Adapting U.S. Monetary Policy to New Economic Uncertainties

With financial markets and economic conditions shifting rapidly, Michelle W. Bowman, Vice Chair for Supervision at the Federal Reserve, has outlined her evolving approach to monetary policy decision-making, emphasizing flexibility, proactive responses, and the need for a limited central bank presence in financial markets.

Bowman reflected on the lessons learned from recent years, highlighting how the Federal Reserve’s commitment to both maximum employment and price stability—the so-called dual mandate—can require quickly shifting the policy focus as economic risks evolve. She noted that delays in adjusting monetary policy toward higher interest rates in 2021 contributed to a surge in inflation, necessitating subsequent rapid rate hikes to restore stability. Bowman now suggests a more forward-looking, forecast-driven approach rather than relying solely on recent data, arguing this can prevent the need for abrupt, disruptive policy changes when signs of labor market or inflation fragility emerge.

Bowman also addressed the importance of gradually reducing the Federal Reserve’s balance sheet and maintaining a “limited footprint” in financial markets. She advocated for a return to a smaller balance sheet, largely composed of Treasury securities, to improve market functioning, incentivize private sector liquidity management, and preserve flexibility for future crises. She cautioned against institutionalizing pandemic-era emergency lending facilities, arguing such tools should be activated only during rare, acute market stress, and not become a permanent part of the monetary toolkit.

Turning to contemporary regulatory issues, Bowman supports reforms to leverage capital requirements for banks, aiming to enhance the capacity of major financial institutions to intermediate in critical markets like U.S. Treasuries while keeping financial risks in check. She also discussed how new legislation, such as stablecoin regulations, could affect Treasury market dynamics and the importance of calibrating regulatory reforms to address these developments.

Bowman highlighted several challenges for monetary policy going forward: dealing with ongoing supply shocks, the potential for rising longer-term interest rates driven by elevated term premiums, downside risks in the housing market, and the uncertainty introduced by the surge in artificial intelligence investment. She emphasized that these factors will influence key metrics like the neutral interest rate and could require a more nuanced, flexible policy stance. Finally, Bowman underscored continued progress and remaining work in bank supervision and regulatory improvements, aiming to maintain both economic growth and financial system soundness.

Bowman’s remarks crystallize the need for adaptability in policy and regulation as the U.S. economy faces new risks and structural changes, highlighting the delicate balance required to sustain both price stability and full employment.