“A small taper might recognize labor-market improvement while still providing the committee the opportunity to carefully monitor inflation during the first half of 2014,” Bullard, a supporter of record stimulus, said yesterday in St. Louis. “Should inflation not return toward target, the committee could pause tapering at subsequent meetings.”

When the FOMC meets next week, I expect discussion about the possibility of reducing the pace of asset purchases. The key issue, in my view, is the extent to which the benefits of further monetary stimulus are likely to outweigh the costs. Economic growth trends currently appear to be driven mainly by population growth and productivity growth, in which case monetary stimulus will only have limited and transitory effects. But further stimulus does increase the size of our balance sheet and correspondingly increases the risks associated with the "exit process" when it becomes time to withdraw stimulus. This is why I have not been a supporter of the current asset purchase program.

In my view, we at the Fed should begin tapering back our bond purchases at the earliest opportunity. To enable the markets to digest this change of course with minimal disruption, we should do so within the context of a clearly articulated, well-defined calendar for reducing purchases on a steady path to zero. We should make clear that, barring some serious economic crisis, we will stay the course of reduction rather than give an imprecise nod as we did after the May and June meetings that led markets to believe the program might end as unemployment reached 7 percent.

Plosser

I now think it is appropriate in coming meetings to put a tapering decision on the table as long as the resulting overall posture of policy preserves a high degree of accommodation.

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If and when the FOMC arrives at a decision to wind down asset purchases, it's my view that it will be helpful to the transition process to provide as much certainty as possible about how this will be done. The minutes of the October FOMC meeting noted that

[S]ome participants mentioned that it might be preferable to...announce a total size of remaining purchases or a timetable for winding down the program. A calendar-based step-down...would be easier to communicate and might help the public separate the Committee's purchase program from its policy for the federal funds rate and the overall stance of policy.

I am among those who see merit in this approach as long as the economy follows roughly the path we expect. Once the decision is made, I favor providing the public as much clarity and certainty as possible about how the change will be executed.

In an interview with Reuters, John Williams, president of the San Francisco Federal Reserve Bank, said the central bank needed to do more to convince investors that rates will stay low long after the Fed stops buying bonds. It should not wait to twin that message with a decision on cutting back its bond-buying stimulus, he said.

But once the Fed decides the economy is strong enough for the Fed to reduce its $85 billion in monthly bond purchases, it should announce an end date and a purchase total for the program, Williams said.

For now, he said, the Fed must drive the message of continued support for the economy.

"My view would be that we would not be raising the funds rate even if the unemployment rate was below 6.5 percent as long as inflation continued to be low, for some time," Williams said. "We need to be communicating more about the post-6.5-percent world now, because it could be with us much sooner than we expect, and I don't want market participants to be surprised."…

The goal, he said, is that people understand the Fed is "not in a rush" to raise interest rates. For his part, he said, he does not expect rates to rise until the latter part of 2015.

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Williams first publicly embraced the idea of capping bond buys in early November as a way to give investors clarity on the Fed's next steps, and the idea may be gaining traction. Philadelphia Fed President Charles Plosser, a hawk who opposed the Fed's current round of bond buys from the start, has also floated the idea of capping QE in order to shore up the Fed's credibility.

A key Federal Reserve Bank of New York staffer said Monday markets may not have been as surprised by the central bank’s decision to press forward with its easy-money policies in September as many now assert.

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The official observed surveys taken ahead of the Federal Open Market Committee showed it isn’t so clear markets and the Fed were on totally different pages.

“What was actually priced into markets, it’s hard to say,” Mr. Potter told attendees at a gathering held by the Money Marketeers of New York University. Mr. Potter said it is true the market’s reaction after the September FOMC showed many were expecting a cutback in bond buying, but it nevertheless remains the case that things are a bit cloudier than the conventional wisdom now seems to hold.

“Market participants had a range of views” about what would happen, but they didn’t have strong conviction, Mr. Potter said. He explained that it may have been overseas investors and traders, who were less connected to the flow of U.S. news, who may have been the only ones truly caught off guard by the Fed’s choice to press forward with its stimulus.

As reported by the Wall Street Journal

The decision to taper is going to depend on the incoming data, and the phrase “in coming months” in the minutes, I felt, was about as precise as you can get at this point.

As reported by Dow Jones News

The spirit of the discussion last time was whether we could improve communications by providing a fuller sense to how policy is going to react to incoming data. [Officials should be] really cautious about tweaking the forward guidance apparatus [because the message is complex and changes may erode the Fed’s credibility]. If you go changing what you are saying about how you are likely to behave from time to time you could erode people’s confidence that you are going to follow through on what you say you are going to do.

As reported by Bloomberg News.

Financial market movements are often difficult to account for, even after the fact, but three main reasons seem to explain the rise in interest rates over the summer. First, improvements in the economic outlook warranted somewhat higher yields--a natural and healthy development. Second, some of the rise in rates reportedly reflected an unwinding of levered positions--positions that appear to have been premised on an essentially indefinite continuation of asset purchases--together with some knock-on liquidations of other positions in response to investor losses and the rise in volatility. Although it brought with it some tightening of financial conditions, this unwinding and the associated rise in term premiums may have had the benefit of reducing future risks to financial stability and, in particular, of lowering the probability of an even sharper market correction at some later point. Third, market participants may have taken the communication in June as indicating a general lessening of the Committee's commitment to maintain a highly accommodative stance of policy in pursuit of its objectives. In particular, it appeared that the FOMC's forward guidance for the federal funds rate had become less effective after June, with market participants pulling forward the time at which they expected the Committee to start raising rates, in a manner inconsistent with the guidance.

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At its September 2013 meeting, the FOMC applied the framework communicated in June. The Committee's decision at that meeting to maintain the pace of asset purchases was appropriate and fully consistent with the earlier guidance… Although the FOMC's decision came as a surprise to some market participants, it appears to have strengthened the credibility of the Committee's forward rate guidance; in particular, following the decision, longer-term rates fell and expectations of short-term rates derived from financial market prices showed, and continue to show, a pattern more consistent with the guidance.

In coming meetings, in evaluating the outlook for the labor market, we will continue to consider both the cumulative progress since September 2012 and the prospect for continued gains. We have seen meaningful improvement in the labor market since the latest asset purchase program was announced in September 2012… Looking forward, we will of course continue to monitor the incoming data. As reflected in the latest Summary of Economic Projections and the October FOMC statement, the FOMC still expects that labor market conditions will continue to improve and that inflation will move toward the 2 percent objective over the medium term. If these views are supported by incoming information, the FOMC will likely begin to moderate the pace of purchases. However, asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's economic outlook. As before, the Committee will also continue to take into account its assessment of the likely efficacy and costs of the program.

When, ultimately, asset purchases do slow, it will likely be because the economy has progressed sufficiently for the Committee to rely more heavily on its rate policies, the associated forward guidance, and its substantial continued holdings of securities to maintain progress toward maximum employment and to achieve price stability.18 In particular, the target for the federal funds rate is likely to remain near zero for a considerable time after the asset purchases end, perhaps well after the unemployment threshold is crossed and at least until the preponderance of the data supports the beginning of the removal of policy accommodation.

All told, he said, the Fed's bond-buying program will probably add about $1.5 trillion or a bit more to the Fed's balance sheet since January 2013.

That's about $250 billion more than he had expected a few months ago, or the equivalent of about three additional months of bond-buying at the current pace. The Fed next meets in December, January and March to discuss policy.

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Evans said he would support lowering the unemployment threshold that would trigger a rethink of the low-rate policy, to as low as 5.5 percent, as his colleague Minneapolis Fed chief Narayana Kocherlakota suggested.

Specifically, he said, the Fed should consider lowering the unemployment threshold at the same meeting it announces a reduction in bond purchases. Doing so, he said, could help avoid an undesirable spike in long-term interest rates that could result if investors equate an end to bond buying with a faster return to normal short-term borrowing rates.

Lowering the threshold would be "credibility-enhancing", he said, because it would underscore, rather than undercut, the Fed's commitment to boost jobs.

As reported by Reuters News

The decision to maintain the pace of purchases in September and await more evidence of sustained economic progress came as quite a surprise to the public, generating widespread public debate about the FOMC's communications surrounding its policy intentions.

Not dissuading the public from its expectation of a tapering and then not taking action undermines the credibility of the FOMC and reduces the effectiveness of forward guidance as a policy tool…

In my view, this whole episode also demonstrates how difficult it is to fine-tune our open-ended asset purchases and our forward guidance about them. We cannot continue to play this bond-buying game by ear and risk the Fed's credibility while creating lingering uncertainty about the course of monetary policy.

We need to define simple, clear dimensions to "right-size" the program. This will reduce policy uncertainty and move the economy forward. My preference would be for the FOMC to announce a fixed amount for QE3, just as we did for the two prior rounds of asset purchases…

We are still learning how asset purchases affect the economy, but many believe it is the ultimate size and composition of the assets, rather than the flow of purchases, that influences interest rates and thus the economy. This was the premise of the early rounds of purchases.

Setting the ultimate size of our asset purchase program will lead us away from trying to fine-tune our decision about purchases based on the latest numbers and creating uncertainty from meeting to meeting about the FOMC's next step... By specifying a fixed amount, we would help the public understand that reducing the pace of asset purchases does not signal a change in our policy rate. Indeed, even an end to purchases only stops the efforts to increase accommodation. It is not a tightening of policy. As I said, after our purchases stop, policy will remain highly accommodative. An end to the purchase program does not imply that increases in the policy rate are imminent. We will simply set our policy rate consistent with promoting the FOMC's goals of price stability and maximum employment.

We do have to take account of what's happening in the markets, what impact market conditions are likely to have on spending and the economic outlook. So it is the case, and we highlighted this in our statement, when we saw a big jump in rates -- a jump that was greater than we would have anticipated from the statements that we made in May and June -- and particularly saw mortgage interest rates rise in the space of a few months by over a hundred basis points, we had to ask ourselves whether or not that tightening of conditions in a sector where we were seeing a recovery and a recovery that could really -- recovery in housing that could drive a broader recovery in the economy -- we did have to ask ourselves whether or not that could potentially threaten what we were trying to achieve.

I think that there are dangers, frankly, on both sides of ending the program or ending accommodation too early. There are also dangers that we have to keep in mind with continuing the program too long or more generally keeping monetary policy accommodation in place too long. So the objective here is to assure a strong and robust recovery so that we get back to full employment, and that we do so while keeping inflation under control.

I’d like to see some movement toward the {inflation} target before tapering.

“I’d like to see some movement toward the target” before tapering, Lockhart said today in a Bloomberg Radio interview with Kathleen Hays. Inflation is “stable but too low” and a move up would “give me some confidence we are not dealing with some downside scenario that might develop,” said Lockhart, who doesn’t vote on policy this year.
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The Fed must also communicate to investors its intent to keep policy stimulus even as it tapers, which could mean changing its communication of “forward guidance” on interest rates at the same meeting, Lockhart said.
“I would be supportive of consideration of that,” he said. “We might enhance the forward guidance to convince the public and the market that the environment is not going to change much” after a reduction in bond buying.