The precision of the forecasts, or lack thereof, needs to be kept in mind when setting monetary policy. We must be forward looking, which means we must rely on models to forecast inflation, but there is no one model that forecasts with much accuracy. The best we can do in this situation is to recognize that there is uncertainty around our forecasts. I am in favor of the FOMC providing some type of error band around its projections. Not only will it help the public understand some of the risks around our forecast, but it will also be a helpful reminder to policymakers that we constantly live with uncertainty. This shouldn’t paralyze us. Instead we should cope with it by looking at the outcomes from multiple models and alternative simulations, using techniques like model averaging, and by continually evaluating the forecasts from the models against incoming data. The FOMC has been expanding the models it routinely examines as a part of the policymaking process — these include the Board of Governors staff’s large-scale FRB/US model and two smaller-scale DSGE models called EDO and SIGMA, as well as various models maintained and utilized at the Federal Reserve Banks. Researchers are now building model archives to aid in the systematic comparison of empirical results and policy implications across a large set of economic models as an aid to policy analysis. One such archive, The Macroeconomic Model Data Base (MMB), headed by Volker Wieland of Goethe University Frankfurt, currently includes 61 models. Given the state of our knowledge, this seems to be a promising approach to ensuring that policy actions are robust across the span of plausible models of economic dynamics and economic circumstances.

In addition to some of the uncertainty around the longer-run steady state of the economy, it bears remembering that our economic forecasting models are, by necessity, simplifications. The economy is dynamic and can be hit by various shocks that might lead to changes in the medium-run outlook for employment and inflation to which policy would want to respond. Indeed, the FOMC’s Summary of Economic Projections, aka the SEP, provides information on average historical errors across a range of forecasts and these show that the confidence bands around forecasts tend to be wide. For example, the 70 percent confidence interval around a forecast of CPI inflation one year out is about plus or minus 1 percentage point. Note that because there is uncertainty around the outlook, there is also uncertainty around the FOMC’s policy path.

Business owners and managers remain cautious and have not substantially increased their capital expenditures despite the solid fundamentals and brighter prospects for consumer spending. Businesses are holding large amounts of cash on their balance sheets, which may suggest that greater risk aversion is playing a role. Indeed, some economic analysis suggests that uncertainty about the strength of the recovery and about government economic policies could be contributing to the restraint in business investment.

The appreciation of the dollar since last summer will likely affect the export sector, to some extent. My view is that the impact of the dollar's more expensive exchange value and, for that matter, the direct impact of lower oil prices on the energy sector are not severe for the national economy as a whole. But whenever two major world "prices" adjust so markedly, unanticipated second- and third-order effects could result. Geopolitical event risk connected to the rapid adjustment of these globally high-impact prices cannot be dismissed. Analytical humility is a sensible posture.

I think the momentum evident in the second half of 2014 will carry over into 2015, and the ongoing outlook will remain solid.

If that is indeed the case, I believe the first action to raise interest rates will in all likelihood be justified by the middle of the year.

The phrase "middle of the year" is admittedly not very precise. That's purposeful on my part. Understandably, some financial market participants are fixated on what exact month the first move will occur. Perhaps it's easy for me to say, but I don't think the exact timing of liftoff is the most important concern. A couple of years hence, whether the first rate increase came at a particular meeting or anotherwhether a bit earlier or later than expectedisn't going to make a great deal of difference for the real, Main Street economy.

The key liftoff decision criteria ought to be closely linked to the FOMC's two principal policy objectivesmaximum employment and low and stable inflation. In my view, the biggest factor influencing the actual timing of a liftoff decision should be the Committee's confidence that these objectives will be achieved in an acceptable timeframe and, especially, that inflation will move at deliberate speed toward the target of 2 percent per annum.
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It's quite possible there will be considerable ambiguity in the picture presented by data in the first half of the year. Beyond the noise in inflation numbers, it's obvious there is simply a lot moving around at this timeoil prices, the dollar, even quarterly growth numbers, in all likelihood.

Noisy, jumpy data affect my confidence in the outlook. I'm likely to decide what policy decision to support based on where I think things are headed. When the numbers come in noisy, it's just harder.

If the early months of this year bring mixed news on the economy, the risk manager in me will lean to preferring a later date for the first policy move to an earlier one. That said, after six years of recovery and considering all that that has both transpired and been accomplished, I don't think we policymakers should get too rigid about liftoff a little earlier or later. My preferred timing may not be the Committee's consensus decision.
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At the recent meeting of the FOMC in December, the Committee made an adjustment of its forward guidance by introducing the theme of patience in beginning to normalize the stance of policy. I supported and expect to continue to support a patient approach, one that is relatively cautious and conservative as regards the pace of normalization of rates.

Clearly, an unusual set of conditions prevails as the Federal Reserve considers beginning a move toward more normal rates. Both short-term and long-term rates are unusually low, and remain below their historical average in most countries. Large central bank balance sheets here and in many developed countries and very low inflation rates in developed countries are important contributors to current low rates. Also, unlike in some previous periods, some countries will be easing while others will likely be tightening, causing more complicated exchange-rate dynamics. These are all factors that complicate the period of normalization.

The low inflation rates experienced globally may also allow for a more gradual normalization process than typically occurs. With so little wage and price pressure, and relatively slow productivity growth, it is possible that rates may not normalize at the same level they were prior to the financial crisis.

In sum, the complexity of monetary policy normalization is more pronounced than in 1994 and 2004. However, as I noted at the outset of my remarks, the fact that discussion of policy normalization is now appropriate is a welcome change from discussions of monetary policy over the past six years.

One thing that we have right now is the so-called dot-plot. So there's interest rate projections from all the 17 participants on the FOMC for 2014, '15, '16, '17. And people are interested in those numbers as a guide to when the Fed is actually likely to lift off.

My own personal opinion is that I think people shouldn't overweight the value of those dots, especially as you get out further in terms of the time horizon. I have a dot for '15, '16 and '17, but if I told you what my confidence and around that dot was you would probably not put a lot of weight on where that dot is precisely located. So I think the subcommittee I think will look at the issue.

Are there improvements that can be made in terms of how we communicate the summary of economics projections information? Obviously if it was obvious that there was a better way of doing it I'm sure we would be doing it already. So I don't think that people should be sort of waiting for big changes, but if we can find ways to that improve the communication process then certainly we'll go forward with that.

Of course, the outlook for the economy and financial markets is never certain, and now is no exception. Therefore, the Committee's decisions about the path of the federal funds rate remain dependent on our assessment of incoming information and the implications for the economic outlook. If the labor market continues to improve more quickly than anticipated by the Committee, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target likely would occur sooner and be more rapid than currently envisioned. Conversely, if economic performance is disappointing, then the future path of interest rates likely would be more accommodative than currently anticipated.

There is a ring of truth to the idea that low interest rates might be acting as life support for companies that are destined to fail. The flip side of that coin, however, is that low rates gave good companies the ability to get back on their feet before they went bankrupt. Its important to provide an economic environment that allows fundamentally sound firms to thrive. That may provide a temporary crutch to some companies that will eventually go bankrupt, but over the longer term, the right companies will survive. Nothing in life is perfect, and in terms of a trade-off, Im happy with a few bad companies staying in the game for a while if it means a lot of good ones have a chance to survive, too.

Market expectations are that the Federal Reserve will start to raise short-term interest rates around the middle of 2015... That sounds to me like a reasonable forecast, but forecasts often go astray, so I wouldnt put too much weight on that particular set of forecasts.

The world is highly uncertain. In the current environment its still very, very appropriate to continue to follow very accommodative monetary policy.

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.

Let me offer an example of how these issues shape policy. Four years ago, in April 2010, the outlook appeared fairly bright... Private-sector forecasters polled in the April 2010 Blue Chip survey were predicting that the unemployment rate would fall steadily to 8.6 percent in the final quarter of 2011.11
This forecast proved quite accurate--the unemployment rate averaged 8.6 percent in the fourth quarter of 2011. But this was not the whole story. In April 2010, Blue Chip forecasters not only expected falling unemployment, they also expected … the federal funds rate to reach 1.3 percent by the second quarter of 2011. …[B]y October 2010. the forecasters expected that the rate would remain in the range of 0 to 25 basis points throughout 2011, as turned out to be the case. Not only did expectations of policy tightening recede, the FOMC also initiated a new $600 billion asset purchase program in November 2010.
Thus, while the reductions in the unemployment rate through 2011 were roughly as forecast in early 2010, this improvement only came about with the FOMC providing a considerably higher level of accommodation than originally anticipated.
This experience was essentially repeated the following year. In April 2011, Blue Chip forecasters expected the unemployment rate to fall to 7.9 percent by the fourth quarter of 2012, with the FOMC expected to have already raised the federal funds rate to near 1 percent by mid-2012.14
As it turned out, the unemployment rate forecast was once more remarkably accurate, but again this was associated with considerably more accommodation than anticipated. In response to signs of slowing economic activity, in August 2011 the FOMC for the first time expressed its forward guidance in terms of the calendar, stating that conditions would likely warrant exceptionally low levels for the federal funds rate at least through mid-2013. The following month, the Committee added to accommodation by adopting a new balance sheet policy known as the maturity extension program. 15
Thus, in both 2011 and 2012, the unemployment rate actually declined by about as much as had been forecast the previous year, but only after unexpected weakness prompted additional accommodative steps by the Federal Reserve. In both cases, I believe that the FOMC's decision to respond to signs of weakness with significant additional accommodation played an important role in helping to keep the projected labor market recovery on track. These episodes illustrate what I described earlier as a vital aspect of effective monetary policymaking: monitor the economy for signs that events are unfolding in a materially different manner than expected and adjust policy in response in a systematic manner.

Economists at the Federal Reserve Bank of San Francisco estimate that the rise in policy uncertainty over the past several years increased the unemployment rate by as much as 1¼ percent, as of late 2012.2 That translates into nearly 2 million lost jobs.

Monetary policymakers must recognize the inherent uncertainties in how the economy may evolve and how our policies may influence those developments. Recognizing this, we have built ample safeguards and conditionalities into our unconventional monetary policy tools.

During the Great Recession, GDP fell by 4.3 percent over a six-quarter interval, but other indicators document even greater hardship. Payroll employment fell by 8.7 million jobs in the recession and its immediate aftermath... The scale and scope of the loss in income and wealth experienced by Americans was far greater than anything seen in the previous 20 years. Given that experience, lenders are bound to re-evaluate the riskiness associated with extending credit to a typical household. Indeed, consumers themselves appear to be re-evaluating the riskiness associated with indebtedness, no doubt reflecting a sense that their income and asset returns may be substantially riskier than they had come to believe during the Great Moderation. Under these conditions, it's no surprise that credit is no longer available on the same terms. And it's no surprise that consumers have been paying off debt and building up savings in order to restore some sense of balance to their household finances... Businesses also appear to be quite reticent to hire and invest. A widely followed index of small business optimism fell sharply during the recession and has only partially recovered since then. Interestingly, when small business owners were asked about the single most important problem they face, the most frequent answer in the latest survey was "government regulations and red tape..." Adding to the uncertainty is the continuing cloud over our nation's fiscal policy. The most recent round of budget deliberations has certainly been a welcome relief from the recurrent legislative cliffhangers of the last several years. The lower odds of an imminent budget showdown may ease some business and consumer concerns, and that may aid growth. But overall government spending has been declining lately, and, given continuing fiscal pressures, that category is likely to make little, if any, contribution to GDP growth in coming years.