In mid-2013, the FOMC announced its intention to taper its ongoing asset purchase program. We can see that this announcement represented a dramatic change in policy from the sharp upward movements in long-term bond yields that it engendered. Personally, I interpret this policy change back in 2013 as the onset of what the Committee currently intends to be a long, gradual tightening cycle. As I noted earlier, we would typically expect that such a change in monetary policy should affect the economy with a lag of about 18 to 24 months. Viewed through this lens, the slow rate of labor market improvement in 2015 is not all that surprising.

Because monetary policy works with a lag, we have to think about where inflation is going to be, not where it's been in the past. Inflation has been -- averaged about two years over -- 2 percent a year over my tenure as chairman, and we expect it to be at 2 percent or below in the next couple of years. So we think that's entirely consistent with a policy of -- accommodative policy.

From the Q&A session

Easing of monetary policy produces its maximum impact on real variables in the economy, including output, consumption, and investment, with a lag of six to 12 months and can be difficult to disentangle.

Given the lag between the time monetary policy is initiated and when it impacts the economy, that wind-down process needs to begin as soon as there are convincing signs that economic growth is gaining traction and that the lending capacity of the banking system is capable of expansion. Cynics retort that "the Fed may know what to do—but will it have the guts to pull the trigger?" Well, we Texans are not afraid to pull the trigger (as anybody knows who has gone duck hunting with vice presidents of the United States!). I have faith my colleagues on the Federal Open Market Committee will stand and deliver in a timely way.

Nonetheless, even if policymakers are confident that a bubble has emerged, the question of the timeliness of the call remains.  The essential problem is the timing of the detection of the bubble relative to the timing of its collapse.  The risk is that the detection and subsequent policy response occurs not long before the bubble collapses on its own.  Given the lags associated with monetary policy, the resulting contractionary effects on the economy of the monetary tightening would occur just when the adverse effects of the bubble's collapse are being realized, worsening rather than mitigating the effects of the bubble's collapse.  And the inevitable lags in detecting bubbles increases the likelihood that, by the time action is taken, speculative activity will have progressed to the point that its collapse is not far off. 

The likelihood of deflation, "whatever I thought that risk was four or five months ago, I think it's bigger now, even if it's still small," he said.   But, "A lesson I take from the Japanese experience is not to let that get ahead of us, to be aggressive in moving against that risk if we see it coming," Kohn said, responding to questions following a speech to the Cato Institute's 26th Annual Monetary Policy Conference 

While "some people have argued that we should save our ammunition, that interest rate cuts aren't effective, etcetera, I think that were we to see this possibility that we should be very aggressive with our monetary policy, as aggressive as we can be," Kohn said.   

From the audience Q&A, as reported by Market News

"We can't wait until we clearly observe the financial markets at normal, the economy growing robustly, and so on and so forth, before we reverse course,'' Stern, president of the Federal Reserve Bank of Minneapolis, said in an interview today.  ``Our actions will affect the economy in the future, not at the moment.''

As quoted by Bloomberg News

[T]here is a risk that an extended period of low interest rates may distort long-run investment decisions; lead to a search for yield that results in excessive risk-taking; and contribute to the development of asset price bubbles.

In my view, these limitations are significant, and they lead me to believe that we should look to fiscal policy to play a more important role in responding to the spillover from a financial crisis. In contrast to monetary policy, fiscal policy can work effectively even when the financial system is impaired, and its effects are felt more broadly across the economy. My own view is that monetary policy may be a good first line of defense, but should not be relied upon too heavily for too long. Of course, we would have to rely less on monetary policy to respond to financial crises if we could, instead, take measures that would reduce the likelihood or severity of financial crises.

Greater caution on the part of businesses and consumers will likely limit increases in their discretionary expenditures. And the strains on credit intermediation and financial balance sheets will likely hold down growth to a degree for some time. Since these financial issues are being worked out against the backdrop of a soft economy, we also have to recognize the risk that interactions between the two might reinforce the weakness in the economy.

In response to these downside influences, and with inflation expectations contained, I believe a relatively accommodative monetary policy is appropriate. At 3 percent, the current federal funds rate is relatively accommodative and should support stronger growth. Indeed, because monetary policy works with a lag, the effects of last fall's rate cuts are probably just being felt, while the cumulative declines should do more to promote growth as we move through the year.

In addition, the fiscal stimulus bill the President signed yesterday will likely boost spending in the second half of the year.

A critical task for the Federal Reserve over the course of this year will be to assess whether the stance of monetary policy is properly calibrated to foster our mandated objectives of maximum employment and price stability and, in particular, whether the policy actions taken thus far are having their intended effects. Monetary policy works with a lag. Therefore, our policy stance must be determined in light of the medium-term forecast for real activity and inflation, as well as the risks to that forecast.

Monetary policy acts with a lag. I liken it to a good single malt whiskey or perhaps truly great tequila: It takes time before you feel its full effect. The Fed has to be very careful now to add just the right amount of stimulus to the punchbowl without mixing in the potential to juice up inflation once the effect of the new punch kicks in.

We have been hard at work trying to find the right mixture.

To be useful, a fiscal stimulus package should be implemented quickly and structured so that its effects on aggregate spending are felt as much as possible within the next twelve months or so.  Stimulus that comes too late will not help support economic activity in the near term, and it could be actively destabilizing if it comes at a time when growth is already improving.  Thus, fiscal measures that involve long lead times or result in additional economic activity only over a protracted period, whatever their intrinsic merits might be, will not provide stimulus when it is most needed...  A fiscal program that increased the structural budget deficit would only make confronting those challenges more difficult.

If we want to slow the stock market in terms of technology stocks, or slow the housing industry, we don't have tools for doing that. We have tools, a blunt instrument, that impacts economic activity six to eight months out and impacts inflation 18 months to two years out, so targeting it to a specific industry is just very complicated.

From audience Q&A as reported by Market News International

I am still optimistic that the economy will improve appreciably by the third and fourth quarters of 2008, and that is when any monetary policy action today will begin to have noticeable effects. Overall real GDP growth will be faster in the second half of 2008 as the economy begins to return to its longer-run trend growth of about 2-3/4 percent. On a fourth-quarter to fourth-quarter basis, I expect that the economy will grow about 2.5 percent in 2008, close to its pace in 2007, and that it will be growing more consistently near its longer-term trend in 2009.

In September, the Committee reduced the federal funds rate target by 50 basis points, and in late October lowered the target by another 25 basis points. These actions reflected the Committee's concern that the financial shock had the potential to intensify the housing correction and thereby to restrain economic growth more generally. The steps were meant to help forestall some of the potential fallout to the economy from the disruptions in financial markets and to promote moderate growth over time.

In line with the forecast-based policy I've described, the Committee's decisions reflected a forward-looking and preemptive approach. In particular, I supported putting a substantial easing in place 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, an approach that was more gradual and reactive than this would have created unnecessary economic risks.