In light of its current outlook, the Committee recently decided to provide more specific forward guidance about its expectations for the future path of the federal funds rate. In particular, in the statement following our meeting earlier this month, we indicated that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013. That is, in what the Committee judges to be the most likely scenarios for resource utilization and inflation in the medium term, the target for the federal funds rate would be held at its current low levels for at least two more years.

I think we need to be clear about conditioning our actions on how the economy evolves. And I think by changing the language, I thought it was inappropriate for us to do that.

It used the calendar. And while the language itself was conditional in the sense that this was the likely outcome, we already had that as the likely outcome through our extended period language.

So I didn`t think it was a well-crafted communication strategy that we used.

“With my diminished outlook for economic growth, and my outlook for inflation to soon fall back to 2 percent, I was in favor of providing additional support to the recovery at last week’s FOMC meeting,” Pianalto said today in a speech in Columbus, Ohio.

“Under the circumstances, I think it made sense to take the unprecedented step of including that conditional guidance in our press statement,”

A very downbeat description of the economy would not do much to engender confidence in the business community or the consumer community. And I was worried that we were playing into that.

But I was also concerned that the action that was taken, which was to change the extended period language to a date, was poorly designed and was inappropriate. Policy should not be dependent on the calendar. It should be depending on the economy.

“Policy should be set according to the state of the economy, not according to the calendar,” Bullard said. “I didn’t like putting calendar dates in.”

Many have read the FOMC statement as virtually guaranteeing that the Fed will hold the funds rate near zero for at least another two years, but Lacker said that is not a valid interpretation. “I would note that it’s a fairly mild statement in the sense that it’s highly contingent,” he said... “I think that if the economic data come in differently than the Committee expected then I think that will provide the opportunity to alter the terms of that statement.” 

 “That statement isn’t so much a commitment as it is a forecast,” he added.

...

Lacker said his main objection to the extended zero rate policy is directed elsewhere: “For me predominantly, it’s a matter of money creation and inflation.”

 “We operate monetary policy by moving short-term interest rates around over the business cycle,” he explained. “We do that because what’s required to get the money supply right, to keep inflation low and stable, a lower interest rate is required when the economy is soft, and a higher interest rate is required when the economy is strong.” “If we get the interest rate wrong we’re going to get the money supply wrong, and that’s going to get inflation wrong,” he continued. “And that’s why we vary interest rates with economic conditions the way we do. People confuse that with providing stimulus and working to offset shocks to growth, positive or negative.” 

 “So for me the chief risk is that it creates the ingredients for an acceleration of inflation.”

 Even with the federal funds rate close to zero, we have a number of ways in which we could act to ease financial conditions further. One option would be to provide more explicit guidance about the period over which the federal funds rate and the balance sheet would remain at their current levels. Another approach would be to initiate more securities purchases or to increase the average maturity of our holdings. The Federal Reserve could also reduce the 25 basis point rate of interest it pays to banks on their reserves, thereby putting downward pressure on short-term rates more generally. Of course, our experience with these policies remains relatively limited, and employing them would entail potential risks and costs. However, prudent planning requires that we evaluate the efficacy of these and other potential alternatives for deploying additional stimulus if conditions warrant.

This largely paralleled Bernanke's comments in his June 22 press conference.  Bernanke dampened expectations of further asset purchases in the short run in his follow-up testimony to the Senate the following day.

We do have a number of ways of acting; none of them are without risks or costs. We could, for example, do more securities purchases and structure them in different ways. We could cut the interest on excess reserves that we pay to banks. And as was suggested by an earlier question—several earlier questions, actually—Jon’s question about giving guidance on the balance sheet or by perhaps even giving a fixed date, you know, to define “extended period,” those are ways that we could ease further if needed.

But, of course, all of these things are somewhat untested. They have their own costs. But we'd be prepared to take additional action, obviously, if -- if conditions warranted.

QUESTION: Do you and your colleagues have a statistical trigger of any sorts, say, a particular level of unemployment or inflation at which you would begin the exit process? If you do, wouldn’t it make sense to announce it? If not, why not?

CHAIRMAN BERNANKE. Well, it’s pretty impossible to create a statistical trigger because we have currently 17 independent members of the FOMC. Each has his or her own view on the outlook, on the efficacy of monetary policy, and on the risks to inflation and unemployment. So we don’t have any such formula.

"Extended period" suggests that there would be a couple of meetings probably before action, but unfortunately, the reason we use this vague terminology is that we don't know with certainty how quickly response will be required. And, therefore, we will do our best to communicate changes in our view, but that will depend entirely on how the economy evolves.

"I know we need to start by, if we were to do that, communicating to the market that we are not guaranteeing them the yield curve, that we are going to remove this language of ‘extended period,’" Hoenig, president of the Kansas City Fed, said in an interview with CNBC today. He said he didn’t know when the central bank may make such a move, while expressing a preference the Fed act this year.

The economy "has been improving," said Hoenig, who added that he believes the Fed should begin to consider "renormalizing" policy and that he favors "non-zero" interest rates.

Rising oil prices are not a "permanent" or "defining" factor for the economy right now, he said.

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.

...

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.

“If we do decide to go ahead with quantitative easing, I think there is a good program we could adopt, one I like, which is to think in units of $100 billion between meetings” of the Federal Open Market Committee, Bullard said today at a conference hosted by the district bank.

“We could give forward guidance for the next meeting that would suggest how likely the committee thinks we would continue these purchases.”

As reported by Bloomberg News

For a competing perspective from the St. Louis Fed's research director the following day, click here.

Promising to remain at zero for a long time is a double-edged sword. The policy is consistent with the idea that inflation and inflation expectations should rise in response to the promise, and that this will eventually lead the economy back toward targeted equilibrium. But the policy is also consistent with the idea that inflation and inflation expectations will instead fall, and that the economy will settle in the neighborhood of the unintended steady state, as Japan has in recent years.

To avoid this outcome for the U.S., policymakers can react di¤erently to negative shocks going forward. Under current policy in the U.S., the reaction to a negative shock is perceived to be a promise to stay low for longer, which may be counterproductive because it may encourage a permanent, low nominal interest rate outcome. A better policy response to a negative shock is to expand the quantitative easing program through the purchase of Treasury securities.

I think it's important to preface the answer by saying that monetary policy is currently very stimulative, as I'm sure you're aware...

You know, that being said, if the recovery seems to be faltering, then we at least need to review our options. And we have not fully done that review, and we need to think about possibilities. But, broadly speaking, there are a number of things that we could consider and look at.

One would be further changes or modifications of our language or our framework, describing how we intend to change interest rates over time, giving more information about that. That's certainly one approach.

We could lower the interest rate we pay on reserves, which is currently one-fourth of 1 percent.

The third class of things, though, has to do with changes in our balance sheet, and that would involve either not letting securities run off, as they are currently running off, or even making additional purchases.

We have not come to the point where we can tell you precisely what the leading options are. Clearly each of these options has got drawbacks, potential costs. So we are going to continue to monitor the economy closely and continue to evaluate the alternatives that we have, recognizing that, as I said, that policy is already quite stimulative.

From the Q&A, in response to a question about what easing options the Fed might have in the event of a downturn.