WINKLER: Five-year bond yields suggested for expected inflation have turned positive for the first time in more than three years. Is the Fed ready to accept this tightening of financial conditions?

DUDLEY: Well I think we evaluate what the economic outlook is and what's happening to financial conditions. And obviously we don't control financial conditions. It also depends on what's happening in the global economy. But we definitely take that on board. I think when I - the dollar it has appreciated a bit over the last few months, not by a significantly (inaudible), but obviously that does factor in terms of our economic forecast. If the dollar were to strengthen a lot it would have consequences for growth. We would have poorer trade performance, less exports, more imports. And if the dollar were to appreciate a lot it would tend to dampen inflation. So it would make it harder to achieve our two objectives. So obviously we would take that into account.

...

I think that the dollar partly reflects the relative performance of the U.S. economy relative to performances in other countries, and in that case that you could sort of understand what we're seeing. I think from our perspective we don't care about the dollar per se. In other words that's not a goal, independent goal of policy. Our goal policy is maximum sustainable employment and two percent inflation. Obviously as the dollar moves that affects the appropriateness of a given monetary policy to achieve those objectives. And we certainly take it on board just like we take on board what's happening to the stock market, what's happening to the bond market, what's happening to credit spreads, what's happening to credit availability. All those factors sort of drive our assessment of what's happening to financial conditions. And then that influences our economic outlook. And then that in turn then influences the monetary policy response.

WINKLER: Five-year bond yields suggested for expected inflation have turned positive for the first time in more than three years. Is the Fed ready to accept this tightening of financial conditions?

DUDLEY: Well I think we evaluate what the economic outlook is and what's happening to financial conditions. And obviously we don't control financial conditions. It also depends on what's happening in the global economy. But we definitely take that on board. I think when I - the dollar it has appreciated a bit over the last few months, not by a significantly (inaudible), but obviously that does factor in terms of our economic forecast. If the dollar were to strengthen a lot it would have consequences for growth. We would have poorer trade performance, less exports, more imports. And if the dollar were to appreciate a lot it would tend to dampen inflation. So it would make it harder to achieve our two objectives. So obviously we would take that into account.

...

I think that the dollar partly reflects the relative performance of the U.S. economy relative to performances in other countries, and in that case that you could sort of understand what we're seeing. I think from our perspective we don't care about the dollar per se. In other words that's not a goal, independent goal of policy. Our goal policy is maximum sustainable employment and two percent inflation. Obviously as the dollar moves that affects the appropriateness of a given monetary policy to achieve those objectives. And we certainly take it on board just like we take on board what's happening to the stock market, what's happening to the bond market, what's happening to credit spreads, what's happening to credit availability. All those factors sort of drive our assessment of what's happening to financial conditions. And then that influences our economic outlook. And then that in turn then influences the monetary policy response.

I gave some remarks on this at a London event for Mervyn King’s retirement. And appropriate of today’s discussion, I used historical examples. I made a distinction of during the 1930s, during the Great Depression, as countries left the gold standard, their currencies temporarily depreciated relative to other countries, and they had a temporary trade advantage because of that; but over time, as all the countries left the gold standard, exchange rates kind of normalized, kind of went back to where they started from, but nevertheless the whole world was nevertheless much better off because there was a global monetary expansion which was desperately needed at that time, in the 1930s.

So that was a positive sum game. It was a situation in which everybody gains because the benefits of — in that particular context, the benefits of growth-enhancing domestic policies spilled over into other economies.

I contrasted that with the Smoot-Hawley tariff, which was more of a zero sum game, where the — or even negative sum, because what was going on there was that each country was trying to divert trade in its own favor at the expense of its trading partners; and as that activity continued and as reprisals and payback continued, actually it destroyed the global trade pattern and was very costly to everybody.

So, what has this got to do with your question? I’m sure you’re wondering. (Laughter.) What it has to do with today is that it’s one thing to use trade or other kinds of interventions to divert — to artificially weaken your currency or otherwise to divert exports to your own producers at the expense of other countries. That’s a very different thing from a situation where countries are using monetary policy appropriately to achieve domestic growth, domestic reflation and that growth spills over and helps the economies of other countries as well. So I think that’s very much the difference, that the exchange rate effects and the currency effects are really secondary. What’s important is that each country provide the necessary monetary accommodation or fiscal accommodation to achieve — to achieve its potential output.

On balance, stronger US growth is beneficial for the entire global economy,” Yellen said at a panel at the IMF annual meeting.

She said that “developing countries do have tools” – principally a looser fiscal and monetary policy – to offset any negative economic impact from a stronger currency. “Interest-rate differentials do drive capital flows and [this] undoubtedly puts press on exchange rates [but] it is not the Fed’s intention to make things more difficult,” she said, acknowledging the political fallout from the Fed’s latest round of asset purchases.

On the market response to the Fed's September 13, 2012 asset-purchase announcement:  [S]tock prices are up substantially, mortgage rates are lower, and exchange rates are lower. On the latter I would point out that our efforts to lower long rates are focused on stimulating domestic demand, but at the same time lower long-term rates affect demand for U.S. assets, resulting in a modest change in the exchange rate – and this is likely to provide some support for export-oriented industries.

Warsh said a reliable currency is a “great historical strength” for the U.S. that allows investment from sources outside the country. In general, having “certainty” over foreign-exchange rates is “useful” for businesses, he said. Economic outcomes tend to be worse when governments are preoccupied with foreign-exchange policy, he said.

[L]ast week, in an unprecedented joint action with five other major central banks and in response to the adverse implications of the deepening crisis for the economic outlook, the Federal Reserve again eased the stance of monetary policy.

It may be that the recent statements made by the Open Market Committee and the recent actions are engendering greater confidence in the dollar. We'll see over time.

... [Currency markets are] manic depressive ... they overshoot. We've had some volatility there, and I'd like to remind people that a lot of people made a mistake by selling the U.S. economy short for a long time.

[Fisher said he is] entertained when I read that today the dollar was weak or yesterday the dollar was weak because the U.S. economy is showing slower growth, then the next day it says it's because inflation was reported higher. I always feel like screaming, "Guys, make up your mind!" So I"m not surprised that the dollar strengthened. The question is what is the trend over time. ... You have to keep in mind that these are manic depressive mechanisms that overshoot on both sides. They're very emotional.

As for the dollar, it has been depreciating since early 2002, and has continued to do so since the financial turmoil began. This development will help to improve our gaping trade deficit and thereby offset some of the otherwise contractionary effects of the tighter credit conditions and lower equity values even though a weaker dollar diminishes the well-being of consumers by lowering their purchasing power.