Policy should normalize in an orderly way—but if inflation starts to look 2.4 structural, policy makers would tighten faster to prevent a structural break Monetary policy is set to tighten - but very gradually If the Fed turns out to be wrong about transitory inflation, it will need to tighten policy faster, which would upset 0 2. n o i markets and could even risk the cycle s r e 1 V 202 r e b o t Market-implied path of policy interest rate (%) c 25 O Soft and gradual exit from ultra-low rates expected by ed 3.0 t a market and Fed as inflation thought to be transitory d p Fed's view of neutral rate u es v i 2.5 t ec p s er P 2.0 e v i If inflation proves not to be transitory, the pace of t u ec x 1.5 tightening will quicken to contain the risk of a structural E G C B break of inflation regime . ed 1.0 v er es r s t h g i 0.5 r l This would rapidly tighten financial conditions and l A . p u disrupt financial markets, threatening the economic expansion o 0.0 r G g 2022 23 24 25 26 27 28 29 30 31 n i t l u s n o C n o Risk of “policy error” is up—could either be to tighten too t s o B Market pricing of the Fed’s rate path does not exhibit expectation of soon or too much (triggering recession) or policy inaction y b 1 2 spiraling inflation 0 (risk of regime break) 2 © t h g i r y p o 17 C Source: Federal Reserve Board, Bloomberg, BCG