Federal Reserve Bank of Dallas President Richard Fisher said Friday that the U.S. central bank's revamped interest-rate guidance might be "sloppier" than its previous incarnation but should be less vulnerable to any errors officials make in their forecasts.

In a speech at the London School of Economics, Mr. Fisher said the Fed has entered "unexplored territory" but that its new guidance is aimed at smoothing the transition between the Fed's expansionary period of large-scale asset purchases and the eventual return to higher interest rates.

"What we are trying to do now is to articulate the best we can what happens after our massive QE," Mr. Fisher said, referring to quantitative easing, another name for central-bank asset purchases.

"What we have done is we have de-quantified our guidance and are seeking to provide qualitative indicators of how we might proceed," he said.

The official added that "by its very nature qualitative guidance will be a little bit sloppy" and that investors tend to prefer more precision. But he said "you cannot expect specific quantitative guidance without mistakes being made," referring to forecasting errors that may have led investors to misjudge the central bank's intentions.
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He said central banks pursuing forward guidance, which include the European Central Bank and the Bank of England, all are aiming "to ensure we have a sustainable recovery."

Mr. Fisher also sounded a warning note on risks that may be building in the financial system from a prolonged period of low interest rates, which many economists fret may inflate bubbles in asset prices.

"We are seeing in my opinion some exhibitions of excessive risk," he said, pointing to low yields on some riskier types of corporate bonds in particular.

STEVE LEISMAN: Question two is, doesn't that implicitly suggest a shallower glide path once you take off, or once Fed funds rates would begin -- when you first hike them -- wouldn't that suggest a shallower glide after the funds rate?

YELLEN: Yes, I think it does suggest shallower glide path. And what the committee is expressing here, I would say, is its forecast of what will be appropriate some years from now based on its -- the understanding that we'll develop about what are the economic forces that has been driving economic activity.

We've had a series of years now in which growth has proven disappointing. Now, members of the committee have different views about why this is likely to be true that the funds rate, when the labor market is normalized and inflation is back to our objective, may be have slightly different views on exactly why it's likely to be the case that interest rates will be little lower than they would in the longer run.

But for many it's a matter of head winds from the crisis that have taken a very long time to dissipate and are likely to continue being operative.
So some examples I would say is we have under -- many households are under going balance sheet repair. There are underwater mortgage holders, difficulties therefore in gaining access to credit, for example, through home equity lines of credit. For some that makes it difficult to finance small businesses. Mortgage credit is very difficult for those still to get without pristine credit scores.

Federal Reserve Bank of Chicago President Charles Evans said Monday “there’s not a large expectation” the current system of numerical thresholds will remain in place for much longer. The Fed is likely to replace it with more “qualitative” guidance, he said in a speech at Columbus State University, in Georgia.

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Mr. Evans said in his speech that when it comes to shrinking the bond buys, “we are going to continue to do that.” He added to reporters after his formal remarks that “we have got a pretty high hurdle for altering our taper plan,” noting that cutting them by $10 billion at each Fed policy meeting “is a nice benchmark” for future reductions.

Mr. Evans also said that if it were up to him, the Fed would refrain from raising short-term rates until sometime in 2016. Most Fed officials believe the first rate increase will come in 2015 if economic conditions improve as they expect.

The 6 ½% is already a little bit obsolete in the sense that we’re really close to it. Most people think that the Fed is not going to raise rates until the unemployment rate is considerably below 6 ½%. So my personal opinion is 6 ½% is not providing a lot of value right now in terms of our communications. So my personal view is this is probably a reasonable time to revamp the statement to take out that 6 ½% threshold because it’s not really providing any great value…

Generally, I think the Bank of England’s approach, I think, is a very good approach. It was qualitative rather than quantitative in that they weren’t putting in specific numerical targets. I think that’s appropriate in the U.S. We are going to have to look at a broad set of labor market conditions rather than one single indicator. The labor market in the U.S. is difficult to interpret right now…We don’t really have a really good sense of how much this fits in which category, how much the decline in participation is demographics versus how much the decline is participation is discouraged workers. So I think that tells you you have to look at a broad array of indicators rather than just focusing on the unemployment rate.

The other thing I liked about the Bank of England’s approach is that they did talk about the longer term, not just focusing on the timing of liftoff, but also what happens after that. And as you recall, the Bank of England made it clear they’ve thought the rate at which rates would rise would be gradual, and that rates would not rise to particularly high levels, because I think their view was that there are going to be persistent headwinds restraining the economy. A neutral interest rate in the current environment is going to be lower than a neutral interest rate has been historically. That same rational applies here in the U.S. I think that the equilibrium real interest rate associated with a neutral monetary policy regime today is considerably lower than it was historically. To me, you want to stretch our your expectations of the whole forward path of short rates, not because you have certainty about that, obviously the world’s going to change and you’re going to get new information, but your expectations about forward path of short term interest rates gets embodied into stock prices. That’s an important component in terms of how financial conditions get set. And financial conditions are very, very important because that’s really the transmission mechanism through which monetary policy works. So the more information the Fed can give about what we’re thinking about, the better market participants can assess us. Therefore, financial conditions can be set at an appropriate level.

Lacker, who votes on the Fed's policymaking Federal Open Market Committee in 2015, said he expects the first rate hike to come in early 2015.

Bullard revealed for the first time that he was one of the two FOMC participants show foresaw a 2014 rate hike in December and said he made that forecast because he was "more optimistic" than many about the outlook for economic growth and employment.  He said he had previously expected the first rate hike to come in 2015.

With the March meeting less than a month away, Bullard said, "I definitely will have to reconsider at this meeting" whether the first rate hike will come in late 2014 or in 2015.

"Even in December, it was a close call," he said, adding that "if it moves back a quarter" it makes little difference.

"We have to start to get out of the mode of emergency policy" and think about making monetary policy "more normal," Bullard said.

He told his audience that, even though the Fed is scaling back its large-scale asset purchases, it is "still buying a lot." He said continued "tapering" remains on track at coming meetings of the FOMC.

The Committee has emphasized that a highly accommodative policy will remain appropriate for a considerable time after asset purchases end. In addition, the Committee has said since December 2012 that it expects the current low-target range for the Federal Funds Rate to be appropriate at least as long as the unemployment rate remains above 6.5 percent, inflation is projected to be no more than a half percentage point above our 2 percent longer-run goal, and longer-term inflation expectations remain well anchored.
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In December of last year and again this January, the Committee said that its current expectation based on its assessment of a broad range of measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments is that it is -- that it will likely be appropriate to maintain the current target range for the Federal Funds Rate well past the time that the unemployment rate declines below 6.5 percent, especially if projected inflation continues to run below the 2 percent goal.

When I began my term I expected to build on the monetary policy framework I had inherited from Paul Volcker and Alan Greenspan I believed that a still more transparent approach would make monetary policy even more effective and further strengthen the Fed's institutional credibility. In particular, as an academic I had written favorably about the flexible inflation-targeting approach used by the Bank of England and a number of other central banks. [T]hese central banks provided a clear framework to help the public and market participants understand and anticipate policy actions I was confident that we could adapt this type of framework to the Federal Reserve's dual mandate to promote both maximum employment and price stability. Indeed, central banks using this framework were already, in practice, often pursuing economic objectives in addition to low and stable inflation--hence the term, "flexible" inflation targeting. Because the financial crisis and its aftermath naturally occupied so much of policymakers' attention, progress toward a more explicit policy framework at the Federal Reserve was slower than I had hoped. Nevertheless, progress was made. In the minutes of its October 2007 meeting, the FOMC introduced its quarterly Summary of Economic Projections (SEP), which included FOMC participants' projections of key macroeconomic variables such as inflation, gross domestic product (GDP) growth, and the unemployment rate. Over time, we added long-run projections of inflation, growth, and unemployment, as well as projections of the path of the target federal funds rate consistent with each individual's views of appropriate monetary policy We took another important step in January 2012, when the FOMC issued a statement laying out its longer-run goals and policy strategy.2 The statement established, for the first time, an explicit longer-run goal for inflation of 2 percent, and it pointed to the SEP to provide information about Committee participants' assessments of the longer-run normal unemployment rate, currently between 5.2 and 6 percent.

In an interview with Reuters, John Williams, president of the San Francisco Federal Reserve Bank, said the central bank needed to do more to convince investors that rates will stay low long after the Fed stops buying bonds. It should not wait to twin that message with a decision on cutting back its bond-buying stimulus, he said.

But once the Fed decides the economy is strong enough for the Fed to reduce its $85 billion in monthly bond purchases, it should announce an end date and a purchase total for the program, Williams said.

For now, he said, the Fed must drive the message of continued support for the economy.

"My view would be that we would not be raising the funds rate even if the unemployment rate was below 6.5 percent as long as inflation continued to be low, for some time," Williams said. "We need to be communicating more about the post-6.5-percent world now, because it could be with us much sooner than we expect, and I don't want market participants to be surprised."…

The goal, he said, is that people understand the Fed is "not in a rush" to raise interest rates. For his part, he said, he does not expect rates to rise until the latter part of 2015.

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Williams first publicly embraced the idea of capping bond buys in early November as a way to give investors clarity on the Fed's next steps, and the idea may be gaining traction. Philadelphia Fed President Charles Plosser, a hawk who opposed the Fed's current round of bond buys from the start, has also floated the idea of capping QE in order to shore up the Fed's credibility.

Although the date-based forward guidance appears to have affected the public's expectations as desired, it did not explain how future policy would be affected by changes in the economic outlook--an important limitation. Indeed, the date in the guidance was pushed out twice in 2012--first to late 2014 and then to mid-2015--leaving the public unsure about whether and under what circumstances further changes to the guidance might occur.8 In December of last year, the FOMC addressed this issue by tying its forward guidance about its policy rate more directly to its economic objectives.9Introducing so-called state-contingent guidance, the Committee announced for the first time that no increase in the federal funds rate target should be anticipated so long as unemployment remained above 6-1/2 percent and inflation and inflation expectations remained stable and near target.10 This formulation provided greater clarity about the factors influencing the Committee's thinking about future policy and how that thinking might change as the outlook changed.

Between November 2008 and June 2012, the FOMC announced or extended a series of asset purchase programs, in each case specifying the expected quantities of assets to be acquired under the program. Like the use of date-based forward guidance, announcing a program of predetermined size and duration has advantages and disadvantages. On the one hand, a fixed program size is straightforward to communicate; on the other hand, a program of fixed size cannot so easily adapt to changes in the economic outlook and the consequent changes in the need for policy accommodation. In announcing its fixed-size programs, the FOMC did state a general willingness to do more if needed--and, indeed, it has followed through on that promise--but such statements left considerable uncertainty regarding the conditions that might warrant changes in an existing program or the introduction of a new one.

In a step roughly analogous to the shift from date-based guidance to the contingent, thresholds-based guidance now in use for the federal funds rate target, in September 2012 the FOMC announced a program of asset purchases in which the total size of the purchase program would not be fixed in advance but instead would be linked to the Committee's economic objectives.

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.

[This] form of forward guidance—pre-commitment to a policy rate path—could create more risk for the central bank. In particular, consider a scenario in which the central bank decided to increase monetary accommodation by committing to maintain a low short-term interest rate for a long time even if this commitment resulted in inflation overshooting the central bank’s objective in the future.

This is not a policy that has been adopted by the Federal Reserve. There are implementation challenges with this approach. In particular, it is difficult for a monetary policy committee today to institutionally bind future monetary policy committees to follow actions that could conflict with their objectives in the future. Without such a credible forward commitment, such policies would likely be ineffective in affecting expectations in the manner needed to provide additional monetary policy accommodation.

The September decision not to reduce purchases clearly took some market participants by surprise. For me, the decision was a close call, and I would have been comfortable with a small reduction in purchases. However, as the minutes of the September FOMC meeting reflect, there were legitimate concerns about the strength of incoming economic data, the economic effects of tighter financial conditions and of tighter fiscal policy, and the prospect for disruptive events on the fiscal front.7 I supported the decision as a reasonable exercise in risk management. Events since the September meeting suggest that the concerns regarding fiscal matters were well founded.

I would like to push back against the narrative that the decision at the September meeting has damaged the Committee's communications strategy. In its communications, the Committee seeks to influence market conditions over the medium term in a way that is consistent with its policy intentions… [A]t the end of the day, my own judgment is that market expectations are now better aligned with Committee assessments and intentions.

The September decision underscored the Committee's intention to determine the pace of purchases in a data-dependent way based on progress toward our objectives. Moreover, the modest net tightening in financial conditions since the June meeting has likely reduced the prevalence of highly leveraged, speculative positions. I believe that the market is now prepared for a reduction in purchases when the economic outlook and the broader situation support it.

Short term rates have fallen back since the September meeting, and are now better aligned with the Committee's forward rate guidance. This is particularly important because, as the Chairman stressed in September, the Committee views rate policy as its stronger and more reliable tool.

A second form of forward guidance is the FOMC’s projections of the federal funds rate for the next few years. Four times a year, the FOMC participants submit their views on the appropriate future path for the federal funds rate, along with the associated projections for economic growth, unemployment, and inflation. The FOMC projections for the federal funds rate from our September meeting are shown in Figure 2. A large majority of FOMC participants—14 out of 17—expect the first federal funds rate hike to take place in 2015 or later. And after the first rate hike, most FOMC participants expect the funds rate to increase only gradually, with the median projection showing it rising to just 2 percent by the end of 2016.