Although my FOMC colleagues are not ready to choose a particular policy rule or reaction function to govern policy, we continue to explore the efficacy of monetary policy rules as guides to policy, as indicated in the minutes of the July 31-August 1, 2012 FOMC meeting. I believe we should continue to identify simple rules that work across a variety of economic models and try to communicate more information about the Fed’s policy reaction function. We could improve policy transparency and communications by identifying the key economic variables on which we base our policy decisions and then frame the rationale for any change in policy around changes in these key variables. If the Fed is systematic about how it sets policy in normal times, the public will form more accurate judgments about the likely course of policy. This will not only improve the efficacy of monetary policy in normal times by reducing uncertainty and promoting stability, it will also increase the efficacy of forward guidance in extraordinary times, like the ones we find ourselves in today.

First, as the statement notes, the committee views its current low rate policy as likely to be appropriate at least until the specified thresholds are met. Reaching one of those thresholds, however, will not automatically trigger immediate reduction in policy accommodation...  Ultimately, in deciding when and how quickly to reduce policy accommodation, the committee will follow a balanced approach in seeking to mitigate deviations of inflation from its longer-run 2 percent goal and deviations of employment from its estimated maximum level.

Second, the committee recognizes that no single indicator provides a complete assessment of the state of the labor market and, therefore, will consider changes in the unemployment rate within the broader context of labor market conditions. For example, in evaluating a given decline in the unemployment rate, the committee will also take into account the extent to which that decline was associated with increases in employment and hours worked as opposed to, say, increases in the number of discouraged workers and falling labor force participation. The committee will also consider whether the improvement in the unemployment rate appears sustainable.

Third, the committee chose to express the inflation threshold in terms of projected inflation between one and two years ahead, rather than in terms of current inflation. The committee took this approach to make clear that it intends to look through purely transitory fluctuations in inflation, such as those induced by short-term variations in the prices of internationally traded commodities and to focus instead on the underlying inflation trend.

In making its collective judgment about the underlying inflation trend, the committee will consider a variety of indicators, including measures such as median, true mean, and core inflation, the views of outside forecasters, and the predictions of econometric and statistical models of inflation. Also, the committee will pay close attention to measures of inflation expectations to ensure that those expectations remain well anchored.

Finally, the committee will continue to monitor a wide range of information on economic and financial developments to ensure that policies conducted in a manner consistent with our dual mandate.

I believe, certainly, that {the indicator threshold approach} is superior. I’m not saying it’s the best possible approach, there may be other things we can do in the future. We’re always looking to find ways to improve our communication but I do think it’s more transparent and will allow the markets to respond quickly and promptly to changes in the outlook by adjusting when they think rate increases will begin, and therefore, it’ll act, to some extent, like an automatic stabilizer. So if the outlook worsens and that leads markets to think that the increase in rates is further out in the future, that will tend to lower longer-term rates and that would tend to be supportive of the economy. So that has an automatic stabilizer type effect. It kind of offsets adverse shocks. So it’s a better form of communication. As I said, we discussed it quite extensively at the last meeting. And so—and frankly, given that it’s a relatively complex change, it seemed like it would be a good idea to do it at a meeting where there was a press conference. So, we decided since we’re ready to go why not make the change earlier and get the benefit earlier.

The Committee may need to recognize that thresholds will likely be treated as triggers for action in financial markets.

Remember that at the beginning of my remarks I characterized my thinking on the meaning of "substantial improvement" as a work in progress. In that spirit, let me share a qualitative framework for defining "substantial improvement."

The starting point certainly should be the headline unemployment rate and the payroll jobs number. The interpretation of movements in these two statistics would be enriched and reinforced by a review of additional data elements.

Here are examples of what I would look for:

First, I would look for lower unemployment rates that are driven by increased flows of job seekers into employment. I would not interpret discouraged workers dropping out of the labor force as a sign of improvement, even if the unemployment rate falls as a consequence.

Conversely, I'd like to see growing public confidence in the labor market as measured by increased movement of people from out-of-the labor-force status into the labor force—that is, growing labor force participation. I would interpret a reduction in the number of marginally attached workers as a sign of improvement, even if the unemployment rate goes temporarily higher.

Third, I'd look for employment gains that are associated with reductions in underemployment. I would interpret a pickup in job growth less positively if it is associated with increases in part-time jobs for people who seek full-time work.

Finally, I'd like to see signs that improvements in all these indicators are gaining momentum and are sustainable. A framework for assessing labor market conditions needs to include forward indicators of labor market health, such as falling claims for unemployment insurance.

“As an accountable central bank in a democratic society, the Federal Reserve has an obligation to clearly articulate what it is trying to achieve with monetary policy,” he said. “The economic thresholds I am proposing put a higher and more predictable standard on the removal of accommodation.”

I believe that the Fed should provide more information about its reaction function. The practice of using systematic rules as guides to monetary policy imposes an important discipline on policymaking and improves communication and transparency. This is because systematic rules make policy more predictable and therefore helps the public and markets make better decisions. Moreover, if policymakers choose to deviate from the guidelines, they are forced to explain why and how they anticipate returning to normal operating practices. Systematic policy also reduces the temptation to engage in discretionary policies.

I believe the Committee is still some way from agreeing on one systematic policy rule or reaction function. Such choices will involve elaborate discussions and agreement on the appropriate class of models and an agreed-upon loss function. One way to move toward more systematic policy would be to describe the variables that are important for our response function.

My preferred policy would be one where we are even clearer in what our intentions are on the federal funds rate and monetary policy.

“I was not supportive of the most recent decision to extend the time frame for exceptionally low rates through 2014,” Plosser said. He also didn’t support the practice of “offering forward policy guidance by saying economic conditions are likely to lead to low rates through some calendar date.”

“Monetary policy should be contingent on the economic environment and not on the calendar,” said Plosser, who is not a voting member of the FOMC this year.

“Continuing to signal that we want to try to ease more raises into question our confidence in the economy,” Plosser told reporters after the speech.

In my view, making a perceived commitment based on calendar time risks confusing the public about how policy is formed. If the Committee wishes to provide forward guidance, then a better way of conveying such information is necessary. My own view is that it would be better to provide more information about how policy responds to economic events, a sort of reaction function, than to make commitments based on the calendar that we may not keep.

 The Fed could sharpen its forward guidance in two directions by implementing a state-contingent policy. The first part of such a policy would be to communicate that we will keep the funds rate at exceptionally low levels as long as unemployment is somewhat above its natural rate. The second part of the policy is to have an essential safeguard — that is, a commitment to pull back on accommodation if inflation rises above a particular threshold. This inflation safeguard would insure us against the risks that the supply constraints central to the structural impediments scenario are stronger than I think. Rates would remain low as long as the conditions were unmet.

 Furthermore, I believe the inflation-safeguard threshold needs to be above our current 2 percent inflation objective — perhaps something like 3 percent...

As I noted in my opening remarks, no decisions have been made. So I want to be very clear that no final outcome here in this discussion.

But clearly there's a range of things that we can do. We can provide more information about our objectives, for example. We could provide information about where we want inflation to be in the long term, for example.  We could also provide information about the future path of interest rates, which we've done to some extent via our mid-2013 language in the statement.

An alternative approach, which Charlie Evans (ph) and others have suggested, is to tie that to economic conditions and to provide more information about under what circumstances we would raise rates. That is certainly something that we have discussed and I think is an interesting alternative.

There's a lot of interest in using the survey of economic projections in constructive ways as we have up till now to provide information to the public about our plans.  And in particular, using the SEP as a way of giving information about our future policy decisions is something that's on the table. There's no decision made about that, but that's one direction that we might find productive.

At our August meeting, the Committee decided to provide more-specific information about the likely time horizon by substituting the phrase "at least through mid-2013" for the phrase "for an extended period." This clarification appears to have reduced market uncertainty about the Committee's current policy expectations.

The Committee's guidance refers to a specific calendar date, which could be periodically revised by the Committee if appropriate. However, it is explicitly framed as contingent on economic conditions, including "low rates of resource utilization and a subdued outlook for inflation over the medium run." Importantly, it is not stated as an unconditional commitment to a specific course for the federal funds rate. Market participants are naturally interested in gaining greater insight into how shifts in the economic outlook would affect the likely timing and pace of policy firming. As noted in the minutes of the August and September FOMC meetings, the Committee has discussed possible approaches to enhance its forward guidance along these lines--that is, to provide greater insight concerning its "reaction function."

One potentially promising way to clarify the dependence of policy on economic conditions would be for the FOMC to frame the forward guidance in terms of specific numerical thresholds for unemployment and inflation. Such an approach was discussed by my colleague Charles Evans, president of the Federal Reserve Bank of Chicago, in a recent speech.

The approach of numerically specifying the values of unemployment and inflation that could prompt policy tightening is not without potential pitfalls, however. For example, such thresholds could potentially be misunderstood as conveying the Committee's longer-run objectives rather than the conditions surrounding the likely onset of policy firming. Thus, in addition to giving careful consideration to this particular approach, it seems sensible to explore other potential enhancements to FOMC communications--a topic to which I will return shortly.

You should make policy according to the state of the economy, not according to the calendar.  It’s very awkward for the committee to be trying to move that date around.

Asked if he would push at the Sept. 20-21 policy meeting for clarity on how long the Fed will leave interest rates unchanged, he said that “would be a welcome addition to our current conditional forward guidance.”

“At the moment we added mid-2013 to the statement and there’s some conditionality associated with that,” he said. “I would prefer to be extraordinarily clear in the conditioning to that. That would be truly clarifying.”