I am closely monitoring how slowing growth, high levels of overcapacity and high levels of debt to GDP in advanced economies outside the U.S. might be impacting economic conditions in the U.S. I am also closely tracking how these issues might be affecting the slope of the U.S. Treasury yield curve as well as measures of tightness in financial conditions.

In light of these challenges, I have been suggesting that removal of accommodation should be done in a gradual and patient manner, based on a realistic assessment of economic conditions. I am also very cognizant that, from a risk management point of view, our monetary policies have an asymmetrical impact at or near the zero lower bound.

To recap, policymakers would have to resort to second-best policy tools to deal with unexpected weakness in activity or inflation, but we can use our old tried-and-true instruments for addressing stronger-than-expected outcomes. Even if the odds of upside and downside shocks are the same, the costs are not. How should the FOMC address these asymmetric risks? Well, we should buy some insurance against unexpected weakness by accepting a somewhat higher likelihood of stronger outcomes. Translated into monetary policy, this means being more accommodative than usual to provide an extra boost to aggregate demand as a buffer against possible future downside shocks that might otherwise drive us back to the effective lower bound.

Even beyond this asymmetry in costs, I see the distribution of future shocks as skewed in the direction of output running somewhat softer and inflation somewhat lower than what I have written down in my baseline projection. This tilting of the odds strengthens the rationale for shading policy in the direction of accommodation and provides additional support for a gradual path in normalizing policy.

To sum up, in 2016, I expect growth that is somewhat above trend and further progress in moving inflation toward our 2 percent target. As I consider how to calibrate monetary policy in the months and years ahead, I see two general — but key — considerations to keep in mind: 1) There are a number of downside risks to my near-term forecast; and 2) the equilibrium real federal funds rate is likely lower today than in the past (not only in the short run, as the economy continues to heal from the past wounds, but also in the long run). Today, the confluence of these considerations leads me to conclude that a very shallow path — such as the one envisioned by the median FOMC participant in March — is the most appropriate path for policy normalization over the next three years.

In today's circumstances, policy could usefully follow two simple guidelines. First, we should not take the strength in the U.S. labor market and consumption for granted. Given weak and decelerating foreign demand, it is critical to carefully protect and preserve the progress we have made here at home through prudent adjustments to the policy path. Tighter financial conditions and softer inflation expectations may pose risks to the downside for inflation and domestic activity. From a risk-management perspective, this argues for patience as the outlook becomes clearer.

Given the persistently-low- inflation record of the past six years and given how slowly inflation evolves when it is at such low levels, it may be difficult to return inflation to target over the next two or three years. So I’m in favor of very gradual policy normalization to help ensure that we meet our inflation goal within a reasonable amount of time. Moreover, as I have argued many times, prudent risk management calls for a slower removal of accommodative monetary policy. From my perspective, the costs of raising the federal funds rate too quickly far exceed the costs of removing accommodation too slowly. So taking both of these concerns into account — and considering how I think economic conditions will evolve over time — I believe that policy should plan to follow an even shallower path for the federal funds rate than currently envisioned by the median FOMC participant.

How does [my current] asymmetric assessment of risks to achieving the dual mandate goals influence my view of the most appropriate path for monetary policy over the next three years? It leads me to prefer a later liftoff than many would like, followed by a very gradual normalization of our monetary policy. I think such a policy setting will best position the economy for the potential challenges ahead.

Now, I take seriously the view that I should go into every FOMC meeting with an open mind regarding the policy decision. And I will do so in our meeting two weeks from now. Should we raise rates or not? I admit to some nervousness about our upcoming decision. Before raising rates, I would prefer to have more confidence than I do today that inflation is indeed beginning to head higher. Given the current low level of core inflation, some evidence of true upward momentum in actual inflation would bolster my confidence. I am concerned, however, that it could be well into next year before the headwinds from lower energy prices and the stronger dollar dissipate enough so that we begin to see some sustained upward movement in core inflation.

There is a risk that the intensification of international cross currents could weigh more heavily on U.S. demand directly, or that the anticipation of a sharper divergence in U.S. policy could impose restraint through additional tightening of financial conditions. For these reasons, I view the risks to the economic outlook as tilted to the downside. The downside risks make a strong case for continuing to carefully nurture the U.S. recovery--and argue against prematurely taking away the support that has been so critical to its vitality.
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Although the outlook for domestic demand is good, global forces are weighing on net exports and inflation, and the risks from abroad appear tilted to the downside. Our economy has made good progress toward full employment, but sluggish wage growth suggests there is some room to go, and inflation has remained persistently below our target. With equilibrium real interest rates likely to remain low for some time and policy options that are more limited if conditions deteriorate than if they accelerate, risk-management considerations counsel a stance of waiting to see if the risks to the outlook diminish.

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.

It is important that in performing this exercise we illustrate the various dimensions of uncertainty that policymakers face. For example, there is model uncertainty, forecast uncertainty, and the variations implied by different rules. Many central banks use fan charts and other devices to highlight such uncertainty, and we, the Fed, would be wise to do the same. Even acknowledging the uncertainty, the exercise will provide a better sense of the likely direction of policy and the variables most related systematically to that policy.

Risk-management considerations strengthen the case for maintaining a highly accommodative policy stance longer than might otherwise be considered appropriate. In particular, the FOMC has considerable latitude to withdraw policy accommodation if the economic recovery were to proceed much faster than expected or if inflation were to come in higher. In contrast, if the recovery faltered or inflation drifted down, the Committee could provide additional stimulus using its unconventional tools, but doing so involves costs and risks. Given the unprecedented nature of the current economic situation and the limits placed on conventional policy by the zero lower bound on interest rates, these issues of risk management take on special importance.

More broadly, these considerations help illustrate why it would be imprudent to adhere mechanistically to the prescriptions of any single policy rule. Such rules can serve as useful benchmarks for facilitating monetary policy deliberations and communications, but a dose of good judgment will always be essential as well.

Bernanke:  Well, this fear of inflation, I think is way overstated. We've looked at it very, very carefully. We've analyzed it every which way. One myth that's out there is that what we're doing is printing money. We're not printing money. The amount of currency in circulation is not changing. The money supply is not changing in any significant way. What we're doing is lowing interest rates by buying Treasury securities. And by lowering interest rates, we hope to stimulate the economy to grow faster. So, the trick is to find the appropriate moment when to begin to unwind this policy. And that's what we're gonna do.

60 Minutes: Is keeping inflation in check less of a priority for the Federal Reserve now?

Bernanke: No, absolutely not. What we're trying to do is achieve a balance. We've been very, very clear that we will not allow inflation to rise above two percent or less.

60 Minutes: Can you act quickly enough to prevent inflation from getting out of control?

Bernanke: We could raise interest rates in 15 minutes if we have to. So, there really is no problem with raising rates, tightening monetary policy, slowing the economy, reducing inflation, at the appropriate time. Now, that time is not now.

60 Minutes: You have what degree of confidence in your ability to control this?

Bernanke: One hundred percent.

Click here for an alternative view on "printing money" from Bernanke's previous 60 Minutes interview.

I am leaning in favor of additional monetary stimulus while acknowledging the longer-term risks the policy may present. At this juncture, and given the circumstances of sluggish growth and measured inflation that is too low, I give greater weight to the risk of further disinflation leading to deflation. In my mind, QE2 is a form of risk management—an insurance policy that is prudent to put in place at this time.

Ultimately, when the decision is made to remove policy accommodation further, prudent risk management may prescribe that it be accomplished with greater swiftness than is modern central bank custom. The Federal Reserve acted preemptively in providing monetary stimulus, especially in early 2008 when the economy appeared on an uneven, uncertain trajectory. If the economy were to turn up smartly and durably, policy might need to be unwound with the resolve equal to that in the accommodation phase. That is, the speed and force of the action ahead may bear some corresponding symmetry to the path that preceded it. Of course, if the economy remains mired in weak economic conditions, and inflation and inflation expectation measures are firmly anchored, then policy could remain highly accommodative.

"Whatever it takes" is said by some to be the maxim that marked the battle of the last year. But, it cannot be an asymmetric mantra, trotted out only during times of deep economic and financial distress, and discarded when the cycle turns. If "whatever it takes" was appropriate to arrest the panic, the refrain might turn out to be equally necessary at a stage during the recovery to ensure the Fed's institutional credibility. The asymmetric application of policy ultimately could cause the innovative policy approaches introduced in the past couple of years to lose their standing as valuable additions in the arsenal of central bankers.

Forces that produce the beginnings and ends of recessions are particularly difficult to predict. Turning points are anomalous events and by their very nature are more difficult to see than variations around a more or less linear scenario, by which I mean continuity from past to present.

As a consequence, economic forecasts will tend to be overly optimistic as the economy goes into a recession but overly pessimistic as the economy comes out of recession and begins its expansion. Perhaps we should take some comfort in that observation today.

I think there are some other lessons to take away from the experience of the last two years. Tail risks—low probability but extremely consequential events—do sometimes materialize. Ignoring tail risks—"black swans," in the words of author Nassim Taleb—may be irresponsible. Because forecasting is an inexact exercise, because shocks by nature aren't anticipated, and because both theoretical models and econometric models cannot incorporate actual complexity, policy must sometimes take what we call a "risk management" approach. Policymakers occasionally need to take out insurance against economic tail risks, and this approach is especially relevant when traditional relationships have broken down. Case in point: Our models are based on a history where financial markets are working.

Yet, undoubtedly, the greatest challenge we face is the enormous uncertainty of our situation. One great feature of being an economist in Chicago is that we benefit from the wisdom of many distinguished scholars at our local universities. An example of such wisdom is an observation made long ago by Robert Lucas, a Nobel Laureate from the University of Chicago: "As an advice-giving profession, we economists are in way over our heads." At any time, this is a sobering and humbling thought to remember. Nevertheless, in the current environment, the pursuit of a range of robust policies in the face of large uncertainties is likely to be most efficacious. A good decision-maker can't place all of his or her policy bets on a single hypothesis when the evidence is still ambiguous.

For example, in light of the demonstrated importance to the real economy of speculative booms and busts (which can take years to play out), central banks probably should always try to look out over a long horizon when evaluating the economic outlook and deliberating about the appropriate accompanying path of the policy rate.  The Federal Reserve staff has for sometime regularly provided the FOMC with this sort of extended-horizon analysis.  In particular, the staff regularly generates likely paths for the economy over the next five years or so under different economic and policy assumptions; these scenarios often highlight different possibilities for the evolution of prices for homes and other assets.  Note that the focus here is not a single baseline outlook; rather, the emphasis is on exploring the various ways events could play out and the implications for monetary policy.