There’s been a long time disconnect and I have been worried. I’ve said so on Bloomberg many times, that I’m worried that that gets reconciled in some kind of violent way where there’s a lot of turmoil caused in markets because of changing expectations of what the Fed is going to do.

So I think the Committee gives its best assessment in that dot plot of what they think is going to happen and — and where they think the policy rate is going to go. It’s not clear to me why the pricing should be very different from that, unless markets have a much more pessimistic view of the U.S. economy, which is certainly something you could — you could have.

But if you look at the forecasts in the private sector of how the economy is going to evolve, those aren’t, you know, materially different from what the Fed thinks.

So — so I’m not quite sure why — why we need to have this — this, you know, constant sort of disconnect.

The immediate market response, and for a number of weeks, to the Fed [liftoff] decision was quite tranquil. It was a decision that I believe had been well communicated and was expected, and there was very little market reaction.

Around the turn of the year we began to see more volatility in financial markets. Some of the precipitating factors seem to be the movement in Chinese currency and the downward move in oil prices. I think those things have been the drivers and they have been associated with broader fears that have developed in the market about the potential for weakening global growth, with spillovers to inflation, so I don't think it's mainly our policy.

I felt that the likelihood of a substantial tightening in financial market conditions due to lift-off was relatively low, in part, because the rate hike was widely anticipated. Market conditions had adjusted quite smoothly—except for some strains observed in the high-yield debt market—as market participants placed higher odds of tightening in the weeks preceding the December FOMC meeting. This reinforced that conclusion. A large market reaction would have been a surprise given that this was one of the most anticipated monetary policy events in history. Also, the policy action needs to be viewed in context. While this decision was the first upward adjustment to short-term rates in nearly 10 years, the actual move was small—only 25 basis points—which, by itself, should have only a very mild impact on the overall trajectory of the economy. As we noted in the FOMC statement and as Chair Yellen pointed out in her December press conference, even after this rate hike, the stance of monetary policy remains accommodative.

The median projected rate in 2017 remains below the 3.75 percent or so projected by most FOMC participants as the longer-run value of the federal funds rate, even though the central tendency of the unemployment rate by that time is slightly below its estimated longer- run value and the central tendency for inflation is close to our 2- percent objective... Participants provided a number of explanations for the federal funds rate running below its normal longer-run level at that time. These included, in particular, the residual effects of the financial crisis, which are likely to continue to constrain spending and credit availability for some time.

Economists have come to understand that expectations about monetary policy can play an important role in determining economic outcomes, such as real economic growth and inflation. For example, todays decision to save or to spend is influenced by the current interest rate as well as tomorrows expected future consumption. In turn, tomorrows expected future consumption is influenced by next periods interest rate and next periods expected future consumption. Therefore, the entire expected path of interest rates, not just the current interest rate, influences todays consumption. This is not only true for personal consumption, but also business investment decisions, and the setting of prices and wages.

Of course, if the Committee is using asset purchases to signal its policy intentions, then the information content of purchase decisions depends importantly on what the public expects it to do. For example, if it is early 2013 and the market has somehow arrived at the belief that the Committee will continue buying assets at an $85 billion per month clip so long as monthly payroll growth does not exceed 200,000 jobs per month for three months in a row, then even a small cut down to $80 billion per month is likely to elicit a powerful market reaction--not because the $5 billion cut is consequential in and of itself, but because of the message it sends about the Committee's policy leanings more generally. But then you can see the feedback loop that arises: The more strongly the market becomes attached to this belief--even if it was initially somewhat arbitrary--the more wary the Committee must be of making an unexpected change, and this wariness further reinforces the market's initial belief. In this sense, the Committee's reaction function for the appropriate quantity of asset purchases under the QE3 program is not only evolving over time, it is coevolving along with the market's beliefs.

However, a key point is that as we approach an FOMC meeting where an adjustment decision looms, it is appropriate to give relatively heavy weight to the accumulated stock of progress toward our labor market objective and to not be excessively sensitive to the sort of near-term momentum captured by, for example, the last payroll number that comes in just before the meeting.

In part, this principle just reflects sound statistical inference--one doesn't want to put too much weight on one or two noisy observations. But there is more to it than that. Not only do FOMC actions shape market expectations, but the converse is true as well: Market expectations influence FOMC actions. It is difficult for the Committee to take an action at any meeting that is wholly unanticipated because we don't want to create undue market volatility. However, when there is a two-way feedback between financial conditions and FOMC actions, an initial perception that noisy recent data play a central role in the policy process can become somewhat self-fulfilling and can itself be the cause of extraneous volatility in asset prices.

Thus both in an effort to make reliable judgments about the state of the economy, as well as to reduce the possibility of an undesirable feedback loop, the best approach is for the Committee to be clear that in making a decision in, say, September, it will give primary weight to the large stock of news that has accumulated since the inception of the program and will not be unduly influenced by whatever data releases arrive in the few weeks before the meeting--as salient as these releases may appear to be to market participants. I should emphasize that this would not mean abandoning the premise that the program as a whole should be both data-dependent and forward looking. Even if a data release from early September does not exert a strong influence on the decision to make an adjustment at the September meeting, that release will remain relevant for future decisions. If the news is bad, and it is confirmed by further bad news in October and November, this would suggest that the 7 percent unemployment goal is likely to be further away, and the remainder of the program would be extended accordingly.

 Financial conditions eased notably in anticipation of the Committee's announcement, suggesting that this policy will be effective in promoting recovery. As has been the case with more conventional monetary policy in the past, this policy action will be regularly reviewed in light of the evolving economic outlook and the Committee's assessment of the effects of its policies on the economy.

It is conventional for central banks to attribute deflationary outcomes to temporary shortfalls in aggregate demand. Given that interpretation, central banks then respond to deflation by easing monetary policy in order to generate extra demand. Unfortunately, this conventional response leads to problems if followed for too long. The fed funds rate is roughly the sum of two components: the real, net-of-inflation, return on safe short-term investments and anticipated inflation. Monetary policy does affect the real return on safe investments over short periods of time. But over the long run, money is, as we economists like to say, neutral. This means that no matter what the inflation rate is and no matter what the FOMC does, the real return on safe short-term investments averages about 1-2 percent over the long run.

Long-run monetary neutrality is an uncontroversial, simple, but nonetheless profound proposition. In particular, it implies that if the FOMC maintains the fed funds rate at its current level of 0-25 basis points for too long, both anticipated and actual inflation have to become negative. Why? It’s simple arithmetic. Let’s say that the real rate of return on safe investments is 1 percent and we need to add an amount of anticipated inflation that will result in a fed funds rate of 0.25 percent. The only way to get that is to add a negative number—in this case, –0.75 percent.

To sum up, over the long run, a low fed funds rate must lead to consistent—but low—levels of deflation. The good news is that it is certainly possible to eliminate this eventuality through smart policy choices. Right now, the real safe return on short-term investments is negative because of various headwinds in the real economy. Again, using our simple arithmetic, this negative real return combined with the near-zero fed funds rate means that inflation must be positive. Eventually, the real economy will improve sufficiently that the real return to safe short-term investments will normalize at its more typical positive level. The FOMC has to be ready to increase its target rate soon thereafter.

That sounds easy—but it’s not. When real returns are normalized, inflationary expectations could well be negative, and there may still be a considerable amount of structural unemployment. If the FOMC hews too closely to conventional thinking, it might be inclined to keep its target rate low. That kind of reaction would simply re-enforce the deflationary expectations and lead to many years of deflation.

One of the guiding principles from contemporary economic theory is that monetary policy should be conducted in a systematic and predictable fashion.

My job is not to second guess the markets or even to think about letting the markets drive policy decisions. From audience Q&A session as reported by Market News International. 

Poole noted while policy makers are clearly mindful of what markets expect, "if all the Fed does is follow the market, there can only be chaos. The Fed must lead this process."

As reported by Dow Jones News

The fact that the public is uncertain about and must learn about the economy and policy provides a reason for the central bank to strive for predictability and transparency, avoid overreacting to current economic information, and recognize the challenges of making real-time assessments of the sustainable level of real economic activity and employment.  Most fundamentally, our discussions of the pervasive uncertainty that we face as policymakers is a powerful reminder of the need for humility about our ability to forecast and manage the future course of the economy.

Turning to the Fed's hefty 50-basis-point cut in the federal-funds rate, Poole said that the market was bound to be surprised, pointing to what the fed-funds futures market was showing at the time.    "There was was going to be a surprise...no matter the way we did it," he said. "The only way to meet market expectations would have been a 14-basis-point cut."

From the Q&A as reported by Dow Jones News

Indeed, the management of expectations about future policy has become a central element of monetary theory, as emphasized in the recent synthesis of Michael Woodford (2003).