As a consequence of observing this process for 10 years, I have concluded that an FOMC attempt to provide forward guidance in the policy statement causes more communications difficulties than it solves.  A key reason is that the economy is subject to more shocks and reversals than one might think. ... Directional language tends to remain in the FOMC policy statement beyond the time it applies and removing the language creates the possibility of miscommunication.  Every change in the policy statement leads naturally to market questions as to what the change means and whether the change is meant to provide a hint about the future direction of policy.  To my mind, every time new language is inserted into the policy statement, there needs to be as much thought given as to how to exit from the language as to the rationale for inserting it. 

Much of my thinking over the past 10 years has been devoted to this subject. What is the right policy? That is, how should individual policy actions be fit into a general policy and not be, or appear to be, drawn at random? I have given a number of speeches on this theme. We clearly have made progress in thinking about policy actions in this general way, although there is a long way to go to make the policy reaction function more precise both to guide policy actions themselves and to make those actions more predictable to the markets.

When I came to the St. Louis Fed, I was well prepared for my FOMC responsibilities in most respects. I knew a lot about monetary economics and monetary history. What I did not know was the art of communicating with the press and general public. The professional literature in economics was full of insights into the importance of private-sector expectations about monetary policy but essentially silent on how those expectations were formed, except for the assumption that expectations would not be systematically wrong and would converge to being correct eventually. Once I started fielding questions from the press after my speeches and talking informally before a wide range of audiences, I was part of the process of trying to establish correct expectations.

My general approach has been to speak primarily about the policy process rather than the specific situation facing the FOMC at its next meeting. I try to think of myself as speaking to portfolio managers who have a medium-term horizon rather than to traders who have a horizon measured in hours or a few days. I do not disparage traders—they perform an important function. Obviously, I have had internal information that would be of interest to traders but it would be entirely inappropriate—indeed illegal—to disclose confidential FOMC information.

Traders, portfolio managers and many others always want to know my forecast of what will happen at the upcoming FOMC meeting. My standard answer is that I do not forecast monetary policy decisions—my job is to participate in making those decisions. I confess that, initially, this response was something of a dodge, because I usually had a pretty good idea weeks in advance of what my own position at a meeting would be. However, over the years I have become impressed by how often my own position would change even in the days just before a meeting as a consequence of the arrival of new information, including staff analysis and sound arguments by my FOMC colleagues

I believe that accommodation is appropriate because the financial shock and the housing cycle have significantly restrained economic growth. While growth seems likely to be sluggish this year, the Fed’s policy actions should help to promote a pickup in growth over time. I consider it most probable that the U.S. economy will experience slow growth, and not outright recession, in coming quarters. At the same time, core consumer inflation seems likely to decline gradually to somewhat below 2 percent over the next couple of years, a level that is consistent with price stability.

However, economic prospects are unusually uncertain. And downside risks to economic growth remain. This implies that, going forward, the Committee must carefully monitor and assess the effects of ongoing financial and economic developments on the outlook and be prepared to act in a timely manner to address developments that alter the forecast or the risks to it.

I see the growth risks as skewed to the downside for the near term. In circumstances like these, we can’t rule out the possibility of getting into an adverse feedback loop—that is, the slowing economy weakens financial markets, which induces greater caution by lenders, households, and firms, and which feeds back to even more weakness in economic activity and more caution. Indeed, an important objective of Fed policy is to mitigate the possibility that such a negative feedback loop could develop and take hold.

For the past few years, we have had a raucous party of economic growth fueled by an intoxicating brew of credit market practices that financed a housing boom of historic, and late in the cycle, hysteric, proportions. With the benefit of perfect hindsight, some have argued that the Fed failed to take away the punchbowl as the subprime party spun out of control, leaving rates too low for too long and not using our regulatory powers to restrain excessive complacency in the pricing and monitoring of risk. But that is beside the point.

Now we are faced with the consequences of a process that lawyers would call the “discovery phase”: As big banks and other financial agents confess their acts of fiduciary omission and excesses of commission, credit markets have effectively de-leveraged important segments of the economy, slowing growth suddenly and precipitously. Instead of taking the punchbowl away, the Federal Reserve is now faced with the task of replenishing the punch.

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.

My dissenting vote last week was simply a difference of opinion about how far and how fast we might re-spike the monetary punchbowl. Given that I had yet to see a mitigation in inflation and inflationary expectations from their current high levels, and that I believed the steps we had already taken would be helpful in mitigating the downside risk to growth once they took full effect, I simply did not feel it was the proper time to support additional monetary accommodation.

I respect the majority view of the committee. I sleep well at night knowing that the collective wisdom of the group is guided by one common goal: the continued prosperity of the American people.

I believe recent actions helped address the risks to the economic forecast I just referenced—that is, weakness in the first half of 2008 followed by improvement in the second half, with inflation moderating from recent levels. The liquidity injections and easing of monetary policy should help housing and financial markets stabilize and avoid an "adverse feedback loop" in which a continuing decline in housing prices fuels financial market volatility with spillover to the broader economy.

The FOMC’s reductions in the federal funds rate have been proactive in responding to evolving economic conditions that led to the deterioration in the outlook for economic growth. My inclination to alter monetary policy depends on whether the accumulation of evidence based on the data between now and our next meeting causes me to revise my forecast further.

Yesterday, Plosser said rate cuts have been ``necessary and appropriate'' in response to a weakening economy. He told reporters he was concerned reductions could lead to accelerating inflation. ``That is the price you can pay if you become too aggressive,'' he said.

As reported by Bloomberg News

As I said, my sense is that the most likely path is sluggish growth in the near term. But I can also see the possibility of a mild recession, similar to the last two we have experienced — in other words, shallow and with a slow recovery. What I don't expect is a more severe recession, like those we saw in 1982 or 1974. Keep in mind that monetary policy has moved aggressively in recent months, and that inflation-adjusted interest rates are now very low by historical standards. That by itself won't solve all our problems, but it will help support activity enough to at least avoid the worst outcomes, and possibly avoid a recession altogether.

A slowing economy requires a lower real interest rate because it means softer relative demand for resources now compared to the future. And the current downside risks mean that further slowing, and thus further easing, is quite possible. But inflation also presents risks. Throughout the period since 2005, when inflation rose, eased off, then rose again, longer-term inflation expectations have remained fairly stable. If energy and food prices continue to push overall inflation above core inflation, then this higher overall trend could work its way into expectations, further complicating monetary policy in 2008.

We have new information about what the future is looking like, and therefore we need to respond to that incoming information about the
future -- not the past, not the current environment but the future.

From audience Q&A as reported by Market News International

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