A crucial feature of the FOMC's policy communications is that the Committee's forward guidance has been framed not as an unconditional commitment to a specific federal funds rate path, but rather as an expectation that is explicitly contingent on economic conditions. Since November 2009, the Committee has specifically indicated that the relevant economic conditions include "low rates of resource utilization, subdued inflation trends, and stable inflation expectations." An important consequence of such conditionality, serving to enhance the effectiveness of the guidance, is that incoming information about economic and financial developments has led forecasters and investors to revise their outlook for the path of the funds rate even in the absence of a change in the forward guidance language.

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Down the road, once the recovery is well established and the appropriate time for beginning to firm the stance of policy appears to be drawing near, the FOMC will naturally need to adjust its "extended period" guidance and develop an alternative communications strategy to shape market expectations about the policy outlook. However, if there were an unexpected faltering of the recovery or a substantial widening of downside risks to economic activity and inflation, the forward guidance now in place might well be sufficient to facilitate an outward shift in the expected path of the funds rate, just as we saw over the course of last year.

"Everything depends on how the economy performs," said Federal Reserve Bank of St. Louis President James Bullard.

While the Fed has for some time officially stated its inclination to keep interest rates very low for an extended period, Bullard said that pledge is "conditional." When it comes to saying when interest rates might rise from their current zero percent range, the official said, "I can't."

One important tool is policy communication.  Even if the overnight rate is close to zero, the Committee should be able to influence longer-term interest rates by informing the public's expectations about the future course of monetary policy.  To illustrate, in its statement after its December meeting, the Committee expressed the view that economic conditions are likely to warrant an unusually low federal funds rate for some time.²  To the extent that such statements cause the public to lengthen the horizon over which they expect short-term rates to be held at very low levels, they will exert downward pressure on longer-term rates, stimulating aggregate demand.  It is important, however, that statements of this sort be expressed in conditional fashion--that is, that they link policy expectations to the evolving economic outlook.  If the public were to perceive a statement about future policy to be unconditional, then long-term rates might fail to respond in the desired fashion should the economic outlook change materially.

Since it began withdrawing monetary accommodation in June 2004, the FOMC has repeatedly stated that its future policy actions will be governed by the expected performance of the economy. Monetary accommodation can be withdrawn at a faster pace if inflation pressures seem to be building to a greater extent than expected. Likewise, if economic weakness emerges, the trajectory of policy could be appropriately adjusted for these circumstances. For now, I believe that our policy of removing monetary accommodation at a "measured" pace is most likely to promote our broader objectives of price stability and maximum sustainable economic growth.

In the United States, the August 2003 statement of the Federal Open Market Committee that "policy accommodation can be maintained for a considerable period" is another example of commitment. The close association of this statement with the Committee's expressed concerns about "unwelcome disinflation" implied that this commitment was conditioned on the assessment of the economy. The conditional nature of the commitment was sharpened in the Committee's December statement, which explicitly linked continuing policy accommodation to the low level of inflation and the slack in resource use.