Monetary policy works best in a stable price environment. In such an environment, the central bank can reduce interest rates without the fear of increasing inflation expectations. Consumers and businesses perceive the reduction in real interest rates as temporary, and so see it as an opportune time to shift spending forward. By doing so, they dampen the recession. Then, as the recovery proceeds, the private sector can anticipate the actions of the central bank and its plan to return short-term rates to more normal levels.

Expectations matter, and they play an important role in the conduct of national monetary policy.

Optimal monetary policy is not simply a matter of establishing a stable price level today, but of ensuring stable prices — and expectations of price stability — into the future. Only then can consumers and investors be confident in the environment in which they must make decisions that have implications far into the future.

Maintaining confidence in sustained price stability is crucial to fostering the most productive saving and investment decisions. In addition, it affords the Federal Reserve considerably more latitude to take short-run policy actions to help stabilize economic growth...[but] it cannot in and of itself force stronger growth than the economy is capable of delivering. Trying to push an economy beyond its potential may temporarily accelerate growth, but it also creates imbalances and increases inflationary pressures that must be addressed, and so boom leads to bust.

In the months following the sharp stock market decline, it was unclear how rapidly economic activity was decelerating. Once it became clear, the Federal Reserve responded aggressively...On the other side, in light of the uncertain and attenuated pattern of recovery and expansion, the Federal Reserve has taken a gradualist approach to removing the monetary accommodation and returning to a more neutral policy stance.

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.

I think the biggest unknown is whether the inflationary pressures that are pretty obvious are a temporary thing--because of energy pass-through--or whether we have a larger inflation problem.  I am more in the former group than the latter...Should we see evidence that we are getting into a more fundamental inflation problem, which as I say is not my best guess, you are going to see the Federal Reserve react more vigorously.

The [March 22nd] statement emphasized the FOMC’s increased concern over inflation, as evidence is accumulating that firms perceive an increase in their pricing power. From my perspective, the market reaction to that statement made a lot of sense and reflected my own assessment of a changing inflation environment. The changed language in the statement not only explained the 25 basis points increase in the target federal funds rate but also the renewal of the “measured pace” phrase that indicates that the FOMC anticipates further increases in the target rate at future meetings.

The upward thrust to the economy appears quite substantial and the risk of higher inflation over the next six months or so seems clearly greater than the risk that inflation will fall below a desirable range. The aim of monetary policy should be to counter inflation pressures with a less accommodative policy stance, so that higher actual inflation does not extend beyond unavoidable transitory effects.

[The disequilibria in the economy] put a very important premium on keeping U.S. monetary policy as close to the frontier of credibility as possible.

A more robust and self-sustaining economy, together with some modest upside risks to inflation imply less need for policy accommodation. How and when such accommodation is reduced, however, will depend on how the economy evolves.

The actions of the Fed over the last 25 years have helped to produce a sustained period of low inflation, less variability in inflation, more stable inflation expectations, and a substantial reduction in output volatility. These are the best measures of credibility, and they look very good against the record of other central banks that now occupy the spectrum between the soft and flexible and pure and harder inflation targeters.

The U.S. monetary policy framework that exists today has proven reasonably good at laying the foundation for price stability that is a necessary condition for sustaining growth at full employment over time.

Independence is the freedom to pursue a defined monetary policy objective without consideration of political or private interests, and without fear of subordination to other economic policy objectives...Independent central banks do, in fact, do a better job of achieving price stability. The greater the independence of the central bank, the lower the average level of inflation and the less volatile the inflation rate

The FOMC controls very short-term interest rates fairly directly. However...the Committee's control over longer-term yields and over the prices of long-lived financial assets depends crucially on its ability to influence market expectations about the likely future course of policy.