Some investors “were thinking the Fed was going to keep buying forever, QE infinity,” Williams said today in a CNBC television interview from Jackson Hole, Wyoming. “We had always communicated that that’s not what our plan was.”

“Some of the adjustment in the bond market probably was kind of bringing people back to reality that this was a program that wasn’t going to continue forever,” he said. “And I think that, maybe, eliminates some of the froth in the bond market.”

As of September, the FOMC will have in hand one more employment report, two reports on inflation, a revision to the second-quarter GDP data, and preliminary incoming signals about growth in the third quarter. I don't expect to have enough data to be sure of my outlook. For that reason, I don't think a decision that commits the Fed to a full phase-out of asset purchases and lays out a precise, beginning-to-end path for doing so would be advisable.

In my mind, the first adjustments to asset purchases, when they occur, should be the beginning of a process with steps that will be determined as later information arrives and certainty about the direction of the economy accumulates. As I see it, a decision to proceed—whether it is in September, October, or December—ought to be thought of as a cautious first step.

Policymaking is quite appropriately forward-looking because monetary policy actions affect the economy with a lag. The rolling outlook from here is what really matters in making future decisions on asset purchases. I will need to get comfortable that the employment progress we've enjoyed is not stalling and that disinflation pressures are not building.

All that said, in considering a decision to reduce purchases, I think it is important to acknowledge the progress that's been made since the launch of QE3. The most recent program of asset purchases has been in force for just short of a year. In August a year ago, the unemployment rate stood at 8.1 percent. A year later, the unemployment rate has fallen to 7.4 percent and monthly job gains, looking back over the year, are averaging just below 200,000. Consumer activity has grown, house prices and housing activity have picked up, and equity markets have shown strength.

We have continued to see steady progress in economic fundamentals, in my opinion. Progress is evident, and we should not lose sight of that.

The efficacy of this effort is the subject of significant debate, even internally within the FOMC. Some who question the efficacy, including myself, note that the effect of our purchasing MBS and driving down mortgage rates has certainly assisted a robust recovery in housing, and with it, construction jobs and manufacturing and transportation of materials that go into homes… [T]he Fed’s muscling of the yield curve has brought what has been a 30-year-long bond market rally to a crescendo…

Counteracting whatever benefits one can trace to the Fed’s unorthodox policies are some obvious costs. First, savers and others who rely on retirement monies invested in short-maturity fixed-income investments, such as bank CDs and Treasury bills, have seen their income evaporate while the rich and the quick, the big money players of Wall Street have become richer still.

Second, the standard return assumptions of 7.5 to 8 percent for retirement pools, as you well know, have been dashed (though I have always felt they were already calculated on an imaginary and politically convenient basis rather than a realistic one).

Third, accompanying the Fed’s growing balance sheet we have seen a dramatic expansion in the monetary base—the sum of reserves and currency. A basic understanding of demand-pull inflation is “too much money chasing too few goods.” Thus, the excess, currently nondeployed money could prove the kindling of an inflationary conflagration unless the Fed is nimble in managing its effect as it works its way into the economy’s production and consumption of goods and services.

A corollary of reining in this massive monetary stimulus in a timely manner is that financial markets may have become too accustomed to what some have depicted as a Fed “put.” Some have come to expect the Fed to keep the markets levitating indefinitely. This distorts the pricing of financial assets, encourages lazy analysis and can set the groundwork for serious misallocation of capital.

…

Whereas before, our portfolio consisted primarily of instantly tradable short-term Treasury paper, now we hold almost none; our portfolio consists primarily of longer-term Treasuries and MBS. Without delving into the various details and adjustments that could be made (such as considerations of assets readily available for purchase by the Fed), we now hold roughly 20 percent of the stock and continue to buy more than 25 percent of the gross issuance of Treasury notes and bonds. Further, we hold more than 25 percent of MBS outstanding and continue to take down more than 30 percent of gross new MBS issuance. Also, our current rate of MBS purchases far outpaces the net monthly supply of MBS.

The point is: We own a significant slice of these critical markets. This is, indeed, something of a Gordian Knot…

There is no Alexander to simply slice the complex knot that we have created with our rounds of QE. Instead, when the right time comes, we must carefully remove the program's pole pin and gingerly unwind it so as not to prompt market havoc. For starters though, we need to stop building upon the knot. For this reason, I have advocated that we socialize the idea of the inevitability of our dialing back and eventually ending our LSAPs. In June, I argued for the Chairman to signal this possibility at his last press conference and at last week’s meeting suggested that we should gird our loins to make our first move this fall. We shall see if that recommendation obtains with the majority of the Committee.

"We must make our exit from the bond-buying programme quick," Richmond Fed President Jeffrey Lacker, one of the Fed's most fiscally conservative officials and a persistent critic of the latest round of bond buying, said in WirtschaftsWoche.

"An end to these bond purchases came into sight at the latest Fed meeting," said Lacker.

…

"First of all we should end the monthly purchases of mortgage bonds as quickly as possible," Lacker said in the interview. It was not the central bank's role to give any sector preferential support, he said.

Lacker said the United States had made hardly any progress in cutting its debt and had instead only come up with temporary solutions for several months at a time. He said he hoped the Fed's planned scaling back of bond purchases this year and rising interest rates would force the U.S. Congress to agree more quickly on reducing debt. "We need a sustainable solution and the sooner the better," he said.

As reported by Reuters.

"Should there a be point at which these type of costs exceed the benefits that the low-interest rate environment is providing generally to the economy, then I would argue it needs to be reevaluated,” Ms. Raskin said. The future course of Fed policymakers’ decision making is “highly data dependent,” and will vary based on how the economy performs.

As reported by The Wall Street Journal.

BACHUS: Chairman Bernanke, I'm not seeing a lot of discussion concerning the reduction in treasury issuance with the deficit coming down. It seems like that would give you more latitude to reduce your purchases of treasuries. Would you like to comment on that?

BERNANKE: Well, the Fed still owns a relatively small share of all the treasuries outstanding. It's true that as the new issuance comes down that our purchases become a larger share of the new flow of treasuries coming into the market. But we have not seen that our purchases are disrupting the treasury market in any way. And we believe that they have been effective in keeping interest rates low.

That being said, as I've described, depending how the economy evolves, we -- you know, we are considering changing the mix of tools we use to maintain the high level of accommodation.

BACHUS: Yeah, but the fact that they are -- will be probably issuing less is a factor you're considering, I guess.

BERNANKE: We would consider that. But, you know, again, our view of it, which, you know, people disagree -- but our view is that what matters is the share of the total that we own not the share of the new issuance.

MULVANEY: But if you've got tremendous losses on your balance sheet because of higher interest rates, you're paying out higher interest to the banks that keep their excess reserves (inaudible). You're (ph) negative cash. Where does the money come from?

BERNANKE: They come from the income -- they come from the income from our -- from our assets. We -- it's just that we have -- from an accounting perspective, we don't have to recognize those losses unless we sell 'em.

MULVANEY: Is there ever a circumstance where you go to your shareholders for a capital call?

BERNANKE: No.

“I don’t want to do it all at once, but I think we should begin to taper very soon and hopefully end it by the end of this year,” Plosser said today in an interview in Jackson Hole, Wyoming. “That would be a healthy thing for the economy. We can do it gradually.”

Fed Chairman Ben S. Bernanke said last month the Fed is on track to begin reducing its bond buying later this year and halt the program by around mid-2014 if the economy performs in line with central bank forecasts. Plosser, who doesn’t vote on monetary policy this year, has repeatedly spoken out against additional easing by the Fed.

“I’d like for us to start in September” to taper the purchases, Plosser said in the Bloomberg Television interview with Michael McKee to air July 15. “We don’t want to create another housing boom,” and “we have to be careful of the unintended consequences of our policies.”

[T]here were large growths in gross inflows of financial flows from Europe to the United States, which again were a demand for safe assets, if you will, which at the time, there being an insufficiency of safe assets. In the view of many people, the — Wall Street was in some sense trying to construct safe assets through securitization and tranching. And we know that that didn’t work out so well.

I think that — you know, there are some issues with safe assets in that, besides collateral, you know, we have potentially increased liquidity requirements, increased margin requirements. And that may create some pressure on supply of safe assets, at the same time that, you know, we’re having sovereign debt issues in some parts of the world, which reduces the supply of safe assets. So I think that’s an interesting, important question, and one that we have discussed at the Federal Reserve.

I would say, however, that I do not think that our asset purchase programs are having a significant affect on that supply-demand balance.

And the reason is the very simple point that when we buy assets — and our total purchases, by the way, are a pretty small share of the global amount of safe assets — but anyway, when we buy safe assets, we of course pay for them with bank reserves, which is another safe asset, and one that’s even more liquid.

So I don’t think that our asset purchases are significantly affecting the net supply of safe assets. But it — but it is an issue, and one that we’ve looked as we’ve thought about, for example, margining and liquidity policy.

He said the Fed statement and subsequent press conference were part of a process to prepare markets for the end of central bank support. It “made sense to socialise the idea that quantitative easing is not a one-way street”, he said, and emphasised any such move would be done cautiously.

[L]et me say a few words about the Federal Reserve's strategy for normalizing policy in the long run. In the minutes of its June 2011 meeting, the committee set forth principles that it intended to follow when the time came to normalize policy and the size and the structure of the Federal Reserve's balance sheet. As part of prudent planning, we've been reviewing these principles in recent meetings. We expect those discussions to continue and intend to provide further information at an appropriate time.

     For today, I will note that, in the view of most participants, the broad principles set out in June 2011 remain applicable. One difference is worth mentioning. While participants continue to think that in the long run the Federal Reserve's portfolio should consist predominantly of Treasury securities, a strong majority now expects that the committee will not sell agency mortgage-backed securities during the process of normalizing monetary policy, although in the longer run limited sales could be used to reduce or eliminate residual MBS holdings. I emphasize that given the outlook in the committee's policy guidance, these matters are unlikely to be relevant to actual policy for quite a while.

Going forward, the economic outcomes that the committee sees as most likely involve continuing gains in labor markets supported by moderate growth that picks up over the next several quarters as the near-term restraint from fiscal policy and other headwinds diminishes. We also see inflation moving back toward our 2 percent objective over time.

If the incoming data are broadly consistent with this forecast, the committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year and that the subsequent data remain broadly aligned with our current expectations for the economy, we will continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around mid-year.

In this scenario, when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7 percent, with solid economic growth supporting further job gains, a substantial improvement from the 8.1 percent unemployment rate that prevailed when the committee announced this program.

Later, in response to a question about whether this was a formal committee decision:

Well, again, we don't think of this as a change in policy. What I was deputized to do, if you will, was to try to make somewhat clearer the implications of our existing policy and to try to explain better how the policy would evolve in various economic scenarios. And that's a little bit difficult to put into, you know, a very terse FOMC statement.

Now, that being said, going forward, I think that, you know, some of this -- some of these elements -- to the extent that we can make them useful will begin to appear in the FOMC statement. It's entirely possible. But it seemed like the right tactic in this case to -- to explain these fairly subtle contingencies in a context where I could answer questions and -- and respond to any misunderstandings that -- that might occur.

“Even if we do adjust downward our purchases, it doesn’t mean we’re now in some autopilot of moving in the same direction,” Williams, 50, said in an interview yesterday in San Francisco. “You could even imagine a scenario where we adjust it downward based on good data and then adjust it back” if the economy weakened.

“We can adjust it down some, watch how things progress from there, and then adjust it again one way or the other,” Williams, who doesn’t vote on monetary policy this year, said at the San Francisco Fed. A slowing or end of the purchases also “doesn’t mean we’re going to start tightening policy anytime soon,” he said.

I want to be very clear that a step to reduce the flow of purchases would not be an automatic mechanistic process of -- of ending the program. Rather, any change in the flow of purchases would depend on the incoming data and our assessment of how the labor market and inflation are evolving. 

 BRADY: Thank you, Mr. Chairman.  If the economy were to accelerate, the Fed would have to start unwinding QE3. So what is the Fed's exit strategy, the steps you'll undertake? And when do you anticipate, again, executing this?

BERNANKE: Mr. Chairman, so first -- the first thing, of course, would be to wind down eventually the quantitative easing program, the asset purchases. As I've said, the program relates the flow of asset purchases to the economic outlook. As the economic outlook and particularly the outlook for the labor market improves in a real and sustainable way, the committee will gradually reduce the -- the flow of purchases.

I want to be very clear that a step to reduce the flow of purchases would not be an automatic mechanistic process of -- of ending the program. Rather, any change in the flow of purchases would depend on the incoming data and our assessment of how the labor market and inflation are evolving.

   So at some point, of course, we will end the asset purchase program. Subsequent to that we will follow the guidance that we've provided about interest rates. Our principal tool for raising interest rates will be the interest rate on excess (ph) reserves that we pay, which will induce higher money market rates and a higher federal funds rate. And we will complement that with other tools, including tools that we have for draining reserves. 

    We may or may not sell assets. At this point it does not appear that it is necessary for us to sell any assets -- or particularly not any mortgage-backed securities -- in order to exit in a way that doesn't endanger price stability. 

    So there are a number of steps. We are currently discussing further our exit strategy, and we hope to provide more information going forward. But we certainly are confident that we can exit over time in a way that will be consistent with our policy objectives. 

    BRADY: You anticipate allowing maturing securities to roll off the balance sheet before you begin selling securities themselves? 

    BERNANKE: As I said, we -- we could normalize policy by simply letting securities roll off, and I think there's some advantages to doing that. For one it wouldn't disrupt markets so much. It would avoid as much irregularity in our fiscal payments to the Treasury. But we will see, ultimately, in the very long run, I think there's a desire to get back to a predominantly Treasury security portfolio. 

    But, again, in the exit process, allowing assets to roll off would be sufficient to bring us to a more normal balance sheet within a reasonable period.