[L]et me say a few words about the Federal Reserve's strategy for normalizing policy in the long run. In the minutes of its June 2011 meeting, the committee set forth principles that it intended to follow when the time came to normalize policy and the size and the structure of the Federal Reserve's balance sheet. As part of prudent planning, we've been reviewing these principles in recent meetings. We expect those discussions to continue and intend to provide further information at an appropriate time.

     For today, I will note that, in the view of most participants, the broad principles set out in June 2011 remain applicable. One difference is worth mentioning. While participants continue to think that in the long run the Federal Reserve's portfolio should consist predominantly of Treasury securities, a strong majority now expects that the committee will not sell agency mortgage-backed securities during the process of normalizing monetary policy, although in the longer run limited sales could be used to reduce or eliminate residual MBS holdings. I emphasize that given the outlook in the committee's policy guidance, these matters are unlikely to be relevant to actual policy for quite a while.

Going forward, the economic outcomes that the committee sees as most likely involve continuing gains in labor markets supported by moderate growth that picks up over the next several quarters as the near-term restraint from fiscal policy and other headwinds diminishes. We also see inflation moving back toward our 2 percent objective over time.

If the incoming data are broadly consistent with this forecast, the committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year and that the subsequent data remain broadly aligned with our current expectations for the economy, we will continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around mid-year.

In this scenario, when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7 percent, with solid economic growth supporting further job gains, a substantial improvement from the 8.1 percent unemployment rate that prevailed when the committee announced this program.

Later, in response to a question about whether this was a formal committee decision:

Well, again, we don't think of this as a change in policy. What I was deputized to do, if you will, was to try to make somewhat clearer the implications of our existing policy and to try to explain better how the policy would evolve in various economic scenarios. And that's a little bit difficult to put into, you know, a very terse FOMC statement.

Now, that being said, going forward, I think that, you know, some of this -- some of these elements -- to the extent that we can make them useful will begin to appear in the FOMC statement. It's entirely possible. But it seemed like the right tactic in this case to -- to explain these fairly subtle contingencies in a context where I could answer questions and -- and respond to any misunderstandings that -- that might occur.

“It is reasonable to think that an outright purchase program has more impact on inflation and inflation expectations than a Twist program,” Bullard said today in a speech in Little Rock, Arkansas. “If the goal is to keep policy on its present course, the replacement rate should be less than one-for-one.”   From the Bloomberg News summary

Responding to questions after his speech, Mr. Bullard said he would like to keep monetary policy on an even keel after Operation Twist's end, and given the desire to keep the potency of policy about the same, he said he favored the Fed buying about $25 billion a month in Treasury purchases.  From the Dow Jones News summary

If we are going to purchase more assets, it would be better to purchase Treasury securities rather than agency mortgage-backed securities. Buying MBS rather than Treasuries may reduce borrowing rates for conforming home mortgages, but if so, it will raise interest rates for other borrowers and thus distort credit flows. This is an inappropriate role for the Fed.

Some observers have argued that a long period of low rates can create incentives among market participants (such as banks, insurance companies, and pension funds) to reach for yield by taking on higher levels of risk with adverse consequences for stability. These concerns should be taken very seriously, and a lot of work at the Fed is devoted to monitoring such risks. A short summary would be that there is some qualitative evidence of reaching-for-yield behavior in certain segments of the market, but that we are not seeing anything quantitatively alarming at this point. Of course, the worry is that one often sees only the tip of the iceberg in these kinds of situations, so one needs to be cautious in interpreting the data.

My current assessment of the both the economy and effectiveness of QE is that I don’t think it really meets the cost-benefit analysis.

If the economy does need more stimulus, restarting our program of purchasing mortgage-backed securities would probably be the best course of action.

I think a realistic assessment of the challenges associated with closing the employment gap call for sustained extraordinary support for what is, like it or not, a gradual process. At the same time, I'm cautious about doing more involving expansion of the Fed's balance sheet. Precisely because I see the transmission mechanism of monetary policy through credit channels as constricted, I have my doubts that the gains from such a policy action taken in the near term would outweigh the longer-term potential costs, including the risk to the Fed's medium-term inflation outlook.

Lockhart commented further in the Q&A session:

If there were to be "an onset of recessionary conditions and a movement in a deflationary" direction, Lockhart said "we would have to consider further balance sheet kinds of stimulus."

Alluding to earlier remarks about the normal credit conditions -- or the "monetary transmission mechanism" -- being "clogged," Lockhart said "a second conceivable possibility" that could lay the groundwork for QE3 would be "more receptive conditions (in credit markets) combined with a clear need of some kind." If credit channels were to become less clogged in a situation where economic and financial conditions otherwise seemed to call for QE3 then "if we do something it would have a measurable effect," he said.

When the Fed engages in targeted credit programs that seek to alter the allocation of credit across markets, I believe it is engaging in fiscal policy and has breached the traditional boundaries established between the fiscal authorities and the central bank. Indeed, some of these actions have generated pointed criticisms of the Fed.

Bullard said if the Fed undertakes another round of bond buying, he’d prefer the U.S. central bank stick to buying Treasuries, instead of mortgage debt, because the Fed aims to get back to a Treasuries-only portfolio.

People outside the Fed have “mentioned that maybe you needed to do well over a trillion dollars in asset purchases in order to begin to move things,” the regional chief told reporters today during a meeting at the bank. “I don’t have a particular number in mind, but it would be more ambitious than most numbers being bandied about.”

As I've said in my statement and as we have in fact in the FOMC statement, you know, we continue to review our holdings -- our portfolio holdings, securities, and we are prepared to take further steps in that direction if we see that the recovery is faltering or if inflation is not -- is not moving toward target.

So that's something -- that's an option that's certainly on the table. I think it would be premature to say definitively one way or the other, but we continue to look at that option, and if conditions warrant, we will certainly consider using it.

In response to a question about additional asset purchases.

Williams told reporters that given his forecast for lower inflation than predicted by private forecasters, “there’s a strong argument for buying more mortgage-backed securities.” That suggests a need for policy that is “more stimulative.”

"Asset purchases ... we have done in these big lumps," Williams said. "The way I guess I prefer to think about it is where do we need financial conditions to be" and "how, given how much additional stimulus you may need what's appropriate amount of additional asset purchases to make."

"It would be beneficial to have an asset purchase program, if we were to do one, that had more consistency over time" and that would "allow us to adjust as the outlook changes ... as opposed to announcing an amount."

“As we get into other securities -- we are in mortgage- backed securities in a big way and we lengthened our activity along the yield curve -- then we’re going outside our normal purview,” Fisher said. “I do think it behooves us to think of what risks that presents.”