Adjusting Monetary Policy While Maintaining Flexibility

When uncertainty is elevated, considering scenarios is more useful than debating a modal outlook. Today, there are at least two possible paths for the economy. In one, the conflict in the Middle East resolves quickly, oil and energy prices fall, and the impact on the U.S. economy is short-lived and muted. Under those circumstances, it likely would make sense to look through the temporary rise in energy prices, assuming inflation expectations remain well anchored.   But if the conflict becomes more protracted, a different scenario is possible. Disruptions in energy supply and associated cost pressures could persist, with increased risks for higher inflation, slower growth, and a weaker labor market. This would amplify the current tradeoffs for monetary policy, making it harder to balance the risks to both sides of our dual mandate. With all of this uncertainty, what’s the outlook for monetary policy? There is no single most-likely path. With policy in a good place, we need to remain flexible, able to respond to rapidly evolving risks. Now, this may seem vague, even dissatisfying.   But offering too much forward guidance in an uncertain world risks conveying a false sense of certainty, reducing rather than improving transparency, and making it harder for the public to clearly predict how the FOMC will react. So, for now, recognizing the uncertainty, examining potential scenarios, and staying focused on restoring price stability and supporting full employment no matter how the economy evolves is optimal communication and appropriate policy.

The Monetary Policy Trilemma: When “Simple” Becomes Simplistic Revisiting my December 2025 Business Standard piece. The current context, from the Iran shock to the sharp INR REER correction, highlights a constraint we continue to underplay: the “Impossible Trinity” is binding. No economy can simultaneously run an independent monetary policy, maintain open capital flows, and have a stable currency. Judicious choices have to be made. India’s Flexible Inflation Targeting (FIT) framework was never meant to ignore this. The 2014 Urjit Patel Committee explicitly acknowledged the constraint, even as it prioritized anchoring inflation expectations at that point in time. Yet neither MPC statements nor the RBI’s August 2025 MPC framework review explicitly recognize these trade-offs. That risks reducing a complex, multi-variable problem into a simplistic single-variable framework. The past year illustrates the point. With inflation benign, policy leaned toward lower rates alongside record RBI bond purchases. Even before the Iran episode, outcomes were visible: •           a sharp correction in INR REER (from ~107 to ~94, and now ~91) •           weak net foreign investment flows These are not coincidences. They are consistent with external balance constraints becoming binding. The suggestion that the INR should simply “find its own level” while monetary policy proceeds independently, is also too casual. Markets are reflexive. If depreciation is perceived to be tolerated, it can become self-reinforcing. At that point, the currency begins to drive fundamentals, not reflect them. The eventual cost of breaking such a vicious loop, including through harsh regulatory measures or by use of monetary instruments, can be significant. Equally, it is inconsistent to argue for a “free” currency while domestic liquidity and interest rates are being actively shaped through large-scale intervention. This is not a plea for diluting inflation targeting. If anything, recent experience argues for greater caution. There are phases where headline inflation metrics permit easier policy, but financial stability and external balance require a tighter stance. Some argue that actually, within FIT, RBI & MPC members do implicitly consider all this. If so, the more important question is this:
 If FIT was meant to enhance transparency and reduce discretion and policy errors, why are these crucial trade-offs left implicit? Bottom line: FIT brought much-needed discipline to Indian monetary policy. The coincident decline in global energy prices certainly helped. But discipline is not completeness. Until we explicitly recognize the interaction between monetary policy, financial markets and the external sector, we risk operating a framework that is internally coherent, but externally incomplete. It is time for a more rigorous and transparent debate. Complexity in macroeconomics and markets cannot be wished away or simplified into irrelevance. https://bit.ly/4ds6GUa

Former President of De Nederlandsche Bank and FSB Chair, Klaas Knot: Monetary Policy Lessons for Policymakers Just watched a very insightful presentation by Klaas Knot. What I liked is that it was not “monetary policy in a textbook.” It was monetary policy as it is actually practiced: under uncertainty, with real trade-offs, and with financial stability always in the background. A few takeaways for policymakers: 1) Monetary policy is about managing uncertainty—not forecasting perfectly. We rarely have perfect real-time data. The right question is not “are we sure?” but “is our strategy robust if we’re wrong?” 2) Credibility is a monetary policy tool. When the framework is trusted, transmission is stronger and less costly. When trust weakens, the same moves can deliver less—and create more friction. 3) Flexibility matters—but so does the anchor. A clear medium-term anchor (price stability) is essential, but implementation has to adapt when shocks hit. 4) Monetary policy and financial stability are connected. When vulnerabilities build in the financial system, they eventually show up in the macroeconomy—and complicate policy decisions at the worst time. 5) Communication is part of the policy package. Clear, consistent communication shapes expectations and improves outcomes—especially when volatility is high. Overall, a practical reminder: monetary policy is not just about rates. It’s about institutions, credibility, expectations—and resilience. Lecture: https://lnkd.in/g3rdc5J4 #MonetaryPolicy #PublicPolicy #CentralBanking #FinancialStability #Macroeconomics #Governance #IMFCEF

#FOMC Minutes Show 'Almost All' Fed Members See Higher Inflation Risks, Cite Trump Policies - source: Wall St Engine @wallstengine 👉 RATE POLICY: — A 25bps rate cut was broadly supported, with the majority favoring a cautious approach to further easing. — Many participants suggested that a variety of factors underlined the need for a careful approach to monetary policy decisions over coming quarters — Some participants noted it might be prudent to pause rate cuts if inflation readings remain above target or economic momentum persists. — A few officials highlighted potential scenarios to accelerate cuts if inflation trends lower or labor market softens more than expected. — Many emphasized the importance of carefully assessing the neutral rate and moving gradually to avoid policy missteps. 👉RISK OUTLOOK: — Inflation risks remain balanced, though higher-than-expected recent readings warrant close monitoring. — Labor market risks were deemed manageable, with no rapid deterioration expected. 👉ECONOMIC CONTEXT: — Inflation progress has slowed but remains on a downward path; core PCE inflation was noted at 2.8% in October. — Labor market conditions have eased slightly, but unemployment remains low at 4.2%. — Participants expect solid GDP growth to continue, though some noted financial strains for lower-income households. 👉BALANCE SHEET AND TECHNICAL ADJUSTMENTS: — Continued reduction in Treasury and mortgage-backed securities reaffirmed, with caps set at $25B and $35B per month, respectively. — Discussed adjusting the overnight reverse repo (ON RRP) rate to align with the bottom of the federal funds rate range. 👉 ADDITIONAL NOTES: — Fed emphasizes data-dependent decision-making, balancing risks to inflation and employment. — Gradual easing remains the likely path, with flexibility to adapt if economic or inflation conditions shift.