I am not suggesting that rates should necessarily be increased now. Our first task is to change the language in a way that allows for liftoff sooner than many now anticipate and sooner than suggested by our current guidance. Raising rates sooner rather than later also reduces the chance that inflation will accelerate and require policy to become fairly aggressive with perhaps unsettling consequences. Thus, I believe that our forward guidance should be adjusted to reflect economic realities and to give us the flexibility to respond sooner and more gradually to the evolution of the economy.

John Williams, president of the San Francisco Fed, said in an interview with Reuters that the first line of defense at the central bank, if needed, would be to telegraph that U.S. rates would stay near zero for longer than mid-2015, when he currently expects them to rise. If the outlook changes "significantly," with inflation showing little sign of returning to the central bank's 2-percent target, he said he would even be open to another round of asset purchases

"If we really get a sustained, disinflationary forecast ... then I think moving back to additional asset purchases in a situation like that should be something we should seriously consider," Williams said.
...
In the interview, Williams repeated he is comfortable with his call for a rate hike about nine months from now. But "if inflation isn't moving above 1.5 (percent) and we get stuck into that gear, that would argue for a later liftoff," he said. "If we don't see any improvement in wages, that would be a sign that we still have a lot of slack in the economy and we are not getting any inflationary pressure to move inflation back to 2 percent."

The Fed next meets on Oct. 28-29, when some policymakers are pushing to ditch a promise to wait a "considerable time" before raising rates, given a sharp drop in the U.S. unemployment rate to 5.9 percent. Williams wants to leave that phrase intact for now, but said the central bank could adjust it as the outlook evolves.

In a progressively integrating world economy and financial system, a central bank cannot ignore developments beyond its country's borders, and the Fed is no exception. This is true even though the Fed's statutory objectives are defined as specific goals for the U.S. economy. In particular, the Federal Reserve's objectives are given by its dual mandate to pursue maximum sustainable employment and price stability, and our policy decisions are targeted to achieve these dual objectives.2 Hence, at first blush, it may seem that there is little need for Fed policymakers to pay attention to developments outside the United States.

But such an inference would be incorrect. The state of the U.S. economy is significantly affected by the state of the world economy. A wide range of foreign shocks affect U.S. domestic spending, production, prices, and financial conditions. To anticipate how these shocks affect the U.S. economy, the Federal Reserve devotes significant resources to monitoring developments in foreign economies, including emerging market economies (EMEs), which account for an increasingly important share of global growth. The most recent available data show 47 percent of total U.S. exports going to EME destinations. And of course, actions taken by the Federal Reserve influence economic conditions abroad. Because these international effects in turn spill back on the evolution of the U.S. economy, we cannot make sensible monetary policy choices without taking them into account.

[T]ightening should occur only against the backdrop of a strengthening U.S. economy and in an environment of improved household and business confidence. The stronger U.S. economy should directly benefit our foreign trading partners by raising the demand for their exports, and perhaps also indirectly, by boosting confidence globally. And if foreign growth is weaker than anticipated, the consequences for the U.S. economy could lead the Fed to remove accommodation more slowly than otherwise.

"What we think now is that the capital markets have it more or less right but we don't ourselves know when we're going to {raise rates}.
"On the basis of our forecasts of the data ... it looks like markets more or less have it right - somewhere in the middle of the year.

The central bank's only official guidance on the timing is that it would wait a "considerable time" after bond-buying ends, a phrase Fed Chair Janet Yellen indicated earlier this year meant something along the lines of six months.
Fischer took a step that essentially downgraded the value of the phrase, saying it meant somewhere between two to 12 months, putting investors on notice that it will be economic data, not the passage of time, that will drive policy change.

And after the recession ended, that sense has led many forecasters, myself included, to predict repeatedly that growth was about to shift to a more robust pace. That just hasnt happened; weve seen short-lived surges in growth, only to see growth subside for the following couple of quarters. For example, real GDP surged over the second half of last year only to falter at the beginning of this year.

This experience has led me to conclude that a sustained increase in growth to something over 3 percent in the near future is unlikely. Given what we know, after more than five years of this expansion, it strikes me as more likely that growth will continue to average somewhere between 2 and 2 percent.

As I think about the process of normalizing policy, I conclude that todays risk-management calculus says we should err on the side of patience in removing highly accommodative policy. We need to solidify our confidence that our ultimate exit from the ZLB will occur smoothly and that our escape can be sustained. A corollary to this conclusion is that we should not shy away from policy prescriptions that imply forecasts of inflation that moderately overshoot our 2 percent target for a limited time

To summarize, I am very uncomfortable with calls to raise our policy rate sooner than later. I favor delaying liftoff until I am more certain that we have sufficient momentum in place toward our policy goals. And I think we should plan for our path of policy rate increases to be shallow in order to be sure that the economys momentum is sustainable in the presence of less accommodative financial conditions. I look forward to the day when we can return to business-as-usual monetary policy, but that time has not yet arrived.

As I think about the process of normalizing policy, I conclude that todays risk-management calculus says we should err on the side of patience in removing highly accommodative policy. We need to solidify our confidence that our ultimate exit from the ZLB will occur smoothly and in a way that sustains our escape from it. A corollary to this is we should not shy away from policy prescriptions that generate forecasts of inflation that moderately overshoot our 2 percent target for a limited time. Such a policy strategy more properly balances expected costs and benefits. And it would leave me with much more confidence that inflation will not stall out below target once we start raising rates.

June is certainly a possibility {for the first rate hike}. My own view once you say appropriate monetary policy, Id be saying I want to make sure that we get inflation up to 2%.

We have in the past seen sort of false dawns, periods in which we thought our growth would speed, pick up and the labor market would improve more quickly. And later events have proven those hopes to be -- to be, unfortunately, over-optimistic. So we are watching very carefully, especially when short-term, overnight rates are at zero, so we have no ability to lower them further.

We need to be careful to make sure that the economy is on a solid trajectory before we consider raising interest rates. And I think the forward guidance that we have provided and the policies we have -- we have put in place are providing a great deal of accommodation to the economy to make sure that it is on a sound trajectory.

Of course, the outlook for the economy and financial markets is never certain, and now is no exception. Therefore, the Committee's decisions about the path of the federal funds rate remain dependent on our assessment of incoming information and the implications for the economic outlook. If the labor market continues to improve more quickly than anticipated by the Committee, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target likely would occur sooner and be more rapid than currently envisioned. Conversely, if economic performance is disappointing, then the future path of interest rates likely would be more accommodative than currently anticipated.

Asked about the potential timing of eventual interest rate hikes, Mr. Fisher said it was too early to start the debate. He noted the central bank is gradually paring down its bond purchases, having reduced them to $45 billion per month at its April policy meeting. I personally expect us to end that program in October. Thats the first step, he said. Then we have to see how the economy is doing, including these broader measures of unemployment, and where we stand, before we can talk about how we might move the short-term rate. Ill make this prediction: Sometime in the next 100 years, interest rates will go up, Mr. Fisher quipped.

WSJ: The policy statement says the Fed will keep the fed funds below long run equilibrium levels even after unemployment and inflation return to their long-run trends. But it doesn’t really explain why officials believe that that’s the right path. Why do you believe it’s the right path?

NK: There’s a number of answers to that question. That’s why it maybe doesn’t appear in the statement. The chair talked a little bit about this in her press conference, but I’ll speak for myself. When I talk to businesses and I talk to households you just feel the scarring effects of 2008 over and over again. Households and businesses are much more leery of spending now. They want to have resources on reserve when they can and that puts downward pressure on the amount of demand you’ll have at any given interest rate I think the interest rate that we’re going to have to maintain in order achieve our goals over the longer run is going to be lower than it would be historically. You see a diminution of this scaring effect of 2008, but it’s going to take time.

WSJ: Is this sort of the new normal? Or are you saying that this is still a dysfunctional economy and this dysfunction is going to persist longer than people realize?

NK: Right now I do not see this as the new normal but we should be open to considering that this could be a very persistent aspect of economic life. All I think this indicates is that the committee would have to follow a lower interest rate policy than you might think, that markets might think in order to achieve its objectives.

WSJ: Let’s call it a “scarring episode” interest rate. What is that rate?

NK: My own estimate is pretty low.

WSJ: Is it a negative real rate?

NK: Yes it is. That’s correct. I would see a negative real fed funds rate as being consistent with achieving our objectives.

I think that fundamentally if you look at the U.S. economic outlook, fiscal drag, which has been a big factor, especially last year, has definitely lessened. Number two, the fundamentals for the household sector are definitely improved. The deleveraging process is far along and real incomes seem like they’re starting to improve. The corporate sector is awash in cash. Profits are high and stock prices are very high. And so it looks like the economy—and monetary policy is very accommodative, so you are still getting quite a bit of support from monetary policy. So it seems to us the economy should do better in 2014 than in 2013. The question mark is the weather. The weather is going to make reading the data more difficult over the near term because it’s been unusually cold and snowy. And that’s going to depress economic activity in the first quarter. I think that it’s hard to know exactly how big an impact that is. Certainly it’s going to have a significant impact in housing and construction. The weather feeds into other areas like consumer spending, like auto sales. I think that’s a little bit harder to determine. For myself personally, a working assumption is that the weather is going to take half to one percent off the annualized growth rate in the first quarter. So the first quarter is probably going to be less than 2% in terms of annualized growth. I would expect as you get close to the spring, we’ll see some of these weather effects dissipate.

Mr. Chairman, let me add as an aside that since my appearance before the House Committee, a number of data releases have pointed to softer spending than many analysts have expected. Part of that softness may reflect adverse weather conditions. But at this point it's difficult to discern exactly how much.
In the weeks and months ahead, my colleagues and I will be attentive to signals that indicate whether the recovery is progressing in line with our earlier expectations.
…

YELLEN: Well Senator, as I mentioned in my opening remarks, we have seen quite a bit of soft data over the last month or six weeks. It was the, you know, employment report, relatively low -- below expectation growth in payrolls, and some of the housing numbers and retail sales and industrial production.
So it's really quite a range of data that has been soft recently. Now, I think it's clear that weather has played -- unseasonably cold weather has played some role in much of that. There are many ways in which weather would have affected the (inaudible). What we need to do and will be doing in the weeks ahead is to try to get firmer handle on exactly how much of that set of soft data can be explained by weather and what portion, if any, is due to softer outlook...
SCHUMER: And -- and if it's not mostly weather, would you consider pausing or changing the rate of tapering?
YELLEN: So, as -- as we have said in our statement, and I would agree, asset purchases are not on a preset course. So if there's a significant change in the outlook, certainly we would be open to reconsidering, but I wouldn't want to jump to conclusions here.

We are paying close attention to the macroprudential risks posed by the low interest rate environment, particularly given the possibility that interest rates may remain historically low for some time even after the FOMC begins to increase its target for the federal funds rate.