Looking back on the period, the run-up to the financial crisis, I don't think by any means measured pace and the very predictable pace of 25 basis points per meeting explains why we had a financial crisis, but it may have diminished volatility and been a small contributing factor. And the committee will have to think about how to do this. I think many people in the aftermath of that episode think that somewhat less of a mechanical pace would perhaps be better, but this is a matter that we will in due time have to discuss.

I would like to see short-term interest rates move higher in response to improving economic conditions shortly after completion of the taper. Many of the rules offering policy guidance on the federal funds rate such as the Taylor rule and its variants are already or close to prescribing a policy rate higher than the current funds rate. Second, the path toward the longer-term neutral funds should be gradual. Given the lengthy period of unconventional policy and low rates, the necessary adjustment by financial markets to less central bank intervention and influence could be volatile. In this environment, the pressure to quickly back away from a rising rate policy will be significant; such pressures will need to be resisted. If not, we risk moving into a confusing stop-and-go policy environment.

In terms of the path after liftoff, the FOMC has signaled that it will take a gradual approach toward the longer-run funds rate... So, the funds rate could reach its longer-run level well after the economic recovery is complete and inflation has returned to the 2 percent goal. These signals suggest to banks that they will continue to contend with a low interest rate environment for a few years, even as economic conditions are likely to improve. I see this as a set of conditions ripe for greater risk-taking as firms reach for yield and the imbalances related to such incentives grow.

Gradualism can promote financial stability, as it reduces the incidence of unexpected shifts in interest rates. Even so, the degree of inertia suggested in the median path of the federal funds rate in the FOMCs Summary of Economic Projections goes beyond what is required to achieve a smooth exit. In my view, it will likely be appropriate to raise the federal funds rate at a somewhat faster pace than the median of committee members projections. Low rates into late 2016 will likely continue to provide incentives for financial markets and investors to reach for yield in an economy operating at full capacity and risks achieving our objectives over the longer run.

Digging deeper, though, it is important to recognize that part of the reason that the bond market would react so strongly to a sharp change in the short-term policy rate is that we have settled into a self-sustaining equilibrium in which the Fed tends to act gradually, and the market has come to expect that gradualism. In other words, the market has learned that a given increase in the federal funds rate at the beginning of a tightening cycle is typically followed by many more moves in the same direction, so there is naturally a multiplier effect on long-term rates of a given change in short-term rates. And that multiplier depends on the expected degree of gradualism: The more inertia there is in Fed policy, the more significant is any small move, and hence the larger is the multiplier. Thus, an expectation of gradualism on the part of the market makes it all the more important for the Fed to adjust the policy rate gradually, thereby fulfilling the market's beliefs. This line of reasoning can be thought of as a piece of positive economics--that is, it may shed some light on why the world is as it is. But what, if any, are its normative implications? On the one hand, as I have emphasized, a gradualist approach to monetary policy is likely to be the best way for us to deliver on our mandate at any point in time, taking as given the market's expectations for Fed behavior. As such, it would probably not make sense, in the short run, for the Committee to deviate from this approach--with an unprepared market, the result might well be an undesirable degree of market turbulence, with attendant negative effects on the real economy. On the other hand, there is clearly a time-consistency problem lurking here; the world we are in need not be the best of all possible worlds. In particular, it is interesting to think about an alternative long-run equilibrium in which the Fed has somehow developed a reputation for worrying less about the immediate bond-market effect of its actions and is known to react more aggressively to changes in economic conditions.10 In this alternative equilibrium, the market would expect the Fed to behave in a less gradualist fashion, so any given move in the funds rate would have a smaller multiplier effect on long rates. Thus, it is possible that in this alternative world, market volatility would be no higher than it is in our world, but the Fed would nevertheless be able to adjust policy more nimbly when it needed to.

I would hazard the view that prudent risk management suggests that policy will likely need to begin normalization before it is obvious that it is necessary, possibly with greater force than is customary, and taking proper account of the policies being instituted by other authorities.

Ultimately, when the decision is made to remove policy accommodation further, prudent risk management may prescribe that it be accomplished with greater swiftness than is modern central bank custom. The Federal Reserve acted preemptively in providing monetary stimulus, especially in early 2008 when the economy appeared on an uneven, uncertain trajectory. If the economy were to turn up smartly and durably, policy might need to be unwound with the resolve equal to that in the accommodation phase. That is, the speed and force of the action ahead may bear some corresponding symmetry to the path that preceded it. Of course, if the economy remains mired in weak economic conditions, and inflation and inflation expectation measures are firmly anchored, then policy could remain highly accommodative.

"Whatever it takes" is said by some to be the maxim that marked the battle of the last year. But, it cannot be an asymmetric mantra, trotted out only during times of deep economic and financial distress, and discarded when the cycle turns. If "whatever it takes" was appropriate to arrest the panic, the refrain might turn out to be equally necessary at a stage during the recovery to ensure the Fed's institutional credibility. The asymmetric application of policy ultimately could cause the innovative policy approaches introduced in the past couple of years to lose their standing as valuable additions in the arsenal of central bankers.

Many people say that the Fed kept interests rates too low for too long in the early part of this decade. During that period, I would have liked to have raised interest rates sooner. When we did raise interest rates, we raised them in a lockstep fashion. I don’t think there is any theory that told you that was the right thing to do.

Part of the rationale for the speed with which the FOMC brought down the funds rate was the risk that the slowdown we are experiencing would prove to be more severe. While that uncertainty has not entirely disappeared, my sense is that such downside risks have diminished appreciably. And just as easing policy aggressively in response to emerging downside risks made sense, withdrawing some of that stimulus as those risks diminish makes eminent sense as well. Moreover, our attention to risks needs to be two-sided, I believe. As we move through this period of low growth, we need to be attuned to the risk that we emerge from the slowdown with inflation following a higher trend than when we went in. This danger associated with the persistence of elevated inflation warrants an additional measure of vigilance.

I believe that it was important to put a substantial easing in place in September so as not to fall “behind the curve.” Given the long lags between policy actions and their impact on the economy, and the possibility that economic downturns can be difficult to reverse once they take hold, a more gradual and reactive approach would have created unnecessary economic risks. That said, it is inherently difficult to assess the stance of policy that is needed to ensure that the economy would grow at a moderate pace given uncertainties about financial developments and their impact on the economy.

Many people had expected the Federal Reserve to follow a gradual path of rate reductions in response to financial market developments--say, 25 basis points in September and another 25 basis points in October.  Such a path would be in keeping with how we have often approached our policy choices, as it has the advantage of allowing us to calibrate our policy as we see how the economic situation is evolving and responding to earlier policy moves.  However, given the circumstances at the time of the September FOMC meeting, there were strong arguments in favor of the larger action of a 50 basis point decrease in the federal funds rate.  

Brainard’s analysis showed that if policymakers are uncertain about how real activity and inflation will be affected over time by monetary actions, they should be less aggressive in responding to changes in economic conditions than would be the case if they knew the true model of the economy...  [C]entral banks should be cautious about boldly acting on the predictions and policy prescriptions of any one model, especially given that policymakers usually are unsure about the nature and persistence of the shocks hitting the economy.

Central bankers around the world certainly seem receptive to taking a gradualist and cautious approach to policy under most circumstances, as indicated by (among other things) their apparent tendency to smooth interest rates.  The behavior of the Federal Reserve during the second half of the 1990s illustrates this approach to policy...  Staff analysis at the time supported Brainard’s conclusion that the appropriate response to heightened uncertainty about the economy’s true productive potential would be to reduce the importance of the estimated output gap in setting policy.  Whatever the persuasiveness of this analysis, the FOMC did respond in a restrained manner to unusually robust real economic activity--as I believe was appropriate in light of the low and stable inflation that followed.

I would expect us to be within the {comfort} zone within a couple of years.  We are a little above the top of the zone now and my own personal expectation is, inflation is moderating, and we will get down to the zone...

To bring inflation down very, very rapidly in a narrow timeframe of a year or two can require swings in monetary policy that can be damaging to the economy.  So there is a trade-off. 

It is always an important consideration to make sure our credibility is intact and that inflation expectations remain well contained.

[P]olicy moved gradually, tightening in one-quarter point increments over fourteen successive meetings. Together with expanded communication, this gradual approach served to stabilize policy expectations and damp market volatility.

In this regard, I think the policy tactics followed by the FOMC over recent years will be helpful. We have moved rates higher gradually and announced our intentions in a manner that underscores that these intentions depend on the economic outlook. The announcement should enable market participants to get a more accurate view of our intentions sooner and build them into financial market conditions, which then feed back on spending. This transparency, together with the gradual trajectory of policy actions, should help us to get a better and more timely fix on the effects of our actions than in the past.

The FOMC has said that it believes it can remove policy accommodation gradually. That strategy should be successful if...growth ahead is moderate and inflation pressures are contained. Such a strategy has advantages. Importantly, the gradual approach should enable us to better gauge the ongoing effects of our actions in an uncertain world--give us more opportunities to assess the effects of past increases in rates when we know that those effects can vary and will occur with a lag--and hence to calibrate our actions better to the needs of the economy. Moreover, to date, announcing that we expect to remove accommodation at a measured pace has not materially impeded market participants from responding meaningfully to incoming data, primarily by extending the anticipated series of gradual rate increases when these data suggested the potential for greater inflation pressures.

The fact that there is uncertainty surrounding the state of the economy and new economic information becomes available on a nearly continuous basis supports the notion that it makes sense for policymakers to move in a slow and cautious manner.