MCKEE: Very quickly, let me ask you, last question, Donald Trump says he would get rid of Janet Yellen and appoint someone who shares his views on interest rates and policy. What would that mean for Fed credibility?

LACKER: I think it would be problematic for a presidential candidate to dismiss a Fed chair on the basis solely of the perceived party affiliation.

So far, survey evidence, like that obtained from the Philadelphia Fed’s Survey of Professional Forecasters, does not indicate any unanchoring of inflation expectations. However, market-based measures are showing that investors are seeking less compensation for inflation. But there are downside risks to my baseline forecast. In particular, we have been below our inflation target for all but two years since 2008. Consistently below-target outcomes will eventually lead to a lack of credibility for our 2 percent goal. Hence, it may be worth erring on the side of accommodation to ensure against that outcome.

I have been concerned about inflation expectations. And when I talked in mid-February especially, you had the five year, five year forward TIPS inflation measures down below 1.5 percent. That got me, you know, kind of nervous and I — and I started to flag those.

Now, they have recovered probably back to December levels. And I find that comforting. But you’d actually like to see those numbers even somewhat higher than they are today. And because they reflect somehow the credibility of the Fed and its ability to hit a long run inflation target of 2 percent.
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The inflation themselves have been stronger. The year-over-year inflation numbers have been stronger, PC core at 1.7 percent. So it’s definitely coming up toward the 2 percent target just as the Committee predicted. So this is one of the cross-currents here. You’ve got slow growth, but you do seem to get inflation moving back toward target.

There’s been a long time disconnect and I have been worried. I’ve said so on Bloomberg many times, that I’m worried that that gets reconciled in some kind of violent way where there’s a lot of turmoil caused in markets because of changing expectations of what the Fed is going to do.

So I think the Committee gives its best assessment in that dot plot of what they think is going to happen and — and where they think the policy rate is going to go. It’s not clear to me why the pricing should be very different from that, unless markets have a much more pessimistic view of the U.S. economy, which is certainly something you could — you could have.

But if you look at the forecasts in the private sector of how the economy is going to evolve, those aren’t, you know, materially different from what the Fed thinks.

So — so I’m not quite sure why — why we need to have this — this, you know, constant sort of disconnect.

Over the past couple of months, however, core inflation moved up to 1.7 percent on a year-over-year basis. I am encouraged by this development, and have raised my forecast for core inflation in 2016 to 1.6 percent. Looking further ahead, I see both core and total inflation moving up gradually to approach our 2 percent inflation target within the next three years.
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However, I am a bit uneasy about this forecast. It is too early to tell whether the recent firmer readings in the inflation data will last or prove to be temporary volatility and reverse in coming months. We saw this happen in 2012. And there are some other downside risks to consider. International developments may result in further declines in energy prices or greater appreciation of the dollar. Most worrisome to me is the risk that inflation expectations might drift lower. Undershooting our 2 percent inflation target for as long as we have raises the risk that the public will expect persistently low inflation in the future. If such a mind-set becomes embedded in decisions regarding wages and prices, then returning inflation to 2 percent will be that much more difficult. Here, I find it troubling that the compensation for prospective inflation built into a number of financial market asset prices has drifted down considerably over the past two years. More recently, some survey-based measures of inflation expectations, which had previously seemed unmovable, edged down to historically low levels. True, financial market inflation compensation and survey measures of inflation expectations have risen some of late, but they still remain quite low.

Liesman: So you're thinking a 75 basis point 1% fed funds rate with a 2%, 2.5% economy and you don't feel like you're behind the curve in that environment?

Evans: No. I don't think inflation is going to get out of hand. Remember, we've been under 2% for a long time, we're supposed to be at 2%. It's a symmetric objective. Half the time we ought to be above 2%. I don't think we should be concerned about going through 2% on the way to making sure we get to 2% with high confidence. Of course we wouldn't want it to get out of hand. I don't think we're looking at anything like that in the U.S. so I think that we have the ability to be cautious.

“The state of the U.S. economy as of the March 2016 FOMC meeting was arguably consistent with December 2015 SEP projections. Yet, the Committee did not increase the policy rate at the March meeting,” Bullard said. “This state of affairs might be viewed as ‘time inconsistent’ in the macroeconomics literature. Financial markets may have trouble interpreting Fed behavior in the future if this is the case.”

The state of the U.S. economy as of the March 2016 FOMC meeting was arguably consistent with December 2015 SEP projections. Yet, the Committee did not increase the policy rate at the March meeting. This state of affairs might be viewed as ‘time inconsistent’ in the macroeconomics literature. Financial markets may have trouble interpreting Fed behavior in the future if this is the case.

Turning to the FOMC’s normalization strategy being predicated on an environment of stable inflation expectations, Bullard said this renewed downward pressure on market-based measures of inflation expectations during 2016 has called this assumption into question. “I regard it as unwise to continue a normalization strategy in an environment of declining market-based inflation expectations,” he said. “A decline in inflation expectations represents an erosion of central bank credibility with respect to the inflation target.”

I’d also like to stress the “above or below” part. Many people think that Fed policymakers’ concern lies disproportionately with inflation that’s too high. They think we view inflation lower than 2 percent as sort of “not great,” but see inflation above 2 percent as catastrophic. That’s not the case. In my view, inflation somewhat above 2 percent is just as bad as the same amount below.

Mr Rosengren said Fed asset purchases have achieved their stated goal, the jobs report for September is already in and his economic forecasts have not changed. There has been substantial improvement in labour markets, he said. As a result I would be pretty comfortable [ending purchases] at the end of the month.

However, he suggested recent turmoil in financial markets which led to the US stock market plunging last week before recovering on Friday means there is no rush to change how the Fed phrases its forward guidance on future interest rates.

It has to be contextual. Financial markets are volatile, he said. The October statement will have to balance the desire to highlight data dependence with the concern this might not be a time that you want to further destabilize financial markets.

That suggests the Feds considerable time language could survive past its October meeting, although Mr Rosengren now wants to do away with forward guidance altogether. He says that, with the economy nearing full employment, there is too much uncertainty to lay out firm plans.

If youre pretty close to where you want to go, you cant have nearly as much certainty how long its going to take, said Mr Rosengren, pointing out that unemployment at 5.9 per cent is a full percentage point lower than the Fed forecast it would be just 18 months ago.

I would like to tighten when were one year away from full employment, said Mr Rosengren, which on his current forecast would mean a first rate rise in 2015. But he points out how a forecast error could make guidance based on that estimate completely wrong.

Mr Rosengren said recent volatility in financial markets was not such as to make him change his outlook. The fact that its just volatile doesnt bother me, he said. If we were to start seeing long-term rates trending well below our inflation target, that is a warning signal . . . financial markets dont have confidence were going to hit 2 per cent.

Financial market movements are often difficult to account for, even after the fact, but three main reasons seem to explain the rise in interest rates over the summer. First, improvements in the economic outlook warranted somewhat higher yields--a natural and healthy development. Second, some of the rise in rates reportedly reflected an unwinding of levered positions--positions that appear to have been premised on an essentially indefinite continuation of asset purchases--together with some knock-on liquidations of other positions in response to investor losses and the rise in volatility. Although it brought with it some tightening of financial conditions, this unwinding and the associated rise in term premiums may have had the benefit of reducing future risks to financial stability and, in particular, of lowering the probability of an even sharper market correction at some later point. Third, market participants may have taken the communication in June as indicating a general lessening of the Committee's commitment to maintain a highly accommodative stance of policy in pursuit of its objectives. In particular, it appeared that the FOMC's forward guidance for the federal funds rate had become less effective after June, with market participants pulling forward the time at which they expected the Committee to start raising rates, in a manner inconsistent with the guidance.

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At its September 2013 meeting, the FOMC applied the framework communicated in June. The Committee's decision at that meeting to maintain the pace of asset purchases was appropriate and fully consistent with the earlier guidance… Although the FOMC's decision came as a surprise to some market participants, it appears to have strengthened the credibility of the Committee's forward rate guidance; in particular, following the decision, longer-term rates fell and expectations of short-term rates derived from financial market prices showed, and continue to show, a pattern more consistent with the guidance.

The decision to maintain the pace of purchases in September and await more evidence of sustained economic progress came as quite a surprise to the public, generating widespread public debate about the FOMC's communications surrounding its policy intentions.

Not dissuading the public from its expectation of a tapering and then not taking action undermines the credibility of the FOMC and reduces the effectiveness of forward guidance as a policy tool…

In my view, this whole episode also demonstrates how difficult it is to fine-tune our open-ended asset purchases and our forward guidance about them. We cannot continue to play this bond-buying game by ear and risk the Fed's credibility while creating lingering uncertainty about the course of monetary policy.

We need to define simple, clear dimensions to "right-size" the program. This will reduce policy uncertainty and move the economy forward. My preference would be for the FOMC to announce a fixed amount for QE3, just as we did for the two prior rounds of asset purchases…

We are still learning how asset purchases affect the economy, but many believe it is the ultimate size and composition of the assets, rather than the flow of purchases, that influences interest rates and thus the economy. This was the premise of the early rounds of purchases.

Setting the ultimate size of our asset purchase program will lead us away from trying to fine-tune our decision about purchases based on the latest numbers and creating uncertainty from meeting to meeting about the FOMC's next step... By specifying a fixed amount, we would help the public understand that reducing the pace of asset purchases does not signal a change in our policy rate. Indeed, even an end to purchases only stops the efforts to increase accommodation. It is not a tightening of policy. As I said, after our purchases stop, policy will remain highly accommodative. An end to the purchase program does not imply that increases in the policy rate are imminent. We will simply set our policy rate consistent with promoting the FOMC's goals of price stability and maximum employment.

Credibility requires consistency, over time, between a central bank's statements and its actual subsequent actions. A central bank's statements will have greater immediate effect on the public's expectations the more they are seen as limiting the central bank's future choices. Yet there are likely to be circumstances, ex post, in which the central bank feels constrained by past statements. Yielding to the temptation to implicitly renege by reworking decision criteria or citing unforeseen economic developments may have short-term appeal, but widely perceived discrepancies between actual and foreshadowed behavior will inevitably erode the faith people place in future central bank statements. So central banks face an ex ante trade-off, as well, between the short-run value of exercising discretion and the ability to communicate effectively and credibly in the future.

Today, I will simply say that I disagreed with the decision of the committee and argued against it. Here is a direct quote from the summation of my intervention at the table during the policy “go round” when Chairman [Ben] Bernanke called on me to speak on whether or not to taper: “Doing nothing at this meeting would increase uncertainty about the future conduct of policy and call the credibility of our communications into question.” I believe that is exactly what has occurred, though I take no pleasure in saying so.