The economic models that have guided monetary policy in recent decades say low unemployment should lead to higher inflation. When that happens, the Fed should respond by hiking interest rates, a move that also readies the Fed to fight the next recession by cutting rates back down.
Right now, however, the Fed faces remarkably low unemployment, low inflation, and low interest rates all at once, leaving the central bank with nowhere to go. Thus, everyone’s wondering what the Fed can do when the next recession eventually comes, and whether the monetary policy toolkit needs an update. The central bank is currently taking a long and hard look at itself, with conclusions and any potential reforms due out later this year. But if a conference featuring former Fed Chair Ben Bernanke over the weekend is any indication, Fed officials aren’t thinking nearly far enough outside the box.