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.

I think we have to be ready for surprising developments in either direction. We have to be prepared to be nimble in either direction. Because it could be that all sorts of things would shake out relatively easily and comfortably and it could be that they won’t. I just don’t know.

In an interview with the Wall Street Journal

[T]he fourth principle is that any monetary policy rule should be robust to uncertainty.5 Indeed, the specification of the original Taylor Rule was not chosen to be optimal in any one particular model, but was based on its "good" performance in monetary-policy-rule evaluation exercises using a variety of macroeconomic models.6 This approach places greatest weight on getting the "basics" right; that is, it emphasizes policy prescriptions in which we have the most confidence. This approach is purposefully modest in that it does not attempt to take advantage of all the potential benefits of the optimal policy in a given model. In fact, subsequent research has shown that the cost of insuring against model misspecification is relatively small because fully optimal rules yield typically only small stabilization benefits over simple rules like the Taylor Rule.7

Unlike the other principles which are uncontroversial, this last principle is still the subject of research and debate. But, based on my experience, John's position on the benefits of robustness seems the right one to me.

But you should view these forecasts even more skeptically than usual...   We will need to be nimble in adjusting policy to promote growth and price stability.

David suggests that monetarism failed when its proponents got too prescriptive by advocating rigid rules for money growth.  Among the lessons he takes from the failed monetarist experiment are that central banking is an applied science and that our imperfect understanding of how economies and markets function implies that a good dose of humility is required--and I agree. 

Active, and sometimes bitter, debates about which modeling approaches are the right ones are ongoing in macroeconomics, and there often is not a consensus on the best model. As a result, central banks must express some degree of humility regarding their knowledge of the structural relationships that determine activity and prices. This humility is readily apparent in the practice at central banks, which involves looking at many different modelsstructural, reduced-form, general equilibrium and partial equilibrium, and continually using judgment to decide which models are most informative.

As you are no doubt aware, the monthly statistics reported on the economy are very volatile and subject to revision. The FOMC works hard to differentiate those factors that may have only a temporary impact on the economy or inflation from those of a more sustained nature...

The Committee looks at a variety of data and economic information in formulating its economic outlook. When information indicates that the outlook for economic growth and inflation has changed, one still has to ask whether it has changed enough to impede the achievement of the Fed’s goals of price stability and maximum sustainable economic growth. As I mentioned, the economy is remarkably resilient. One must also ask how much monetary policy can influence that forecast over the relevant time horizon. Thus the Committee usually does not base its decision to change monetary policy on any one number, but instead assesses the cumulative impact of all incoming data for the outlook in light of its ultimate goals.

The conditions we see prevailing in global financial markets today reflect a range of different factors, some fundamental and others that are less likely to be enduring. The most effective thing that policymakers and market participants can do in what is a necessarily uncertain world is to work to ensure that the shock absorbers are strong relative to the range of potential economic and financial outcomes.

The puzzle, as I put it then, was: Why is the labor market apparently going gangbusters, while growth in real GDP has turned in only a middling performance? The reason I’d like to revisit the puzzle is that, in the intervening period, its mystery has deepened: economic growth has unexpectedly slowed from “middling” to a crawl, while the unemployment rate has actually inched down and employment growth has remained robust.

More fundamentally, I believe that long-run inflation expectations remain a key determinant of the path of inflation. But what are the current expectations for long-term inflation? Unfortunately, that is not an easy question to answer. The results from the Survey of Professional Forecasters, readings on household opinion such as the Reuters/Michigan survey, and the spread between standard Treasury securities and Treasury inflation-protected securities--taken together--suggest that long-term inflation expectations are currently around 2 percent, although this guess is far from certain.

Given my estimate of the current level of long-run inflation expectations as well as the likelihood of some easing of resource pressures in labor and product markets, I expect that core inflation will slow to around 2 percent over the next couple of years. Although I believe that inflation expectations will play a primary role in determining the course of inflation, I want to emphasize that neither economists nor policymakers understand the expectations-formation process very well.

Nonetheless, during my tenure at the Fed, the FOMC has had to react to a number of important and difficult challenges: the Asian financial crisis, the Russian debt default, major movements in asset prices, the acceleration in productivity, Y2K, 9/11, and the risk of deflation. All of these issues generated policy questions that did not fit neatly into any familiar textbook framework. They exemplify how, when making tough decisions in unusual circumstances, it's important to follow sound policy-making principles:

• Look at a wide range of data and information, instead of one or two summary indicators;
• Use cogent economic theory to shape analysis;
• And respect the risks of undesirable outcomes for growth or inflation, even in environments that appear benign.

In particular, over the past few decades the natural unemployment rate and the path of potential output have apparently moved around quite substantially. If we do not recognize the potential for such shifts, they can pose serious pitfalls for the conduct of monetary policy...

To be sure, central banks need to form some views about the economy's potential to produce on a sustained basis. After all, as I have already noted, the amount of slack in the economy is a key determinant of inflation. But, rather than focusing on fixed estimates of potential output or the natural rate of unemployment, central banks should take an eclectic approach in assessing the overall balance of economic activity relative to productive capacity. In other words, in pursuing the dual mandate, the central bank should recognize that a wide variety of indicators drawn from labor, product, and financial markets provide information about the overall balance of supply and demand in the economy. In addition, central banks should use information from various price indicators to tell them whether the economy is overheating or running well below productive capacity.

As always, my view on economic growth and inflation emphasizes longer-run conditions. I could point to numerous past episodes of either faster or slower growth for a few quarters that we now ignore because long-run developments dominated the outcome and indeed dominate our current assessment of these periods. In assessing short-run developments, it is also essential to keep in mind that forecasts have standard errors. Over a four-quarter horizon, a GDP forecast has a standard error of about 1.5 percentage points and an inflation forecast has a standard error of about 0.5 percentage points. We know also that data are often revised. Finally, monetary policy cannot affect near-term conditions anyway. Thus, a focus on medium- and long-term fundamentals is always appropriate.

Our statement included a description both of the situation on the real side of the economy and on the inflation side and our sense was both, that the risks had increased on both sides, that the outlook for output was a bit weaker, as we indicated in our statement, but that, also, the inflation situation had become slightly riskier, as well.

From Q&A session

I'd say it would be more accurate to say we are looking for a bit more flexibility, given the uncertainties that we are facing and the risks that are occurring on both sides of our outlook.

An additional point. We, in general, this is more technical, but we, in general, prefer not to give advance rate guidance, that is, not to tell the market we're going to do this, that and the other. Rather, it's better for the FOMC to describe our outlook and the risks that we see for the outlook and let the markets make their own determination about how to price assets. One aspect of this change has been to move away from forward rate guidance, which we view as being something that should be undertaken mostly under unusual circumstances.

...

Our statement included a description both of the situation on the real side of the economy and on the inflation side and our sense was both, that the risks had increased on both sides, that the outlook for output was a bit weaker, as we indicated in our statement, but that, also, the inflation situation had become slightly riskier, as well. And so both sides of the mandate have -- are facing somewhat greater risks.

From the Q&A session