In response to a question about helicopter money

In normal times, I think it's very important that there be a separation between monetary and fiscal policy, and it's a primary reason for independence of the central bank.

We've seen all too many examples of countries that end up with high or even hyperinflation because those in charge of fiscal policy direct their central bank to help them finance it by printing money. And maintaining price stability and low and stable inflation is very much aided by having central bank independence.

Now, that said, in unusual times where the concern is with very weak growth or possibly deflation, rather rare circumstances -- first of all, fiscal policy can be a very important tool. And it's natural that if it can be employed, that just as monetary policy is doing a lot to try to stimulate growth, that fiscal policy should play a role. And normally, you would hope in an economy with those severe downside risks, monetary and fiscal policy would not be working at cross- purposes to get -- but together.

Now, whether or not, in such extreme circumstances there might be a case for let's say coordination -- close coordination where the central bank playing a role in financing fiscal policy.

This is something that academics are debating.  And it is something that one might legitimately consider. I would see this as a very abnormal extreme situation where one needs an all-out attempt, and even then it's a matter that academics are debating, but only in an unusual situation.

The most comprehensive and complete evaluation of monetary policy tools can take place only after a return to more normal economic conditions and monetary policy. Still, with that caveat, my overall assessment of quantitative easing is that it was quite successfully utilized in the United States. One reason the U.S. is now relatively close to achieving both aspects of the Federal Reserve’s dual mandate from Congress – full employment and price stability (which the Federal Reserve targets at 2 percent inflation) – is the early and forceful use of quantitative easing in the aftermath of the financial crisis.

With regard to the use of negative interest rates, I would say the experience in Japan and parts of Europe seems mixed. It will take some time before one can fully assess the overall impact on the Japanese and European economies. But my assessment so far of the effectiveness of the transmission mechanism of negative-rate policy, and of behavioral responses to negative interest rates, make this a tool to use only after other nontraditional monetary policy tools – the “more-conventional unconventional” tools – have been exhausted.

In terms of transparency, I do think it is a fair critique that, in the past, the Federal Reserve has not always been sufficiently transparent... During the crisis, I also believe we could have done more to explain the motivations for our extraordinary interventions. At times, while the motivations and objectives might have been obvious to us, they weren’t always as readily apparent to Congress or to the public. I think this created uncertainty about what we were trying to accomplish, and made it more difficult for outside observers to assess the appropriateness of our actions and our motives.

A central bank can use its balance sheet to alter the allocation of credit in the economy. By lending to or buying the securities of private sector entities, central bank credit allocation can cause more resources to flow to those segments of the economy than would otherwise be the case. This deprives other sectors of resources, however, and may distort economic activity in a way that is unproductive. Importantly though, I would not characterize central bank credit allocation as monetary policy, but rather as fiscal policy. As a result, I believe it is appropriate for such actions to be taken only by elected branches of government, not by the central bank.

This is why I have dissented on FOMC decisions to purchase securities backed by home mortgages.

Mr. Williams said that in a world where the natural rate of interest is low, the Fed has less room to lower short-term interest rates in response to economic downturns and “you’re going to hit the zero-lower or effective-lower bound more often, whatever that lower bound may be.” As a result, the central bank needs to consider possible alternative tools or other solutions, he said.

“You could think about keeping a permanently higher balance sheet” as a way to raise the natural interest rate, he said, which is “something we haven’t studied that much, but I think needs a lot more thought.” He added, “We need to think more about whether going to negative interest rates gives us more room.”

Mr. Lockhart said the idea the Fed might face economic conditions so worrisome that it would have to turn to fresh stimulus efforts are unlikely. He pointed out while he's watching the conversation about the possibility of using negative short-term rates to boost growth, "the notion we would have to use that tool in the near term is not very plausible."

I don’t see raising the target range for the fed funds rate above its current low level in 2015 or 2016 as being consistent with the pursuit of the kind of labor market outcomes that we are charged with delivering. Indeed, I would be open to the possibility of reducing the fed funds target funds range even further, as a way of producing better labor market outcomes.

There is, of course, a risk that inflationary pressures could build up more rapidly than I (or others) currently anticipate. But the solution to this scenario is relatively simple: Raise interest rates. Given my current outlook, I believe that it would be appropriate to wait until 2017 to initiate liftoff and then raise the fed funds rate at about 2 percentage points per year.

WINKLER: So you mentioned the balance sheet earlier in this discussion, which is now more than $4 trillion. The Fed has said that in the long run it should be reduced to the smallest level consistent with, "the efficient implementation of monetary policy." So what would say is the new normal for the balance sheet post crisis?

  DUDLEY: Well that statement was I think is a little bit deliberately vague because I don't think we really know what monetary policy regime for sure is going to be the right monetary regime in the long run. We're going to get a lot of information over the next few years conducting monetary policy with a large balance sheet, relying on the interest on excess reserves as the main tool of monetary policy. If that turns out to be fabulously successful it's possible that we could run monetary policy with what's called a floor system where we set an interest rate that actually has essentially the magnet-setting rates in money markets broadly. Or we could decide that this isn't so - this doesn't work so well, and we want to go back to the system that we had before the crisis, which was just a very small amount of reserves in the system with the federal funds rate balanced by the Federal Reserve adding and subtracting reserves to keep things in balance. I think my own view is it's too soon to make that call. That call will be made by future committees.

And my own personal opinion is let's see how things go. Let's learn. And as we learn then we can figure out what regime is right. And then that will determine the size of the balance sheet. Now what the principals are basically saying though, whatever regime we pick we're going to want to keep this balance sheet as small as possible, consistent with that regime being effective.

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.

Nevertheless, I don’t see LSAPs as being part of the FOMC’s toolkit once we leave the zero bound behind us. We’re still much less certain about their effects than we are about the effects of changes in the federal funds rate. According to Brainard’s classic analysis, the more uncertain you are about the effects of a policy tool, the more cautiously you should use it. Instead, you should rely more on other instruments in which you have greater confidence…

That said, I expect that the explicit link between future policy actions and specific numerical thresholds, as in the recent FOMC statements, will not be a regular aspect of forward guidance, at least when the federal funds rate is not constrained by the zero lower bound… [S]uch communication is difficult to get right and comes with the risk of oversimplifying and confusing rather than adding clarity. Therefore, in normal times, a more nuanced approach to policy communication will likely be warranted. I see forward guidance typically being of a more qualitative nature, highlighting the key economic factors that will affect future policy actions. Of course, if we again find ourselves in a situation where conventional policy has reached its limits, then we will have the ability to return to more explicit forward policy guidance to provide additional monetary stimulus.

I expect that the explicit link between future policy actions and specific numerical thresholds, as in the recent FOMC statements, will not be a regular aspect of forward guidance, at least when the federal funds rate is not constrained by the zero lower bound. This guidance has proven to be a powerful tool in current circumstances, when conventional policy stimulus has been limited by the zero lower bound. But such communication is difficult to get right and comes with the risk of oversimplifying and confusing rather than adding clarity. Therefore, in normal times, a more nuanced approach to policy communication will likely be warranted. I see forward guidance typically being of a more qualitative nature, highlighting the key economic factors that affect future policy actions. Of course, if we again find ourselves in a situation where conventional policy has been fully utilized, then we will have the ability to return to more explicit forward policy guidance to provide additional monetary stimulus.

We should, however, only resort to asset purchases as a policy tool in special circumstances, such as when the federal funds rate is near zero and we have fully utilized forward policy guidance. Despite all that we’ve learned, the effects of asset purchases are much less well understood and are much more uncertain and harder to predict than for conventional monetary policy. Indeed, the recent outsize movements in bond rates in response to Fed communications about our current asset purchase program illustrate the difficulty in gauging the effects of asset purchases. Moreover, given our limited experience, we can’t be sure of all their consequences, which may play out over many years. When the federal funds rate was at zero and we were still facing a severe recession, it was the right call to turn to asset purchases. But, once the federal funds rate is back to a more normal level, we should relegate asset purchases to a backup role, employing it only when conventional policy and forward guidance fall short.

Former Federal Reserve Chairman Alan Greenspan said in an interview that taking bold action as a central bank looks easier than it is. Central banks are creatures of legislatures, which can be suspicious of extraordinary actions, and financial markets can react in unexpected ways, he said.

Greenspan said there is an unspoken consensus about keeping in the bounds of orthodox policy that is difficult for any central banker to violate.

“If we are right, but the consensus is wrong, we are tolerated,” Greenspan said. “If we are wrong, and the consensus is right, we get pilloried. So there is an acute bias to staying with short-term policy and that is what limits the range of action.”

As reported by Bloomberg News.

This analysis highlights three important insights for monetary policy under uncertainty. First, even in the presence of considerable uncertainty about the effects of monetary policy, the optimal policy nevertheless responds strongly to shocks: uncertainty does not imply inaction. Indeed, in the estimated model, the optimal conventional and unconventional policy responses in the current situation are quite strong, just not as strong as would be called for absent uncertainty. Second, one cannot simply look at point forecasts and judge whether policy is optimal or not. One needs to evaluate policy in the context of the distribution of forecasts that accounts for uncertainty. Indeed, once one recognizes uncertainty, some moderation in monetary policy may well be optimal. Third, in the context of multiple policy instruments, the optimal strategy is to rely on the instrument with the least uncertainty and use other, more uncertain instruments, only when the least uncertain instrument is employed to its fullest extent possible.

Federal Reserve Bank of Boston President Eric Rosengren said the central bank could still enlarge its $85 billion monthly purchases of bonds if policy makers are not making progress toward their twin goals of stable prices and full employment. “I think there is the capacity to enlarge it if that were to become necessary,” Rosengren, 55, said in a telephone interview with Bloomberg News... “We’re partly calibrating this on trying to get the appropriate amount of stimulus without creating market functioning problems,” he said. “Given the risks of market functioning problems I think we’ve appropriately calibrated it at this time, but if it became necessary to do more I think we have some capacity to do that.”