[The Fed] “opened the floodgates” and “it worked,” the regional bank chief, who votes on monetary policy this year, said during a speech today in Dallas. “We re- liquefied the economy. In my opinion, we might have done too much."

I really want to take away the punch bowl before the room gets drunk, because this punch is, I think, a little bit spiked.  I’m not for tight monetary policy, I’m for non-zero monetary policy.

The entire FOMC knows the history and the ruinous fate that is meted out to countries whose central banks take to regularly monetizing government debt. Barring some unexpected shock to the economy or financial system, I think we are pushing the envelope with the current round of Treasury purchases. I would be very wary of expanding our balance sheet further; indeed, given current economic and financial conditions, it is hard for me to envision a scenario where I would not use my voting position this year to formally dissent should the FOMC recommend another tranche of monetary accommodation. And I expect I will be at the forefront of the effort to trim back our Treasury holdings and tighten policy at the earliest sign that inflationary pressures are moving beyond the commodity markets and into the general price stream. I am a veteran of the Carter administration and know how easily prices can spin out of control and how cruelly markets can exact their revenge. I would not want to relive that experience.

The entire FOMC knows the history and the ruinous fate that is meted out to countries whose central banks take to regularly monetizing government debt. Barring some unexpected shock to the economy or financial system, I think we have reached our limit. I would be wary of further expanding our balance sheet

[I]n a 2006 speech about the historic use of monetary aggregates in setting Federal Reserve policy, Chairman Bernanke pointed out that, "in practice, the difficulty has been that, in the United States, deregulation, financial innovation, and other factors have led to recurrent instability in the relationships between various monetary aggregates and other nominal variables." Still, my colleagues and I will be monitoring a wide range of financial and economic developments very closely -- including the growth of the money supply, inflation, and many other financial and nonfinancial variables -- and, based on a full assessment of those developments, the FOMC will withdraw monetary accommodation at the appropriate time. My view is that the elevated reserve balances would be inflationary only if they prevented the FOMC from effectively removing monetary accommodation by raising interest rates when the time comes to remove such accommodation, and I am convinced that that will not be the case.

In essence, the Federal Open Market Committee has maintained an emergency monetary policy stance in a recovering economy and has continued to ease into the recovery. I believe these actions risk creating a new set of imbalances, or bubbles. Importantly, such actions as they continue are demanding the saving public and those on fixed incomes subsidize the borrowing public.

Monetary policy can surely have great influence--most notably by establishing stable prices and appropriate financial conditions--on the real economy. By my way of thinking, the risk-reward ratio for Fed action peaks in times of crisis when it has a full toolbox and markets are functioning poorly. But when non-traditional tools are needed to loosen policy and markets are functioning more or less normally--even with output and employment below trend--the risk-reward ratio for policy action is decidedly less favorable. In my view, these risks increase with the size of the Federal Reserve's balance sheet. As a result, we cannot and should not be as aggressive as conventional policy rules--cultivated in more benign environments--might judge appropriate.

And overseas--as a consequence of more-expansive U.S. monetary policy and distortions in the international monetary system--we see an increasing tendency by policymakers to intervene in currency markets, administer unilateral measures, institute ad hoc capital controls, and resort to protectionist policies. Extraordinary measures tend to beget extraordinary countermeasures. Second-order effects can have first-order consequences. Heightened tensions in currency and capital markets could result in a more protracted and difficult global recovery. These, too, are developments that the FOMC must monitor carefully.

These rare occasions of liquidity traps are very different from typical economic recessions. Consequently, they require a unique monetary policy response. Economic theory tells us that in such circumstances monetary policy should aim to lower the real, or inflation-adjusted, rate of interest by temporarily allowing inflation to rise above its long-run path. My preferred way of doing so is to implement an approach called price-level targeting. Simply stated, under this approach, the central bank strives to hit a particular price-level path within a reasonable period of time. For example, if the rate of change of the price-path is 2 percent and inflation has been under-running the path for some time, monetary policy would strive to “catch-up” so that inflation would be higher than the inflation target for a time until the path was regained. This higher inflation rate would decrease the real interest rate, raising the opportunity cost of holding money. This would provide an incentive for banks and corporations to release funds for investment, and in the process spur job creation.

In my opinion, such a strategy is entirely appropriate.

[T]he current circumstances are really extraordinary. It seems to me if we could somehow get lower real interest rates so that the amount of excess savings that is taking place relative to investment needs is lowered, that would be one channel for stimulating the economy. That could be done through communication. I take our price stability mandate to be 2% inflation. We’re not at 2%. I foresee 2012 inflation as 1%. If we could indicate to the public that we want inflation to increase toward that price stability goal, that would serve to lower real interest rates given that short-term nominal interest rates are close to zero. Thinking about the fact that we’re running below our inflation objective and what it might mean to make up some part of that somewhere along the line, that would also give rise to lower real interest rates. Convincing the public that this is what we intend to do, that could be a useful tool.

Question:  New York Fed President William Dudley talked about making up lost ground on inflation later. You support that?

Evans: That is a potentially useful policy tool at this point and I definitely think we should study that more. That comes out of the literature.

In my view, if policymakers insist on waiting until the level of real activity has plainly and substantially returned to normal--and the economy has returned to self-sustaining trend growth--they will almost certainly have waited too long. A complication is the large volume of banking system reserves created by the nontraditional policy responses. There is a risk, of much debated magnitude, that the unusually high level of reserves, along with substantial liquid assets of the banking system, could fuel an unanticipated, excessive surge in lending. Predicting the conversion of excess reserves into credit is more difficult to judge due to the changes in the credit channel.

I am sympathetic to the view that policy-makers should consider intervention in certain circumstances. That may simply be by speaking against the practices ... as opposed to taking action with interest rates.

As reported by Reuters.

[W]hile one can argue that by agreeing to purchase up to $300 billion in long-term U.S. Treasuries, the FOMC provided a needed short-term tonic to private credit markets, we dare not come to be viewed as a handmaiden to the Treasury. By loosening the anchor we have established for long-term inflation expectations, we could create the perception that monetary policy is subject to political imperatives, doing lasting damage to our ability to maintain price stability and restore full employment. I believe we have come as close as we dare to the line between acceptable and unacceptable risk in this regard, and do not personally wish for us to expand or extend our purchases of Treasuries beyond the cumulative $300 billion planned by this fall.

I expect to see further deterioration in some areas, notably job market conditions, before our policies gain full traction. Weak economic news by itself would not imply that we have misjudged the size of our latest actions. In my view, it would take a significant deterioration relative to our outlook for me to view our current policies as inadequate.

[T]here is still a lot we don't know about the magnitude and duration of the effects of these policies {Fed asset purchases}. Our standard monetary policy models do not incorporate financial frictions that lead to asset purchases having real effects. We lack both the data and theory to provide strong guidance on these policies. Truly, we are sailing in uncharted waters, marking our maps with every bit of information along the way.