal Reserve under new leadership will face tough challenges in the year ahead. Monetary normalization is well underway, with the Federal Open Market Committee (FOMC) having raised the Federal funds rate five times since it left the zero lower bound two years ago and started shrinking the bloated balance sheet built up through three rounds of bond buying.
As the FOMC said in mid-June after raising the Federal Funds rate for the second time this year, but just the fourth time since leaving the zero lower bound in December 2015, “monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2% inflation.”
After making just three modest interest rate hikes since abandoning a seven-year stay near zero, the Federal Reserve can scarcely be accused of having a tight credit stance. As the rate-setting Federal Open Market Committee reiterated when it took the federal funds rate up 25 basis points in mid-March, “monetary policy remains accommodative.”
U.S. monetary policy morphed dramatically to a “new normal” of persistently depressed interest rates since the 2008 credit crisis, but with the advent of a dynamic new administration, the Federal Reserve may have to move back toward old normal.