I believe globalization and monetary policy are intertwined in a complex narrative that is only beginning to unfold...The realization of the importance of global economic conditions for making monetary policy decisions is becoming more widespread. 

The creation of vast new sources of inputs and production have upset all the calculations and equations of the very best economics minds, including those of the Federal Reserve staff. Many of the old models simply do not apply in the new real world. This is why I think so many economists have been so baffled by the length of the current business cycle as well as the non-inflationary prosperity we have enjoyed for almost two decades.

So what does the limited research on resource utilization and output gaps tell us? There are a few key, but preliminary findings from work done at the Bank for International Settlements...and some as yet unpublished work done by several of our Dallas Fed economists. Here are a few key points:
- The relationship between measures of domestic economic slack, such as industrial capacity utilization, and domestic inflation seems to have declined across a broad range of advanced countries in recent years.
- At the same time, proxies for global slack—such as unemployment rates and output gaps in a wide array of countries—seem to be of growing importance.
- And for some countries, including—and to my mind especially—the United States, the proxies for global slack have become more important predictors of changes in inflation than measures of domestic slack.

Policymakers should be aware of any emerging stresses in the financial system, including those related to new instruments and institutions. Indeed, some central banks have created "financial stability" staff groups to oversee such monitoring and, in some cases, to publish regular financial stability reports. In the event that such monitoring suggests that the operations of some institutions or markets are under significant strain and, importantly, that the resulting pressures on businesses and households could have a material adverse effect on the real economy, the central bank may want to respond by adjusting the stance of monetary policy.

Financial firms may not consider the effects of their decisions on the stability of other firms or on the broader financial markets, and some may lack the incentives and ability to learn about and manage the risks induced by financial innovations. In such cases, policymakers may need to work with markets and their participants, and on occasion regulate them, to achieve the desired outcomes. However, policymakers should, wherever possible, avoid premature regulation that could stifle innovation.

Rather than demonstrating the need for preemptive extra action to restrain emerging bubbles, these examples [of the Great Depression and the recent Japanese deflation experience] are object lessons concerning the wisdom of central banks' easing promptly and aggressively following market slumps when inflation is already low, so as to head off the threat posed by the zero lower bound. By doing so, policymakers should be able to avoid the severe nonlinear dynamics of deflation.

If we can identify bubbles quickly and accurately, are reasonably confident that tighter policy would materially check their expansion, and believe that severe market corrections have significant non-linear adverse effects on the economy, then extra action may well be merited. But if even one of these tough conditions is not met, then extra action would be more likely to lead to worse macroeconomic performance over time than that achievable with conventional policies that deal expeditiously with the effects of the unwinding of the bubbles when they occur. For my part, I am dubious that any central banker knows enough about the economy to overcome these hurdles. However, I would not want to rule out the possibility that in some circumstances, or perhaps at some point in the future when our understanding of asset markets and the economy has increased, such a course of action would be appropriate.

My best guess is that a good part of this strength is the flip-side of the factors that made the economy weak in the fourth quarter, and therefore should not be extrapolated to subsequent quarters. Therefore, it seems likely that growth will settle back to a trend-like pattern as the year progresses. One likely contributing factor is the winding down of the rebuilding effort later in the year. Another is the lagged effect of monetary policy tightening; in other words, tighter financial conditions will have a dampening impact on interest-sensitive sectors, such as consumer durables, housing, and business investment.

Fisher...said he would "err on the side of being a little bit tighter rather than being a little bit looser" with US monetary policy.  The Fed, he said, should make sure "we don't let inflation rear its ugly head."

I believe these two features of Fed monetary policy—a systematic approach to policy and the steps towards more open communication and transparency—are particularly noteworthy in contributing to our policy success over the past two decades. They have helped strengthen public confidence in the Fed and thereby helped anchor inflation expectations to price stability. Additionally, by providing clear explanations of its policies to the public, greater transparency has also enhanced Fed accountability, a vital consideration for a government institution in a democracy.

I attribute the relatively low level of long-term rates generally to several factors, including a tendency in recent years for global saving to exceed the amount of potential capital investments, yielding historically normal rates of return as well as relatively low term premiums to interest rates to compensate investors for interest rate risk.  In the unlikely event that any of these factors tended to push real long-term yields to levels that appeared to be incompatible with our macroeconomic objectives, the Federal Reserve would respond by adjusting the stance of monetary policy appropriately.

When Alan Greenspan first used the term “conundrum” to describe the surprising behavior of forward interest rates, he was reacting to the decline in forward nominal rates over a period in which the Federal Open Market Committee was raising its federal funds target rate. This behavior of forward rates, the counterpart of which is the behavior of the bond yield curve, looked anomalous both in comparison to observations from past tightening cycles and with what seemed to be strong evidence about the fundamental soundness of the outlook for the real economy. The source of the relatively low level of nominal rates is still a matter of considerable debate. Part of the explanation lies in the decline in expectations of future inflation and uncertainty about future inflation. Part of the explanation may also lie in greater confidence that the secular decline in the variability of economic growth observed over the past two decades in the United States is likely to continue. However, even with the information provided by the development of the market for inflation-indexed government securities, we have less ability than we would like to draw conclusions about what any nominal forward rate means for expectations about the level of future real rates, uncertainty about future real rates, and what those might imply about expectations about future economic activity. This uncertainty makes it harder to assess the appropriate path of monetary policy.

To the extent that these forces act to put downward pressure on interest rates and upward pressure on other asset prices, they would contribute to more expansionary financial conditions than would otherwise be the case. And, if all else were equal, which of course is unlikely ever to be the case, monetary policy in the affected countries would have to adjust in response; policy would have to act to offset these effects in order to achieve the same impact on the future path of demand and inflation. To do otherwise would run the risk that monetary policy would be too accommodative, pulling resources from the future in a way that would alter the trajectory for the growth of the capital stock, perhaps amplifying the imbalances, and compromising the price stability.

These aspects of global monetary arrangements and financial conditions have important implications for how we communicate about monetary policy. They strengthen the case for why central banks should be clear about their objectives and credible in their commitment to price stability. They reinforce the case for preserving the flexibility to adjust policy in response to changing conditions. And they underscore the importance of being open about the greater level of uncertainty we face in understanding the forces at work on the trajectory of demand and inflation. Central banks, of course, need to be careful not to convey more certainty about what we know than we reasonably can know.

It's important to avoid big policy errors, and it's important to get this as right as we can, but in an economy as big and complex and flexible as ours, a quarter point more or less on the federal funds rate is unlikely to be all that big a deal at the end of the day... because I don't think the economy is that sensitive to quarter percent age points on the federal funds rate.