It is important to recognize that providing more information on our forecasts does not represent a new way to do policy. Rather, it helps clarify what the Committee is focused on. It also makes more explicit that the Committee is looking forward, does have a plan to pursue its dual mandate, and is attentive to situations where the risks to its forecast may be unusually large or asymmetric.

Clearly, recent Fed policy actions have not protected investors in subprime paper. The policy objective is not to prevent losses but to restore normal market processes. The issue is not whether subprime paper will trade at 70 cents on the dollar, or 30 cents, but that the paper in fact can trade at some market price determined by usual market processes. Since August, such paper has traded hardly at all. An active financial market is central to the process of economic growth and it is that growth, not prices in financial markets per se, that the Fed cares about.   

In voting to ease policy, I carefully considered the effect of that decision on our other objective--price stability. I reasoned that the anticipated softening of economic growth and perhaps the emergence of some slack in the labor market might reduce those pressures, and I judged that a cut of 25 basis points in the target federal funds rate would not materially alter that modal outlook. However, I recognized the risk that, even if readings on core inflation have improved modestly this year, recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation. Consequently, in considering appropriate future adjustments to policy, I will monitor inflation developments carefully.

Overall, I think that the cumulative policy easing the FOMC put in place at its past two meetings reduced significantly the downside risks to growth so that those risks are now balanced by the upside risks to inflation. In these circumstances, I will want to carefully assess incoming data and gauge the effects of financial and other developments on economic prospects before considering further policy action. As always, my colleagues on the FOMC and I will act to foster our dual objectives of price stability and sustainable economic growth.

The Fed has three main responsibilities that pertain to these developments: promoting financial stability to help financial markets function in an orderly way, supervising and regulating banks and bank holding companies to ensure the safety and soundness of the banking system, and conducting monetary policy to achieve its congressionally mandated goals of price stability and maximum sustainable output and employment.

With respect to the Federal Reserve’s dual mandate, behavioral research supports the view that inflation is costly, although very modest inflation might help protect against downward nominal wage rigidity.  Behavioral macroeconomic models also provide theoretical underpinnings for the view held by most policymakers that, in the short run, monetary policy can and should strive to stabilize the real economy.    

I take this opportunity to reiterate the Federal Reserve’s strong support of the dual mandate; in pursuing maximum employment and price stability, monetary policy makes its greatest possible contribution to the general economic welfare. 

Turning to monetary policy, I hope I've made it clear that—based on what we know now—I think the current stance of policy is likely to foster sustainable growth with a gradual ebbing of inflationary pressures. It has been heartening to see core consumer inflation edging down in recent months. However, as the most recent statement noted, "a sustained moderation in inflation pressures has yet to be convincingly demonstrated." Moreover, upside risks to inflation continue to be present, given the possibility that labor markets are somewhat tight. I believe it is important to be particularly attentive to these risks not only because price stability is desirable in its own right, but also because a credible commitment to keeping inflation low and stable is necessary to ensure that inflation expectations remain well-anchored. At the same time, we must be careful not to pose unnecessary risks to continued expansion.

The best way to achieve the mandate is for the Federal Reserve to have a strong commitment to a nominal anchor to promote price stability, but with a focus on keeping employment as close as possible to its maximum sustainable level.  

Unforeseen shocks to the economy--an adverse supply shock, for example--might lead to inflation that is temporarily above levels consistent with price stability at the same time that employment is growing more slowly than its maximum sustainable pace. In such a situation, returning inflation too quickly to levels consistent with price stability might unnecessarily exacerbate the economic weakness. Instead, while restoring price stability remains critical, the central bank should do so at a pace that does not do undue harm to the economy.

Finally, central banks should respond aggressively to output and employment fluctuations on those (hopefully rare) occasions when the economy is very far below any reasonable measure of its potential. In this case, errors in measuring potential output or the natural rate of unemployment are likely to be swamped by the large magnitude of resource gaps, so it is far clearer that expansionary policy is appropriate. Furthermore, taking such actions need not threaten the central bank's credibility in its pursuit of price stability.

It used to be thought that the dual mandate required the Fed to temper pursuit of its inflation goal from time to time in the interest of minimizing disturbances to employment. That view began to change 40 years ago. Over time, the mainstream view in the economics profession has increasingly emphasized the importance of price stability for achieving maximum employment and maximum sustainable economic growth. I myself have become passionate about price stability. It is important to remember that the two greatest employment disasters in U.S. history were the Great Depression and the Great Inflation. Deflation from late 1929 to 1933 drove the U.S. economy down and down, and the unemployment rate rose to 25 percent. During the Great Inflation, from 1965 to 1981, the United States suffered four recessions, the last of which in 1981-82 drove the unemployment rate to a peak of 10.7 percent at the end of 1982, the highest since the Great Depression.

Experience abroad confirms the connection between price instability and unemployment. For one example, Japan suffered a decade of deflation in the 1990s; economic growth was minimal and unemployment rose.

You say we have the two objectives, stable prices and employment - but one of those might - I mean, I appreciate the fact that you have two children and you love them both, but I'm afraid that one of them might get a little bit more for Hanukkah than the other if we're not careful.

In Q&A session with Chairman Bernanke

I've always been struck -- and I have to say, I haven't found this to be Alan Greenspan's issue or Ben Bernanke's, but there are people in this country who think that the Fed somehow should be above democracy.
 
     I mean, I remember talking to some people in the Clinton administration:  Oh, we can't discuss interest rates.
 
     I mean, we can debate whether Terri Schiavo's life should be recognized as over.  We can debate abortion.  We can debate wars in Iraq.  We can debate the most fundamental questions in human existence, but God forbid anybody in elected office should talk about whether or not we need a 25-basis point increase in the Fed.  Somehow, that's sacrosanct.  No, it isn't.  It's public policy.
 
     One, I don't want a change.  There are people who have been arguing that the Fed should have its mandate changed, that the
Humphrey-Hawkins Act, which says it should deal both with stable prices and maximum appointment, that that should be changed, and it
should just go to stable prices.
 
     That's not going to happen when we're in power.  And we can prevent that from happening.

Uncertainty over trend labor force growth will complicate the Fed’s job next year.  While we know that there is no long-run tradeoff between inflation and unemployment, policymakers try to maintain an equilibrium in the labor market at approximately full employment both because full employment is an important goal and because avoiding short-run strains in the labor market helps to maintain price stability.  If actual employment growth slows, we will have to make the judgment as to whether the slowing is consistent with a slowing of trend labor force growth or is a sign of impending recession. If employment growth next year remains only modestly below this year’s average pace of about 150,000 per month, we will have to make the judgment as to whether this growth is outrunning available labor, which would be the case if we accept the low estimate of trend labor force growth, or whether one of the higher estimates of trend labor force growth is being realized. To make this judgment, we will have to collate as many different scraps of information we can find to supplement the standard labor force statistics released every month.

Credibility is not, however, one-dimensional. Sustained low inflation is desired for its own sake but even more for the contribution it makes to high employment and economic growth. Thus, while inflation damages credibility, so also can high unemployment. There is a fine balance here. We know that monetary policy cannot affect employment in the long run, but we also know that monetary policy mistakes can create unemployment over an uncomfortably long short run. When unemployment rises, policymakers need to be able to explain in credible fashion why the problem is not a consequence of a monetary policy mistake, for that perception is always present among some observers in such circumstances. There is, after all, some historical justification for such a perception given that almost all economists agree that monetary policy mistakes contributed to the severity of the Great Depression. Given the importance of high employment, a period of sustained excessive unemployment may create doubts about future policy, and this uncertainty is a manifestation of impaired credibility.

The Federal Reserve has a three-part mandate: price stability, low/moderate long-term interest rates and maximum employment.  Clearly, keeping inflation low and stable addresses directly the first two of those, in particular, since long-term interest rates can only be low if investors expect inflation to remain low.  I would argue that there's very strong evidence that low and stable inflation and well-anchored inflation expectations also contributes mightily to the third objective which is strong and stable employment growth.