Market expectations now point to a rate cut at the US Federal Reserve’s December meeting, probably an outcome that will come with dissents. At the same time, the announcement of the new Fed chair is going to be postponed to January and Polymarket probabilities for “no announcement by Dec. 31” have adjusted promptly, with Kevin Hassett leading among the likely contenders.

The incoming administration’s preference for lower rates is well known, but the stakes extend far beyond the near-term policy stance. The new leader could fundamentally reshape the Fed’s intellectual framework and write an entirely new playbook for monetary policy. The post-COVID-19 pandemic economy is governed by forces very different from those that defined the post-financial-crisis era, and the Fed’s most recent strategic review may have underestimated the scale of the challenges ahead.

The real question is whether the current framework is adequate for an economy driven by AI-enabled productivity, expansive fiscal policy, labor displacement, supply-chain fragmentation and a financial system where leverage, rather than bank lending, drives the cycle. The next Fed chair will inherit a world that the old playbook simply does not describe.

The pre-COVID-19 playbook

The decade between the global financial crisis and the COVID-19 pandemic was defined by a persistent effort to use monetary policy as the primary engine of inflation. The Fed cut interest rates to zero, deployed multiple rounds of quantitative easing, offered increasingly explicit forward guidance, and, just before the pandemic, adopted “make-up” strategies such as average inflation targeting. This was also the era of the secular-stagnation debate and the consensus around a structurally low neutral real interest rate, or r*.

Yet despite the extraordinary expansion of the policy toolkit, the Fed’s underlying macroeconomic framework remained essentially the same as in the precrisis “Great Moderation” period. The intellectual model assumed that adjusting the short-term policy rate would influence overnight funding costs, transmit smoothly through the banking system, affect credit conditions, steer aggregate demand and ultimately manage inflation. It was the same interest-rate-centric paradigm, even if the instruments had multiplied and the policy rate had hit its effective lower bound.

While the Fed’s analytical model stayed rooted in the old framework, its operational regime changed significantly. The large-scale asset purchases launched after 2008 shifted the system from a scarce-reserves regime to today’s ample-reserves or floor-system framework, effectively transforming how the Fed implements policy, even as its conceptual framework did not.

The post-COVID-19 challenges

The COVID-19 pandemic marked the first major break with the pre-2020 world. Global supply-chain disruptions — captured by the New York Fed’s GSCPI — combined with a sustained fiscal expansion to produce an inflation dynamic fundamentally different from the post-GFC era. Inflation has remained above target for an unusually long period, and its composition has shifted: services inflation has been notably persistent, while geopolitical shocks, beginning with Russia’s invasion of Ukraine, have introduced durable supply-side pressures.

These forces were not temporary anomalies. They were early signs of a deeper, policy-driven and structural transformation of the economic environment in which the Fed now operates — changes significant enough to warrant a rethinking of the monetary policy playbook.

At the same time, the economy is entering what appears to be an AI-driven technological transition. The new administration’s agenda — on immigration, regulation, fiscal expansion and the return of tariffs — marks another clear departure from the globalization era. None of these developments are isolated; together, they reflect a broader reordering of geopolitical alignments and economic priorities.

Recent commentary, including Steve Miran’s speech on r* (the neutral real interest rate), has begun to explore how these largely nonmonetary forces might shift long-run equilibrium conditions. But even these analyses are bound within the traditional framework in which r* is defined. A larger question is whether that framework itself is still adequate.

The emerging challenges touch every part of the Fed’s existing intellectual model.

The US labor market is now experiencing a structural productivity shock driven by AI, robotics and automation, technologies designed to replace labor, not complement it as the internet did in the late 1990s and early 2000s. Firms are “doing more with less,” a secular shift rather than a cyclical one. Unlike the internet era, which created new roles across e-commerce and digital services, AI displaces existing jobs faster than it generates new, higher-skilled ones. The result is weaker labor demand, pressure on middle-skill occupations and a more polarized wage distribution. This is the essence of today’s K-shaped economy.

At the same time, geopolitical fragmentation is unfolding after decades of deep integration. Reengineering supply chains in such a world is potentially slow, asymmetric and inflationary. Layered on top of this is a new fiscal reality: The federal government, rather than the private sector, has become the primary driver of demand and macroeconomic outcomes (the fiscal primacy hypothesis).

Together, these forces create an environment defined not by cyclical fluctuations but by deep structural change. And a structural world cannot be managed by thinking in terms of a cyclical playbook.

The evolving transmission mechanism

The second major shift concerns how monetary policy transmits through the economy. The traditional channels — where changes in the short-term policy rate influence bank lending, household borrowing, corporate investment, and aggregate demand — are far less effective than in the past. Today, they operate mainly through different parts of the economy.

The Fed Funds Rate still matters, but its influence is now concentrated in financial markets, not in household or corporate credit decisions. The overnight rate anchors SOFR, which anchors repo markets, and repo rates determine the cost of leverage for hedge funds, dealers, mortgage real estate investment trusts and basis traders.

In a highly financialised economy, monetary policy increasingly works through leverage, collateral valuation, dealer balance-sheet capacity and liquidity conditions, not through the IS–LM transmission logic of the Great Moderation. This is why financial markets can move sharply even when the real economy barely reacts, and why adjusting the policy rate often does little to stimulate investment or consumption.

This is the defining feature of the new regime: The financial plumbing is more sensitive to the short-term policy rate than the real economy

For the real economy, what matters is not the overnight rate but the 10-year Treasury yield, which anchors mortgage rates and corporate borrowing. These long-term rates are only loosely connected to the Fed Funds Rate, shaped instead by regulatory balance-sheet constraints, global savings flows, Treasury issuance, duration demand and risk premia.

It is therefore unsurprising that transmission to the real economy has weakened. Large corporations increasingly finance capital spending from retained earnings rather than borrowing. Mortgage rates depend on term premia and bond-market volatility, not the policy rate, and longer mortgage durations have slowed the pass-through of rate cuts to households. Small firms are constrained mainly by credit standards and collateral requirements, not overnight funding costs.

When households and businesses respond only weakly to changes in the policy rate, the old textbook channel — raising rates to cool demand, cutting rates to stimulate it —naturally becomes less effective. Instead, the dominant transmission mechanism now runs through the interaction between financial markets and household balance sheets: repo → leverage → liquidity → asset prices → household wealth → consumption

Although the Fed already monitors financial conditions, the modern transmission mechanism requires a deeper focus on the specific market structures through which policy now operates. Asset prices, rather than short-term borrowing costs, have become the most immediate channel linking policy decisions to aggregate demand. Recognizing this shift means placing greater analytical weight on the components of financial conditions that matter for transmission today: dealer balance-sheet capacity, market volatility indicators such as MOVE and VIX, and the functioning of key collateral markets that underpin secured funding.

These elements now drive how policy impulses propagate through the financial system far more powerfully than changes in the overnight rate alone.

Recent remarks by Dallas Fed President Lorie Logan highlight this evolution. She argues that the federal funds rate has become an increasingly outdated operational target in a market structure dominated by secured funding and repo activity. Her suggestion to shift toward a repo-based target, such as the Treasury General Collateral Rate, underscores the importance of structural shift also in the implementation of policy.

Towards a new Federal Reserve playbook

If the structure of the economy has changed, and the transmission of monetary policy now runs less through bank lending and more through financial plumbing and asset prices, then the Fed’s playbook should adapt as well. The challenge is not only about which tools to use, but how to design the reaction function for a world shaped by structural rather than cyclical forces. The key question is no longer just whether to tighten or ease; it is how policy should respond to shifts driven by technology, geopolitics, fiscal policy and market structure, and which instruments are best suited to each task.

Monetary policy can no longer be calibrated as if shocks were temporary deviations from a stable trend. Structural forces are now determining potential output, reshaping income distribution and influencing the effectiveness of policy itself.

From a macroeconomic perspective, if long-term yields are what shape the real economy, then the Fed’s balance sheet should become a more prominent policy instrument. A large and persistent balance sheet may simply be a feature of the new regime. Asset purchases and run-off could be used more routinely to influence the level and volatility of long-term rates, especially the 10-year yield that anchors mortgages and corporate borrowing. This approach is best viewed as a form of “yield-curve engineering.”

In an environment of persistent fiscal stimulus and high public debt, balance-sheet policy also becomes the natural interface between monetary and fiscal authorities. The Fed will need to consider when stabilizing term premia is consistent with its mandate and when such actions risk drifting into de facto debt management.

By contrast, managing the short end of the curve becomes less about steering aggregate demand and more about governing the financial system. In a new playbook, the policy rate would be seen primarily as a tool for regulating leverage, money-market conditions and the pricing of secured funding, rather than as the main driver of household or corporate borrowing. This suggests linking rate decisions more explicitly to indicators of financial stability: dealer balance-sheet constraints, repo-market functioning, and volatility in key funding markets.

Put simply, the short-term rate could evolve into the Fed’s financial-stability instrument, while the balance sheet would take more a role as macroeconomic tool.

Finally, as economics and geopolitics become increasingly intertwined, the Fed’s playbook will also need to account for the effects of tariffs, sanctions, industrial policy and rising defense spending. These forces now shape supply chains, inflation and investment decisions in ways that traditional models did not anticipate, and the policy framework will need to adapt to this new reality.

A new Fed Chair will soon be appointed. But the more consequential development may be the emergence of a new monetary policy playbook, one designed for the economy as it is becoming, not the one the Fed used to know.

Gianluca Benigno

Gianluca Benigno is currently a professor of economics at the University of Lausanne. The views expressed here are the writer’s own. — Ed.

khnews@heraldcorp.com