Charles Plosser

Speaking to journalists at an educational seminar, Plosser said "almost anyone" can predict a low headline consumer price index number because of the recent oil price slide. Oil prices, however, are volatile, he said, and "it would be dangerous to interpret low inflation numbers" as a lasting trend or a predictor of Fed policy.

 "I wouldn't be so confident" that low inflation for September means "the Fed was right" when it left the benchmark interest rate unchanged at its last meeting, he said.

From a DJ Newswires report

[T]he outlook for inflation depends on why you think inflation has trended up in the last two years. I see two inflation scenarios as being plausible and each has different implications for monetary policy. In the first scenario, inflation is elevated mainly due to transitory factors – like the pass-through of higher oil prices.  If oil prices stabilize, we’d expect to see core inflation fall…

In the other scenario, stimulative monetary policy during the last five years has been a major contributor to the rise in core inflation. In this case, we would not expect to see a deceleration in core inflation until monetary policy has firmed enough to take out the cumulative effects of the accommodation…  Thus, to my mind, there remains some risk that policy is not yet firm enough to ensure a return to price stability over a reasonable time horizon.

To begin, the Federal Reserve is charged by Congress with conducting monetary policy “so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” Lofty and desirable goals all, yet most economists, myself included, agree that focusing on achieving one of them — stable prices — is the most effective way monetary policy can support the other two.

A few minutes ago I made the point that monetary policy cannot influence the economy’s growth or employment potential over the long run. The fact is that economists have had a very difficult time identifying any reliable and exploitable link between monetary policy actions and real output or employment in the short run either. Policymakers have neither the knowledge nor the tools to manage aggregate demand with the timing and precision necessary to neutralize the impact of unexpected shocks on output or employment.

Nonetheless, it is the economy’s best interest for policy to respond to conditions in a manner that is consistent with the goal of price stability. So, for example, if stronger productivity growth enables the economy to sustain higher output growth, then the market will demand a higher level of interest rates…

…Now, I recognize that the policy approach I am advocating here is difficult to implement. We often don’t observe economic shocks in a timely way, nor are we able to precisely measure the level of interest rates the economy is seeking in response to such shocks. Consequently, monetary policy should not be overly sensitive to short-run fluctuations. Thus, keen judgment is called for, and a little luck doesn’t hurt either.

But I believe the principle behind the approach is sound. Indeed, it is simply an elaboration of my first principle: the central bank should always set interest rates consistent with the goal of maintaining long-run price stability so as to foster maximum economic growth and employment. Moreover, trying to use monetary policy to stabilize output and employment in the short run — can actually do more harm than good.  A look back at the 1970s underscores the point quite dramatically. When the economy was hit with a series of oil price shocks, the Fed responded with stimulative policies intended to maintain output and employment growth. These policies largely failed, generating excessive inflation even as the unemployment rate rose and the economy weakened. The Fed was relying on a short-run relationship between economic activity and inflation that is simply not reliable.

This leads me to my first principle: price stability is and should be the primary focus of monetary policy. I think almost every economist would agree that sustained inflation is ultimately a monetary phenomenon, and, of course, the Fed is the monetary authority in the United States.

The robust job market is reinforced by the data on wages. September and October saw substantial increases in real average hourly earnings. Evidence of this wage trend has been reinforced in my conversations with many business leaders who indicate that hiring qualified people remains one of their primary challenges. Moreover, this tightness in the labor market exists for both skilled and unskilled workers.

Up until July, most economists would have said that the rate was somewhere close to 3.5 percent... [However], the commonsense estimate of trend growth has now been lowered slightly. My own view is that trend growth is closer to 3 percent than 3.5 percent. Some even claim that trend growth is as low as 2.8 percent. I don’t think it is useful to quibble over two-tenths of a percentage point, since our ability to measure productivity is so fraught with problems. Nevertheless, almost everyone agrees that estimates of trend growth are now lower.

So far, the decline in the housing sector has had very limited consequences for other sectors, and I think the spillover effects of the housing downturn will be modest for several reasons.
 
First, the housing boom we experienced over the past few years was clearly unprecedented, and I think most people saw it as unsustainable. A second reason that I think the spillover impact of the slowdown in housing will be modest is that the modest declines in house prices are largely being offset by a strong stock market and strong income growth. Thus, household balance sheets are still healthy...

A second reason that I think the spillover impact of the slowdown in housing will be modest is that the modest declines in house prices are largely being offset by a strong stock market and strong income growth. Thus, household balance sheets are still healthy.

Finally, despite the increase in the fed funds rate, mortgage rates remain at relatively low levels and are lower than they were in 1999 or early 2000 by about 2 percentage points. What’s more, as mortgage rates have begun to move up from their historical lows, the percentage of people moving to long-term fixed rate loans has been rising.

While I am fairly optimistic that the fundamentals remain sound for continued economic expansion, I am not as sanguine about the prospects for inflation.

...So we need to remain vigilant and recognize that maintaining the current stance of policy, or even firming further, may be in the best interests of the economy’s long-run performance.

He declined to specify his preferred {inflation} range. ``I'm kind of deferring making a public stand on that until I think through some more things,'' Plosser said.

As reported by Bloomberg News

"It's very dangerous to focus in on one number,'' Plosser told reporters during a conference hosted by the Philadelphia Fed on economic growth and development today. ``You have to focus on context and not allow yourself to get hung up on one particular number.''

 As reported by Bloomberg News

I expect real GDP to grow by about 3 percent, which I estimate to be its underlying trend rate. That kind of growth should hold the unemployment rate to just below 5 percent. The outlook for inflation is more uncertain. Inflation stopped accelerating in the last few months, but whether it will continue to recede in the coming year is not yet clear. Additional monetary policy action may be needed to keep us moving along the path to price stability. 

 It is noteworthy that we saw a significant reduction in the trade deficit in the fourth quarter of 2006. Exports grew at a very robust 8.4 percent pace, while imports expanded by just 1.2 percent during the second half of the year. This shift in the direction of net exports has been driven primarily by two factors. First is the strong economic growth of our trading partners. Europe and Japan have been experiencing stronger than expected growth, and other nations such as China have been growing very rapidly. This growth in the world economy boosts demand for our exports. Second, the recent declines in the value of the dollar have made our exports cheaper on the world market and at the same time made imports more expensive here in the U.S. While there is no guarantee these trends will carry over into 2007, the signs are encouraging.

[T]he recovery path of the housing market is a major source of uncertainty in forecasters’ outlook for the 2007 economy. It is a source of uncertainty for me as well. But I think both the economic fundamentals and the data we have seen thus far point to gradual improvement in the housing sector over the course of 2007.  

We often hear the assertion that rapid growth in wages is an important source of inflationary pressures. I do not subscribe to this view. As an empirical matter, wage growth is not a very useful predictor of future inflation. If anything, it seems to work the other way: inflation is a useful predictor of future wage growth.

Perhaps more important in the current environment, wages tend to rise with labor productivity. Productivity growth in the U.S. has shifted up over the past decade or so, and as long as that continues, we should expect to see a pattern of persistently higher wage increases. The important point is that increases in wages matched by productivity gains are not indicative of any inflationary pressure.

It is a truism in economics that the primary source of persistent inflation is monetary policy, and clearly monetary policy was accommodative for the period from 2001 through 2005. It is an open question whether our current monetary policy is sufficiently restrictive to return the economy to price stability over a reasonable horizon.

Although the Fed is much more transparent than at any time in its history, it is arguably less transparent than a number of other central banks.  Many central banks use an inflation target as a way to communicate policy objectives and report more extensive or frequent forecasts of economic activity and inflation to the public.  These reports are done in a number of different ways, and it is not clear if any particular method dominates the other.

As you may well be aware, the FOMC is currently studying ways to further improve its communications. It is too early, however, to say precisely what the results of that inquiry will be.

 

I anticipate that the yield curve is likely to be flatter, on average, than at comparable points in past business cycles. This is not to say that the yield curve is going to be inverted all the time, but, on average, I believe the curve will be flatter. My case for a flatter yield curve is based on two premises: first, inflation and inflation expectations are likely to be lower and more stable, and hence, the inflation premium will be smaller than in the past; and second, inflation and the real economy are likely to be less volatile, so the risk premium will be smaller.

This flattening of the yield curve is happening not only in the United States; it is, in fact, a global phenomenon. There has been significant flattening or inversion of the yield curve in the United Kingdom, Canada, and Japan, just to name a few.

This is not surprising once we realize that the Great Moderation and the decrease in inflation expectations are also global phenomena. Since the 1980s, the median inflation rate for advanced economies has declined from 7 percent to 2 percent and the volatility of inflation has declined as well. Over the same period, the median inflation rate has fallen from 9 percent to 4 percent in emerging markets.

So I would suggest that, going forward, as you think about the kind of environment you are going to be in, you may want to anticipate a world where, on average, the spread between short-term rates and long-term rates is likely to be smaller than it has been in some recent periods.

"Consumption growth is strong," Plosser said following a speech at the University of Delaware Tuesday night.  "Employment growth is strong.  Business investment is weaker than we thought."

" The economy is not as strong as we thought it was two months ago. Inflation is higher than we thought it was going to be two months ago."

"What do you do? Your guess is as good as mine."

From the audience Q&A, as reported by Dow Jones News

For certain, the current Federal Reserve is the most open and transparent in history. We announce policy moves and issue policy statements. Further, the minutes of FOMC meetings are released on a timely basis so that the public can get a better sense of the range of views on the FOMC.

Although the Fed is much more transparent than at any time in its history, it is arguably less transparent than a number of other central banks. As you may well be aware, the FOMC is currently studying ways to further improve its communications. It is too early, however, to say precisely what the results of that inquiry will be. Suffice it to say that there is a realization in monetary policy-making circles, gained through recent advances in monetary theory and the experience of the last 30 years, that maintaining credibility for low inflation is an important aspect of good monetary policy.

Central bankers have one instrument (the policy rate) and changes in that instrument are likely to affect other assets, not just the one whose price is rising rapidly. In the U.S., house prices and stock prices do not necessarily move in tandem. Yet, preemptively raising the fed funds rate to slow a rise in house prices may affect the stock market and other assets, not just the housing market. By focusing excessive attention on one sector or asset, the law of unintended consequences may raise its ugly head, resulting in more economic harm than good.

Excessive attention to the price behavior of a particular asset or asset class sends confusing and potentially misleading messages to the public. Will the public come to expect the central bank to implicitly place a ceiling on rates of return on certain assets, to the exclusion of its other stated goals? Undermining the credibility of the central bank’s commitment to price stability would complicate and raise the costs of achieving that goal. Hence, I view it as unwise to single out the price of houses, or any other item, for special consideration in conducting monetary policy.

In the U.S., the recent reversal of the boom in housing activity and house prices has contributed to a slowdown in economic growth. But the consequences of the declines in housing activity and house prices, in my view, have so far not derailed the prospect that economic growth will return toward trend at the end of 2007 and in 2008.

Data on new orders and shipments of manufactured goods have shown modest improvement in recent months, suggesting a bounce back in manufacturing and business investment in the second quarter.

"If I started to see some of the spillovers occur in some of the prime mortgages, I’d get more nervous...You’d start to look for higher delinquency rates on auto loans and credit card loans and they haven’t materialized yet."

"From the Fed’s point of view, the real issue is not to stop or contain adjustments in markets, our prime concern needs to be whether there are systemic effects of what’s going on… that create more aggregate type of effects."

He said in the past, slumping housing markets had broader consequences because they led to impaired loans at banks, which then reined in lending, creating a "credit crunch." But in the last 10 to 20 years, financial innovation has enabled banks to distribute much of that risk through the financial system, he said.

"Does that say nothing bad can happen? Of course not. But it means I’m a little more sanguine that that whole view of a credit crunch is probably not as applicable now as it might have been 10 or 20 years ago…. Banks in this district are pretty healthy…Their biggest complaint is not housing mortgage defaults and credit crunch, it’s the yield curve. They’ve got money to lend."

As reported by the Wall Street Journal

Mr. Plosser said some of the decline in core inflation — which excludes food and energy — during the spring, to 1.9% by the Fed’s preferred measure, was "transitory." Nonetheless, he said, “I can’t see core in the latter half of 2007 being much more than a little over 2%."

As reported by the Wall Street Journal

He also said he views trend growth in the economy as “close to 3%, maybe a little below.” He said he last lowered that view last summer when government revisions showed the government grew more slowly in prior years than previously thought.

As reported by the Wall Street Journal

A change in monetary policy would be required if the outlook for the economy changes in a way that is inconsistent with the Fed’s goals of price stability and maximum sustainable economic growth. Certainly, standing here today, it is obvious that tighter credit conditions and disruptions in financial markets have increased the uncertainty surrounding our forecasts of the economy. The FOMC continues to monitor incoming data and other economic information for signs that these disruptions are having a broader impact on the economy. In my view, it will be very important to assess such information in light of the Fed’s commitment to achieving its long-run goals of price stability and sustainable economic growth.

Since 2003 the discount rate on primary credit has been above the Fed’s target for the federal funds rate. Reserve Banks lend freely at this higher rate to healthy banks that pledge acceptable collateral, basically on a “no-questions-asked” basis. Virtually all assets held by banks are eligible for use as collateral. What’s more, banks are not required to exhaust alternative sources of funds before coming to the discount window, and banks can request a discount window loan at any time of the day. In addition – and very importantly at times of financial market stress – banks are able to relend the funds to other banks or to other parties.

Thus, the Fed does not seek to remove volatility from the financial markets or to determine the price of any particular asset; our goal is to help the financial markets function in an orderly manner. I agree with Chairman Bernanke that we should not seek to protect financial market participants, either individuals or firms, from the consequences of their financial choices.

Fortunately, legislative and regulatory changes in the U.S. over the past several decades have allowed banks and other financial firms to diversify their portfolios of assets and their geographic boundaries. Institutions that make mortgage loans no longer are limited to taking deposits within limited geographic areas. They no longer are restricted as to what interest rate they can pay on those deposits. And they no longer are prevented from making other types of loans. In addition, financial innovations, such as asset securitization, have allowed the spreading of risks in the financial system. This means that today banks and many other financial institutions are much better diversified than during previous housing cycles. Thus, both deregulation of the financial system and innovations in financial products have lessened the risk of asset price declines triggering substantial adverse effects in the financial sector. 

The U.S. economy has proven to be very resilient to all sorts of shocks over the past several decades. In part this reflects the fact that not all sectors of the economy move together, and a decline in one sector does not always imply major problems in the economy as a whole. The economy withstood Hurricane Katrina, oil shocks, and 9/11 with remarkable resiliency.

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.

We want to be careful not to overweight one piece of information.

Referring to the weak August 2007 payroll data in an interview following his speech, as reported by Bloomberg News.

We will also have to remain vigilant on the inflation front. The reduction in the funds rate runs the risk of higher inflation and expected inflation in the future. While the inflationary signs this summer have been encouraging, I do not think we are in a position to be sanguine. If inflation begins to creep up or expectations of future inflation rise in the coming months – which is a risk given our decision to cut rates – the outlook will be affected and policy may have to be adjusted.

It is important to understand that the economy is expected to grow more slowly in the coming months, despite last week’s decision to reduce rates. Therefore, I will not be surprised to see weaker statistics making headlines.    

The sustainable or long-run trend growth rate of the economy is an important benchmark in calibrating the stance of monetary policy. In general, economies that grow faster exhibit real, or inflation-adjusted, interest rates that are somewhat higher than those of slow-growing economies. Monetary policymakers must be cognizant of that fact in setting the target for the fed funds rate. Failure to do so would likely result in the creation of either too much or too little liquidity, leading to too much or too little inflation or perhaps even deflation.

The Federal Reserve’s goals for monetary policy, as established by Congress, are to seek price stability, maximum sustainable economic growth, and moderate long-term interest rates.

From my perspective, price stability is and should be the primary focus of monetary policy. Sustained inflation is ultimately a monetary phenomenon, and the Federal Reserve is our nation’s central bank and monetary authority. Thus achieving and maintaining a stable price level is uniquely the Fed’s responsibility. There is no other agency or policy arm of the government that can deliver on this goal. In addition, achieving price stability supports the other two goals.

In my view, the Federal Reserve has two related, but distinct, responsibilities. The first and primary responsibility is monetary policy, which involves ensuring price stability, which contributes to sustainable economic growth. The primary tool of monetary policy is the federal funds rate, and the FOMC meets about every six weeks to determine an appropriate target for the funds rate consistent with these longer-term goals. The Fed’s second responsibility involves promoting financial stability by ensuring that the payment system and financial system function effectively.

It is important to recognize that the Federal Reserve cannot resolve this price discovery problem. The markets will have to figure this out.  Arbitrarily lowering interest rates or providing liquidity to the market does not provide the answers the market seeks.  Indeed, in some circumstances, lowering interest rates may prolong the painful process of price discovery.

...

In the current environment, providing insurance through a reduction in the fed funds rate creates its own set of additional risks. It may exacerbate moral hazard problems as I suggested earlier.

I expect that overall real GDP will grow faster in the second half of 2008 as it returns to its longer-run trend of about 2-3/4 percent.

On the inflation front, the data since early spring have been encouraging. Inflation rates excluding food and energy have been stable, while headline measures have moved up and down with energy price fluctuations. Moreover, inflationary expectations have remained fairly well anchored. While I did not, and do not, take this as evidence that inflation is no longer a risk, it is encouraging.

...

We also cannot rule out the possibility that the Fed’s reduction in the fed funds rate target runs the risk of higher inflation and inflation expectations. While the inflationary signs in recent months have been encouraging, I do not think we are in a position to be sanguine. If inflation begins to creep up or expectations of future inflation rise in the coming months – which is a risk given the FOMC’s decision to cut interest rates – the outlook will be affected and policy may have to be adjusted.

November 27, as reported by Bloomberg News

``I will not be surprised to see weaker statistics making headlines,'' Plosser said today. ``Too often people seem to think that when a weak economic number is released, the Fed will respond to it immediately with a policy action.''

November 30, after more market-friendly guidance from Vice Chairman Kohn and Chairman Bernanke, as reported by Dow Jones:

In a press conference ahead of a Fed policy forum here, Plosser said the Fed will closely monitor economic data due out over the next two weeks to assess whether the economic outlook should be revised downward...

Plosser said the Fed will evaluate the new data and assess "whether the outlook should be revised downward again," and if so, what change in monetary policy might be appropriate.    "I'm just sort of cautiously waiting to see what kind of data is available at the time," he said.

Asked whether the Fed would consider other liquidity measures to stabilize financial markets, such as narrowing the spread in the discount rate, Plosser said "that's certainly something one could entertain."

Plosser acknowledged there was "perhaps a stigma" attached to banks borrowing from the Fed's discount window, which has limited borrowing.  But he said the act of cutting that rate in August itself had a positive effect on markets.

As reported by Dow Jones

I like the way we came out in the last statement, similar to the statement in September: an agnostic view of the balance of risks. I have some concerns about our use of this balance of risks language. It has served a purpose at times but can also put the committee in an awkward position. Markets often use our balance of risks to infer something about what they think the path of the funds rate is going to be and that is not I believe the best way to do business. I would like us to be more
explicit about how the evolution of the economy impacts our decisions, rather than signaling the path of the funds rate.

The circumstances have focused my attention on this language issue, particularly in the balance of risks and I suspect people are struggling right now with, `Okay, maybe we have to think through this a little more carefully than we had before.’ In the current circumstance it makes sense [not to state the balance of risks] and I’m thinking about what else can we say that might improve our communications.

WSJ: Your bank’s board asked for a quarter point cut in the discount rate before last week’s FOMC meeting. Was that to narrow the penalty over the federal funds rate, or for a parallel move with a presumed reduction in the federal funds rate?

Plosser: It was a little bit of both. A case could have been made for reducing the penalty rate. It was a complicated mixture of what the right strategy should be for the funds rate, the discount rate and the and the term auction facility.

The problem with the recent data, including the CPI and PPI, is that the price increases are becoming more broad-based. Thus it is becoming harder to view the increases as isolated relative price shocks that will dissipate over time. While not all the increases are big, they are showing up in more things. The more widespread are the price increases, the more it begins to suggest there are underlying inflationary pressures out there.

...It’s mostly nominal demand driven, whether it be nominal domestic demand or global demand. We’re getting conflicting signals on demand but it’s something we have to watch carefully. It may be evidence that monetary policy had been too easy.

Somebody asked me today was I open to rate cuts, further rate cuts in the future. Absolutely, I'm open to those.

From press Q&A session, as reported by Market News International

I don't think we've overshot yet. From press Q&A session, as reported by Market News International

My job is not to second guess the markets or even to think about letting the markets drive policy decisions. From audience Q&A session as reported by Market News International. 

The introduction of the TAF was aimed at addressing the Fed’s objectives for financial stability, not its objectives for monetary policy.

Going forward, we must be careful to distinguish when financial conditions call for Fed actions to help markets function effectively, such as we are now seeing with the Term Auction Facility, as opposed to situations when a change in the overall stance of monetary policy is called for.

I am still optimistic that the economy will improve appreciably by the third and fourth quarters of 2008, and that is when any monetary policy action today will begin to have noticeable effects. Overall real GDP growth will be faster in the second half of 2008 as the economy begins to return to its longer-run trend growth of about 2-3/4 percent. On a fourth-quarter to fourth-quarter basis, I expect that the economy will grow about 2.5 percent in 2008, close to its pace in 2007, and that it will be growing more consistently near its longer-term trend in 2009.

Consequently, we must remain vigilant on the inflation front and be prepared to act as necessary to avoid the risk of undermining public confidence in the central bank’s commitment to price stability.

I think the economy has slowed considerably. My own forecast for the first half of ’08 is a rather slow economy.  I think what’s happened recently is that the data that have come in in the last few weeks on the end of the 4th quarter of last year have suggested more weakness.  I think the challenge is going to be, going forward, is to thinking about what data comes in and how that’s affecting our forecast going forward. So I am certainly open to that [additional interest-rate cutting] and there is a lot of uncertainty right now about the economy.

Employment growth  has been strong and that supports consumer spending.  However, the combined weakness in wealth… that is both housing wealth and stock market wealth… and some softness in employment growth seem to be suggesting that the robustness of consumer spending going forward may not be as healthy as we thought it was just a few months ago. So that’s the source of concern, and whether that spending and employment growth will continue to support consumer spending going forward.

 I am more uncertain about the future path of the economy than I once was. But my forecast at this point does not include a recession.

Yesterday, Plosser said rate cuts have been ``necessary and appropriate'' in response to a weakening economy. He told reporters he was concerned reductions could lead to accelerating inflation. ``That is the price you can pay if you become too aggressive,'' he said.

As reported by Bloomberg News

Although the economy’s resilience to past shocks makes me cautious about making changes to my outlook based on just one or two pieces of economic news, the string of weaker than anticipated numbers released in late December and in January had a cumulative effect on my own assessment of the 2008 outlook. While I would not be very surprised if the economy bounces back more quickly than many forecasters are now projecting, I am now, nevertheless, anticipating a weaker first half of 2008 than I did in October. This downward revision to the economic outlook is what led me to conclude that a substantially lower level of interest rates was needed to support the process of returning the economy to its trend rate of growth. Consequently, I believe the recent reductions in the federal funds rate were a necessary and appropriate recognition of this changed outlook.

The FOMC’s reductions in the federal funds rate have been proactive in responding to evolving economic conditions that led to the deterioration in the outlook for economic growth. My inclination to alter monetary policy depends on whether the accumulation of evidence based on the data between now and our next meeting causes me to revise my forecast further.

Fortunately, so far inflation expectations have not changed very much. But they bear watching because there are some signs that they, too, are edging higher. These may be early warning signs of a weakening of our credibility, and we must be very careful to avoid that.

The ongoing housing correction and the volatility and uncertainty in the credit markets are significant near-term drags on the economy and I expect growth in the first half of the year to be quite weak, around 1 percent. As conditions in the housing and financial markets begin to stabilize, I expect growth to improve in the second half of the year and to move back to trend, which I estimate is around 2.7 percent, in 2009. Overall, I am now anticipating economic growth in 2008 of near 2 percent.  

Given the slowdown in economic growth this year, payroll employment will rise more slowly than last year and will remain below trend for much of the year before picking up in 2009. Slower job growth will also lead to an unemployment rate near 5-1/4 percent in 2008, after fluctuating between 4‑1/2 and 5 percent in 2007.  

The current economic environment does have some extraordinary features, namely the tremendous difficulties that are affecting the smooth working of capital markets. Some interest rate spreads remain high, and financial capital has taken serious hits at a number of institutions. Thus, I believe we are in a situation where monetary policy cannot be made by focusing solely on inflation and deviations of output from potential. The current turmoil in financial markets has already had a significant impact on the economy and has the potential to continue to restrain economic growth going forward

One important desirable feature of simple interest rate rules such as Taylor’s is – it is a rule. That is, it systematically describes the behavior of policy. The advantages of simple rules are many. First, they are transparent, and allow for simple and effective communication of policy decisions. The result is that policymakers can more easily be held accountable and it is easy for the public and financial market participants to form expectations about policy. Thus, relying on simple rules enhances the credibility of monetary policy and helps anchor expectations. Second, when rules are simple and transparent, the public’s expectations are easily aligned with the Fed’s intentions, which minimize policy surprises and the detrimental effects often caused by such surprises. Thus, I place significant importance on systematic behavior both as a prescription for good policy and in terms of my own policy deliberations.

....

The benefits of operating in an environment with the transparency afforded by simple rules is that it gives monetary policymakers the ability to anchor expectations and affords them the opportunity to temporarily deviate from the simple rules in extraordinary circumstances without eroding central bank credibility. We are now, perhaps, in a period of extraordinary circumstances and have deviated from the benchmarks suggested by simple rules. But such deviations should be temporary and limited and promptly reversed when conditions return to normal.

Once the genie is out of the bottle, it's hard to get it back in. We can't wait too long for inflation expectations to materialize; otherwise we'll get behind the curve.

From press Q&A  as reported by Market News International

The idea that monetary policy should be conducted in a systematic and predictable way is not new. One of the earliest, and most controversial, proposals was Milton Friedman’s famous k-percent money growth rule.2 Friedman argued that monetary policy was a major contributor to cyclical fluctuations. He argued that efforts by the central bank to “stabilize” or “fine-tune” the real economy were fraught with danger because we didn’t know enough about the short-run dynamics of monetary actions to reliably predict their effects on the real economy. As a result, monetary policy ended up being a source of real instability rather than a stabilizing influence.

In addition, Friedman correctly argued that sustained inflation was always a monetary phenomenon and that in a world of paper or fiat money, the central bank had the obligation to preserve money’s purchasing power so that markets would not be distorted by inflation. Price stability would therefore promote a more efficient allocation of resources. At the time, this view of the importance of price stability was controversial, but today it is widely accepted.

Thus, Friedman highlighted two central features of good monetary policy that are hallmarks of the rules that I will turn to shortly. First, he argued that monetary policy should be formulated in a way that stabilized the purchasing power of money. Second, he stressed monetary policy should not be used to “fine-tune” real economic activity because attempting to do so often introduced instability into the real economy instead of improving economic performance. His actual proposal was that the Federal Reserve should announce that the money supply would be allowed to grow at k-percent a year -- period. With k a suitably low number, such a policy rule would ensure that inflation would never become a problem and that monetary policy would cease to be an independent source of cyclical fluctuations.

The Friedman rule is simple and easy to communicate. It also gives a high degree of predictability to monetary policy. Had it been implemented, it surely would have prevented the double-digit inflation the U.S. economy suffered in the late 1970s, as well as much of the subsequent economic disruptions in the early 1980s that occurred as inflation was brought back down to acceptable levels.

Yet the rule has several shortcomings that have limited its appeal. Most important, many economists view money demand as volatile, so that a constant supply of money could lead to more variability in inflation, and perhaps output, than necessary. Thus, most economists believe that some sort of policy that responds to the state of the economy could perform better.

I'm sure there'll be some other instrument that the market chooses to challenge. This is part of what I've described in the past as the price discovery process ... I'm guessing it will still be bumpy for a while to come.

From press Q&A, as reported by Market News International

We are thinking of the forecasts for the real economy not where it is today.

From Q&A as reported by Market News International

There is no inherent conflict They do go together ... I don't think there is a fundamental trade-off. ... [But] while related, they need to be thought about separately.

As reported by Market News International, on whether there is a conflict between the Fed's monetary policy job and its role as lender of last resort, and on the relationship between monetary and policy and financial stability.

Inflation is a very real phenomenon out there. It is there. We have to protect our credibility.

From audience Q&A as reported by Reuters.

A less aggressive cut would have been more appropriate.

From Q&A as reported by Bloomberg News, referring to the March 18 0.75-point rate cut.

One important characteristic of simple rules is that they can be more easily explained to the public. That makes it easier for the public and for financial market participants to form expectations about policy. Simple rules could enhance the credibility of monetary policy, help anchor expectations, and better align the public’s expectations with the central bank’s intentions, which would minimize policy surprises and the detrimental effects often caused by such surprises.

If a central bank is to assume the responsibility of being a lender of last resort, it should clearly articulate its objectives in doing so. It should make credible that commitment and act in a way that is consistent with that commitment. It should clearly communicate its lending policies to the public. What’s more, the independence of the central bank’s decision making from short-term political interference is essential to sound policymaking in this arena as well.

Unfortunately, what the public has come to expect of monetary policy, and central banking more generally, has risen considerably over the years. Indeed, there seems to be a view that monetary policy is the solution to most, if not all, economic ills. Not only is this not true, it is a dangerous misconception and runs the risk of setting up expectations that monetary policy can achieve objectives it cannot attain. To ensure the credibility of monetary policy, we should never ask monetary policy to do more than it can do.    

[E]ducation is critical to the long-run well-being of our economy and everyone who participates in it. It enhances our productivity and raises living standards. It enables consumers and businesses to make more informed and thus better decisions and choices — improving the broader economy in the process. But the responsibility does not rest solely with government and policymakers, who clearly must do their part. It rests mostly on individuals taking the responsibility to engage in life-long learning, making investments that will reward them handsomely.  

The U.S. and the world have greatly benefited from the expansion of trade and the improved economic conditions of developing countries. Growth in countries like China and India expand the markets for U.S. products while also offering the U.S. consumer a greater variety of products at lower costs. U.S. workers are, on average, among the most highly paid in the world. That can be sustained only if they remain among the most highly productive and highly skilled workers in the world. If the U.S. is to capitalize on the benefits of globalization, investing in a more educated and a more flexible workforce is essential.

The current economic environment underlines not just the importance of education but the need for improved economic and financial literacy. I am not the first, nor will I be the last, to make this plea. As an economist, I have a particular interest in economic and financial education. The events of the last decade, as well as our current economic and financial situation, have reinforced my sense of urgency in this regard.

I don't know whether we're going into a recession or not. ... It's clear that the U.S. economy has slowed dramatically. Whether we're in a recession technically or not -- it's like a definition. It's not very meaningful in a substantive sense.

From Q&A as reported by Market News International

The Fed has to be careful not to aggravate boom-bust cycles in monetary policy and the economy. We have to be somewhat cautious in our approach.

From press Q&A as reported by Market News International

If you have monetary policy that's too accommodative for too long, you generate inflationary pressures. Now what does too accommodative for too long mean in terms of actually time dimensions? It's a tougher question, people have different judgments. Monetary policy is currently accommodative. It's below the inflation rate

From press q&a, as reported by Market News International

Taking expected inflation into account, the level of the federal funds rate in real terms — what economists call the real rate of interest — is now negative. The last time the level of real interest rates was this low was in 2003-2004. But that was a different time with a different concern — deflation — and monetary policy was intentionally seeking to prevent prices from falling. Recently, we have had reason to be worried about rising inflation, not declining prices. Thus, comparing the nominal funds rate today with the stance of policy in 2003–2004 is like comparing apples and oranges.

In times of economic turbulence and uncertainty, forecasting becomes more difficult. That does not mean that you can stop forecasting, but it does mean that the uncertainty surrounding any forecast will be unusually large.

The current turmoil in financial markets has led to a tightening of credit that has affected the broader economy and has the potential to continue to restrain economic growth going forward. The risk that the financial turmoil could become more severe and further adversely affect the functioning of financial markets suggests to some that short-term interest rates need to be lower than they would be otherwise in order to provide a form of insurance. However, determining the appropriate extent of such extra accommodation is difficult to quantify.

In sum, the Federal Reserve has been acting on several fronts to address the recent turmoil in financial markets. Some of those actions are intended to stem the immediate problems. Others are intended to have longer-term benefits in helping to prevent future financial problems. But let me also add some words of caution about expecting more from the Fed than it has the ability to deliver. 

I think it is particularly important, for example, to recognize that monetary policy cannot solve all the problems the economy and financial system now face. It cannot solve the bad debt problems in the mortgage market. It cannot re-price the risks of securities backed by subprime loans. It cannot solve the problems faced by those financial firms at risk of being given lower ratings by rating agencies because some of their assets are now worth much less than previously thought. The markets will have to solve these problems, as indeed they will. But it will take some time. 

Unfortunately, the public perception of what monetary policy is capable of achieving seems to have risen considerably over the years. Indeed, there seems to be a view that monetary policy is the solution to most, if not all, economic ills. Not only is this not true, it is a dangerous misconception and runs the risk of setting up expectations that monetary policy can achieve objectives it cannot attain. To ensure the credibility of monetary policy, we should never ask monetary policy to do more than it can do.

The same could be said of the Fed’s lender of last resort function. All of the special lending facilities I described can be interpreted as part of that responsibility.  Traditionally, in times of financial crisis, a central bank is supposed to lend freely at a penalty rate against good collateral.  The experience of the past nine months suggests to me that we need to better understand how to apply this lender of last resort maxim in the context of today’s financial environment

A slowing economy is no guarantee of slowing inflation pressures.

From audience Q&A as reported by Reuters.

My concerns about inflation really tie in to this notion that, if you look at the broader base from which we see price increases, the more concerns I have that it's not these isolated price shocks, but that it's ... broad based.

From audience Q&A as reported by Reuters

The Fed has worked hard for 30 years to develop credibility with the public that we will deliver on low and stable inflation. That credibility is hard to earn, but easy to lose if you’re not careful.

These new facilities are Ben’s initiatives. He has been willing to take a fresh look at how the system works and press the boundaries in a thoughtful way.

If a central bank’s financial stabilization policy is designed simply to smooth out fluctuations in asset prices, it runs the risk of delaying necessary price adjustments and creating substantial inefficiencies in the marketplace. Financial stabilization policies, if misapplied, can effectively subsidize risk-taking by systemically important financial institutions. Such policies run the risk of increasing moral hazard and ultimately raise the risk of systemic instability rather than lowering it.

I do believe, however, that lender-of-last resort policies should take a lesson from what we have learned from the theory of monetary policy. In particular, policy should have important rule-like features. Specifying in advance the conditions or states of the world under which the central bank will lend is an essential first step. But policy must also make credible commitments to act in a systematic way consistent with explicit ex-ante guidelines. Discretion in lending practices runs the risk of exacerbating moral hazard and encouraging financial institutions to take excessive amounts of risk. Nevertheless, the issue of trading off financial stability and moral hazard will likely remain. 

"We need to take steps to insure that inflation does not get out of control," Plosser said in an interview on the CNBC television network. "We need to act preemptively."

"It is certainly clear that rates will have to rise. The question is when."

As reported by MarketWatch.

Keeping policy too accommodative for too long worsens our inflation problem. Inflation is already too high and inconsistent with our goal of — and responsibility to ensure — price stability. We will need to reverse course — the exact timing depends on how the economy evolves, but I anticipate the reversal will need to be started sooner rather than later. And I believe it will likely need to begin before either the labor market or the financial markets have completely turned around.
...

I am more optimistic about the outlook for 2009 and I expect we will see economic growth return to near its longer-term trend. But to prevent recent inflation from continuing to plague the economy and to avoid a rise in inflation expectations, I believe the current very accommodative stance of monetary policy will need to be reversed, and depending on how economic conditions evolve, I anticipate that this reversal will likely need to begin sooner rather than later.

As policymakers, we must remember that the path of inflation over some intermediate term is not independent of our policy decisions. While monetary policy cannot control relative price movements, sustained inflation is not something that is imposed on us. As policymakers we have a choice. If we remain overly accommodative in the face of these large relative price shocks to energy and other commodities, we will ensure that they will translate into more broad-based inflation that — once ingrained in expectations — will be very difficult to undo. I believe we must and will take the appropriate steps to ensure that does not happen.

My own outlook for the rest of this year is for continued sluggish growth and weakness in labor markets. My 2008 forecast is for GDP growth of around 1.7 percent, which is near the upper end of the range of FOMC participants’ projections...The recent failure of IndyMac and the problems of Fannie Mae and Freddie Mac are the most recent events that have shaken confidence in our financial institutions and markets. This has raised the uncertainty surrounding forecasts for the economy, including my own. As I have said before, and as these recent events demonstrate, the road to recovery is likely to be a bumpy one.

Nevertheless, I continue to be generally more optimistic about 2009. As the housing market gradually completes its necessary adjustments and investors and the public regain confidence in financial markets, economic growth should return to its long-run trend of about 2¾ percent next year and the unemployment rate will gradually decline to about 5¼ percent by the end of 2009.

My outlook is that headline personal consumption expenditure (PCE) inflation will remain near 4 percent in 2008, reflecting in part the increase in energy prices. I expect core PCE inflation to be around 2½ percent this year.

In 2009, as energy and other commodity prices level off, I expect both measures of inflation to be lower — in the 2 to 2¼ percent range by the end of next year — provided we set monetary policy appropriately to restrain inflation and keep inflation expectations well-anchored.

I want to make clear that the rise in inflation expectations in the 1970s was not caused by a wage-price spiral. That story has things backwards. The wage-price spiral was a consequence of the inflation and the unanchoring of expectations of inflation, not the other way around. And the unanchoring of inflation expectations was caused by the public’s loss of confidence in the Federal Reserve’s resolve to bring inflation back down. The credibility of the Fed’s promise to deliver price stability was lost.
...
I want to emphasize that what we have been seeing in the economy this past year, and in my own outlook going forward, is very different from the 1970s, because I see the Fed as committed to keeping inflation expectations well-anchored. I agree with a statement Fed Chairman Bernanke made in June that the Fed will strongly resist an erosion of longer-term inflation expectations, because an “unanchoring” of those expectations would be destabilizing for economic growth as well as inflation.

The Fed needs to be accountable for meeting its goals. Yet, we must take care to set reasonable expectations for what a central bank can achieve. We must recognize that over-promising can erode the credibility of a central bank's commitment to meet any of its goals, whether for monetary policy or financial stability.

Our preference is to allow market forces to handle any required restructuring in the financial services industry. However, in some cases this is not possible when the risks to financial stability are too high.

Regardless of our intentions, we need to recognize that by taking these actions, we create expectations about future interventions and who will have access to central bank lending. These expectations, in turn, can create moral hazard by influencing firms' risk management incentives and the types of financial contracts they write, which may ultimately increase the probability and severity of future financial crises.

Going forward, just as we should avoid setting unrealistic expectations for monetary policy, we should also avoid encouraging unrealistic expectations about what the Fed can do to combat financial instability. As I have argued, in times of financial crisis, a central bank should act as the lender of last resort by lending freely at a penalty rate against good collateral. Yet, recent experience suggests we need to clarify what the Fed can and cannot be expected to do in today's complex financial environment.

The events of the past year underscore the importance of carefully assessing the current financial regulatory structure. Regulatory reforms should aim to lower the chances of financial crisis in the first place, for example, by setting capital and liquidity standards that encourage firms to appropriately manage risk. We should consider market structures, clearing mechanisms, and resolution procedures that will reduce the systemic fallout from failures of financial firms. Indeed, it would be desirable to be in an environment where no firm was too big, or too interconnected, to fail.

...

I believe that the central bank should clearly state objectives and set boundaries for its lending that it can credibly commit to follow. Clarifying the criteria on which the central bank will intervene in markets or extend its credit facilities is not only essential but critical.

This expansion of the scope and scale of Fed lending may not have been so large had we had better resolution mechanisms to deal with such failing firms as Bear Stearns and AIG. And perhaps our lending would not have become so wide-ranging had there been better regulation or more resiliency in the payment and settlement systems, including more transparency about the markets for mortgage-backed securities and credit default swaps.
...

Some may think access to the Fed's lending facilities should be permanently expanded to include a wide range of financial institutions. I believe such expanded access to central bank credit would raise significant issues of moral hazard that would need to be addressed. And I have urged that we must continue to avoid compromising the Fed's independence — one of the great strengths of central banks.

Some people might think that expanding the Federal Reserve's regulatory and supervisory authority and giving it a sweeping mandate for financial stability would prevent the types of financial crises we have been experiencing this year. That is unrealistic.

...

Going forward our focus should be on better regulation, not necessarily more regulation. We need to focus on ways to strengthen our financial markets to make market discipline more effective at mitigating systemic risk. We should think about which financial markets are critical to the efficient functioning of the payment system rather than focusing on individual firms. Ideally, we need to determine which aspects of the financial system are critical and then make sure we have the market mechanisms, regulations, and supervision to ensure those sectors are resilient.

History tells us that financial crises invariably lead governments to adopt regulatory reforms intended to prevent similar crises in the future. Moreover, without careful analysis of the crisis, hasty reform may fail to address the problem and could impose unneeded and burdensome regulation. In general, I would argue against making major policy reforms in the "heat of battle" because doing so risks adopting policies that have unintended consequences. Such "quick fixes" may inadvertently hamper market competition or innovation and create conditions that may provide the foundation of the next crisis.

After a slight contraction in real GDP in the third quarter, I anticipate a somewhat sharper decline in the fourth quarter. This forecast will put real GDP growth for 2008 in the neighborhood of one-half of 1 percent (0.5 percent) (measured on a fourth-quarter-to-fourth-quarter basis). Growth in the first half of 2009 is also likely to be weak, but I expect improvement in the second half of the year. Even so, overall growth for 2009 (fourth-quarter-to-fourth-quarter) is likely to be below 2 percent. With relatively weak performance over the next several quarters, I expect the unemployment rate to rise above 7 percent in 2009 before it begins a gradual decline in the latter half of the year.

At a time of great concern about financial turmoil, we should keep in mind that instability in the general level of prices — whether inflation or deflation — is itself a significant source of financial instability. Federal Reserve officials, myself included, have spoken of the importance of keeping inflation expectations well anchored. When the public's inflation expectations begin to rise, that can contribute to higher actual inflation. It is therefore important for the Fed to maintain its credibility to keep inflation low and stable when large relative price movements in energy and food commodities led to large increases in the consumer price index.

During 2009 the housing sector should finally bottom and the actions taken by the Federal Reserve and the Treasury will gradually help financial markets return to some semblance of normalcy. So I expect the economy will start to pick up in the second half of next year with a gradual return to growth close to its trend of 2.7 percent in 2010 and 2011.

At a time of great concern about financial turmoil, we should keep in mind that instability in the general level of prices — whether inflation or deflation — is itself a significant source of financial instability. Federal Reserve officials, myself included, have spoken of the importance of keeping inflation expectations well anchored. When the public's inflation expectations begin to rise, that can contribute to higher actual inflation...

It is just as important that inflation expectations remain well anchored in the face of falling energy prices. Significant declines in gasoline and fuel oil prices, for instance, have recently led to declines in the consumer price index. This has prompted some commentators to suggest that the U.S. is facing a threat of sustained deflation, as we did in the Great Depression or as Japan faced for a decade. I do not believe this is a serious threat. Although the recent dramatic declines in energy prices have led to declines in the monthly headline CPI, it still increased 3.7 percent over the last 12 months while core CPI increased 2.3 percent. So we are not close to a sustained deflation. The recent declines are simply the mirror image of the increases we saw earlier in the year. As long as inflation expectations remain well anchored, these declines in energy prices are unlikely to lead to sustained deflation any more than their previous increases were likely to lead to sustained inflation.

To help anchor expectations, the Fed must credibly commit to preventing sustained deflation from becoming widely anticipated, just as it must prevent sustained inflation from becoming widely anticipated. I have long argued that monetary policy would benefit from establishing a clear and explicit inflation target as a way of signaling a commitment to keep inflation low and stable. Such an inflation target would be just as valuable in preventing expectations of deflation from materializing.

In general, we should avoid giving the Fed overly broad mandates, missions, or goals that conflict with the one goal that is uniquely the responsibility of a central bank: price stability. As I noted earlier, instability in the general level of prices — whether inflation or deflation — is itself a significant source of financial instability. Consequently, we must make sure that in trying to cure one source of financial instability, we do not sow the seeds of another.

Finally, as we revisit our central bank lending policies, we must not overlook the importance of central bank independence. The record shows that central bank independence leads to more effective monetary policy. That principle is vital to our lending policy as well.

To protect that independence, central bank lending policies should avoid straying into the realm of allocating credit across firms or sectors of the economy, which is best left to the marketplace. The perception that the Federal Reserve is in the business of allocating credit is sure to generate public pressures on the Fed from all sorts of interest groups. In my view, if the government must intervene in allocating credit, it should be the responsibility of the fiscal authority rather than the central bank. This division of labor, so to speak, will better ensure the Fed's ability and credibility to maintain price stability and promote economic growth.

Because of the financial crisis and the response by the Treasury and the Fed, the financial services industry is restructuring. When some normality returns to the markets — which eventually it surely will — some type of regulatory reform will be needed.

Some people may think that expanding the Federal Reserve's regulatory and supervisory authority would prevent the types of financial crises we have been experiencing this year. Yet, I believe it is important to be realistic about recognizing the limits of what a central bank can and should do. A modern financial system will never be immune to all financial stress. Setting up expectations that the Fed will surely be unable to fulfill would undermine our ability to achieve our primary monetary policy and financial stability objectives.

The exact outcome of this regulatory reform is unknown at this point. However, as we work on this reform, I believe we must strive to develop sound policies that obey the four principles I have discussed today — clear and feasible objectives; a commitment to systematic policies; transparency; and a healthy respect for the independence of the central bank.

As I have indicated, some of our new lending facilities were created to replace impaired or poorly functioning private credit markets. We must consider the possibility that our presence in these credit markets will deter private-sector participants from returning to and restoring these markets. To prevent our policies from having these perverse effects, we should consider a gradual increase in the cost of borrowing from these facilities to discourage their use and encourage other participants to return to these markets. This should be an important element of our exit strategy.

I am not particularly concerned about the possibility of persistent deflation. When oil and commodity prices stabilize, the negative rates of inflation we have seen in the CPI are likely to disappear. Moreover, I am confident that the FOMC is committed to maintaining price stability. Nonetheless, we must act to ensure that expectations of deflation do not take root, just as we must act to ensure that expectations of higher inflation do not emerge. The failure to maintain well-anchored inflation expectations can wreak havoc with the real economy, foster unnecessary volatility, and make it more difficult for the Fed to deliver on its dual mandate to keep the economy growing with maximum employment and price stability.

I and others have long proposed establishing an explicit inflation target as one way to signal the FOMC's commitment to price stability and help anchor expectations. Such a commitment not only helps prevent inflation expectations from rising to undesirable levels, but it can also help prevent expectations from falling to undesirable levels.

Despite its length, though, I don't expect this recession to necessarily rival the deep recession in the early 1980s in terms of unemployment. In the early 1980s, the unemployment rate rose above 10.5 percent. I do not expect the unemployment rate to stray into double digits during this recession. Yet, I also don't expect it to begin coming down soon. Keep in mind that unemployment is a lagging indicator. It will not begin to come down until after the economy is well on its way to recovery.

Fortunately, I believe there is a way out of this dilemma: the Fed should adopt an explicit inflation objective and publicly commit to achieving that objective over some intermediate horizon. To me, the exact number or price index for the objective is somewhat less important than the public commitment to a goal. Such a commitment would help anchor expectations more firmly and diminish concerns of persistent inflation or persistent deflation — not an inconsequential issue in the current environment.

In addition to announcing an inflation objective, we must also clearly communicate our policy strategy to the public so that they understand how the FOMC anticipates achieving that goal. There are different ways to accomplish this. For example, Taylor-like rules that involve adjusting the federal funds rate in response to deviations of inflation from target and shocks to output or economic growth have some advantages. Such simple rules can be useful guides for conducting systematic policy and can help effectively communicate to the public the conditional nature of policy choices.

The second step toward strengthening the credibility of our commitment to sound monetary policy is to clarify the criteria under which we choose to step in as a lender of last resort. We must spell out when we will intervene in markets or extend unusual credit to firms — and then we must be willing to stick to those criteria. Moreover, we also need to complement such clear commitment with a well-articulated exit strategy from such liquidity or credit programs.

Our lending programs were created for extraordinary times and involve significant intervention in the private markets, but they run contrary to a long-standing and sound Fed practice of trying to minimize the effect of its actions on the allocation of credit across market segments. In my view, such programs are not, and should not, be part of the normal operation of a central bank.

One suggestion that would promote a clearer distinction between monetary policy and fiscal policy and help to safeguard the Fed's independence would be for the Fed and Treasury to reach an agreement whereby the Treasury takes the non-Treasury assets and non-discount window loans from the Fed's balance sheet in exchange for Treasury securities. Such an accord would offer a number of benefits.⁴ First, it would transfer funding for the credit programs to the Treasury — which would issue Treasury securities to fund the programs — thus ensuring that credit policies that place taxpayer funds at risk are under the oversight of the fiscal authority. Second, it would return control of the Fed's balance sheet to the Fed, so that we can continue to conduct independent monetary policy. Going forward, an agreement with Treasury would also state that if the fiscal authority at some point wanted the central bank to engage in lending outside its normal operations and, importantly, should the Fed determine "unusual and exigent circumstances" warranted such action, then any accumulation of nontraditional assets by the Fed would be exchanged for government securities.

Eventually economic conditions will improve, demand for excess reserves will fall, and in order to maintain price stability, the Fed will have to begin withdrawing the extraordinarily large supply of liquidity with which it has flooded the market. Under normal operating procedures, this isn't a problem, as the Fed holdings are mainly short-term Treasuries, which can be liquidated to reduce reserves and increase interest rates.

To mitigate these risks, we must find a credible way to resolve these uncertainties and eliminate the need for ad hoc rescues by government agencies and the Fed in particular. One wrong-headed approach would be to erect a battery of new regulatory restrictions in an attempt to drive the probability of failure to zero. Such an approach would generate large supervisory costs, stifle innovation, and result in regulatory arbitrage as markets work to evade the regulations. This type of arbitrage was a contributor to the current financial crisis.

[A] reasonable resolution regime for nonbank financial institutions could easily be modeled on the FDIC's bridge-bank approach. Such a resolution procedure should address some of the shortcomings of existing bankruptcy law, which seeks to maximize the payoffs to the firm's creditors and makes no provisions for systemic considerations. We need a resolution mechanism that explicitly addresses ways to reduce financial disruptions and minimize the costs to taxpayers. As in the FDIC's bridge-bank authority, uninsured creditors could receive expedited payoffs based on historical recoveries, generally less than 100 percent, while shareholders of the failed institution would be wiped out.

My key concern in considering the Fed's future role in ensuring financial stability involves my fourth principle: how to ensure the Fed's independence to conduct monetary policy. I have already argued that the Fed should not have responsibility for funding or managing the resolution mechanism for failing institutions. Nor should its lending policies stray into the realm of allocating credit across firms or sectors of the economy. The perception that the Federal Reserve is in the business of allocating credit is sure to generate pressure on the Fed from all sorts of interest groups. In my view, if government must intervene in allocating credit, doing so should be the responsibility of the fiscal authority rather than the central bank.

[B]efore we set clear and explicit objectives for financial stability, we first must be clear about what we mean by financial stability. Policymakers cannot and should not try to prevent all types of financial instability. Indeed, the economy benefits when financial institutions and markets take on and manage risk. That means inevitably some firms will fail. As my friend the economist Allan Meltzer has said, "Capitalism without failure is like religion without sin. It doesn't work."  Our goal should not be to try to prevent every failure, but rather to reduce the systemic risks to the financial system that a failure may create.

Congress created the Federal Reserve System with independent regional Reserve Banks and a Board of Governors in Washington that provided checks and balances — checks and balances between centralization and decentralization, checks and balances between the public and private sectors, and check and balances between Wall Street and Main Street — all to ensure that policy decisions were balanced and independent.

Congress also wanted a central bank accountable to Congress, yet not subject to undue political influences. That is why Congress chose to make the Fed independent from the Treasury Department and the administration; why Fed Governors have 14-year terms; why the 12 Reserve Banks are structured more like banks than like government agencies; and why Reserve Bank employees, officers, and directors are generally restricted from engaging in political activities.

Thus, while forecasting in the current environment is tricky, many forecasters, myself included, expect the second quarter of this year to exhibit a less severe decline in real GDP. Yet, I remain relatively optimistic and expect positive but modest growth in the second half, making fourth-quarter to fourth-quarter real GDP growth only slightly negative for 2009.

I am also relatively optimistic about growth next year. In fact, since January, I have not changed my growth forecast for 2010 or 2011. I expect the recovery to gain traction in 2010, with growth picking up to about 3 percent and then settling down to its long-run steady state of about 2.7 percent in 2011.

The sharp rise in the unemployment rate in the first few months of 2009 and the steep declines in payroll employment have led me to revise upward my unemployment rate forecasts. I expect the unemployment rate to peak sometime early next year above 9 percent, before falling gradually.

I see greater risk of higher inflation over the intermediate to longer term.

I have several reasons for this view: First, monetary policy is extremely accommodative. Second…my forecast relies more on forward-looking expectations of inflation compared to the forecasts of many economic models, in which backward-looking elements are more heavily weighted. This means that the very low levels of inflation resulting from the plunge in oil prices during the past year are not given as much weight in assessing whether inflation will remain low in the future as in a model that depends less heavily on recent past inflation to determine inflation expectations. Third, I put less weight on output gaps or other measures of slack as predictors of inflation, which is consistent with both theory and empirical estimates from a variety of economic studies.⁴ And fourth, I am not convinced that the size of the output gap is nearly as big as suggested by others for reasons I just discussed.⁵

[T]he economy's potential output may be lower than previously estimated for some time. This means measures of the so-called output gap, the difference between the level of actual and potential output, will not be as high as they otherwise would be and may be volatile and hard to measure, especially since potential output is inherently unobservable.

...

I put less weight on output gaps or other measures of slack as predictors of inflation, which is consistent with both theory and empirical estimates from a variety of economic studies.⁴ ...I am not convinced that the size of the output gap is nearly as big as suggested by others for reasons I just discussed.⁵

These last two points seem particularly appropriate and consistent with work that demonstrates the pitfalls of depending too much on measures of the output gap, which empirical studies have shown are not reliably measured in real time.⁶ Indeed, one study found that ex post revisions of the output gap are of the same order of magnitude as the output gap itself — which means that a data revision could make an output gap disappear.⁷ Since it is particularly hard to measure the output gap near business cycle turning points, making policy decisions based on measures of such gaps becomes problematical.

We need to draw a bright line once again between monetary policy and fiscal policy. The recent crisis has muddied that separation considerably and we must restore it. The Fed must not be seen by the public or the Congress as a piggy bank that can substitute for difficult fiscal policy decisions.

When a nation's treasury or finance ministry and its central bank work too closely together, there is a clear risk that the government's spending will end up being financed by the central bank's power to create money and that the public will become confused as to their respective roles...Independence is essential to central bank success and the Federal Reserve's current governance and decentralized structure has been an important contributor to ensuring that independence.

I think we will probably have to begin raising rates sometime in the not-too-distant future...I also don't want to repeat the Great Inflation of the 1970s.

As reported by The Wall Street Journal and Dow Jones Newswires.

If we don’t execute an exit strategy carefully, we could be setting the fires for inflation down the road in the next year or two.

This mix of private and public governance makes the Federal Reserve System uniquely American. It provides a valuable form of checks and balances — between centralization and decentralization, between the public and private sectors, and between Wall Street, Washington, and Main Street — all to ensure that policy decisions are balanced and independent. I might add that the Fed receives no government appropriations from Congress.

While I see little risk of inflation in the near term, I do see greater risk of higher inflation in the intermediate to long term for several reasons. First, monetary policy is extremely accommodative. We have expanded the Fed's balance sheet to an unprecedented degree since last fall and have kept interest rates at historically low levels. Second, I put less weight than many other economists do on the idea that economic slack or low resource utilization is a reliable predictor of inflation.

Today, I often hear some forecasters argue that inflation will remain low in the coming years because the slack in the economy is not likely to disappear for some time. Yet, several empirical studies have shown that economic slack is difficult to measure with any accuracy. It is particularly hard to measure slack near the turning points in business cycles, so making policy decisions based on measures of such slack becomes problematic.

A credible inflation target would not only help prevent inflation expectations and actual inflation from rising to undesirable levels, but it would also help prevent expectations of deflation from materializing that could initiate an undesirable episode of falling prices.

Asked about record gold prices and the decline of the dollar, Plosser said "I think we don't want to entirely dismiss that... I do think from a policy standpoint that we need to be cognizant of what these asset markets are doing and.. better understand how they may or may not be giving us clues about what the future may hold."

Plosser, who is seen as one of the most "hawkish" Fed officials on inflation, reiterated he was "not worried about inflation in the near-term; my worries about inflation are in the intermediate to long-term."

Plosser told Market News the timing and pace of eventual policy tightening will depend on the economy.  "It's contingent on the path of the economy and of inflation ... It's hard to predict now what that may look like," he said.

"All the excess reserves in the banking system that are sitting there right now are not inflationary, but they could become inflationary if we're not careful," he said.

During the last three decades, many central banks around the world have adapted to advances in the science of monetary policy. We have learned much from the experiences of those central banks that were early adopters of these advances. One theme that has emerged from this mix of academic research and experience is the important role played by the public's and market participants' expectations regarding policy actions. Uncertainty regarding policymakers' goals and the actions they will take to achieve them can make it more difficult to achieve those goals. Moreover, this uncertainty introduces unnecessary volatility into economic outcomes.

During the last three decades, many central banks around the world have adapted to advances in the science of monetary policy. We have learned much from the experiences of those central banks that were early adopters of these advances. One theme that has emerged from this mix of academic research and experience is the important role played by the public's and market participants' expectations regarding policy actions. Uncertainty regarding policymakers' goals and the actions they will take to achieve them can make it more difficult to achieve those goals. Moreover, this uncertainty introduces unnecessary volatility into economic outcomes.

In my view, it is more important that central banks focus on some measure of inflation in conducting monetary policy and less important whether that measure is headline inflation or core inflation. Over time, the trends in headline inflation and core inflation in most countries tend to move together. Also, an average inflation rate over a two- or three-year period will be less subject to food price volatility than an average over a one-year period. Consequently, policymakers could choose either inflation measure in setting a medium-term policy goal. For me, the key issue is that central banks seek to achieve a relatively stable price level, rather than the measure they choose.

Good monetary policymakers, like good hockey players, must be forward-looking in their actions. Setting policy that is appropriate for where the economy is today, or has recently been, is not likely to deliver the kind of economic outcomes we desire. Anticipating where the economy is headed is important because monetary policy actions affect the economy with long and variable lags. The major impact of policy often comes only after several quarters, or sometimes several years.

I expect real GDP growth from fourth quarter to fourth quarter to be between 3 and 3½ percent this year and in 2011. These rates of growth are slightly above what I believe is the underlying trend growth rate of the economy of about 2¾ percent.

To promote a clearer distinction between monetary policy and fiscal policy and to help safeguard the Fed's independence, I advocate that we implement monetary policy using a portfolio that contains only Treasury securities, preferably concentrated in bills and short-term coupon bonds. Like Ulysses and the Sirens, the Fed could help preserve its independence by limiting the scope of its ability to engage in activities that blur the boundary lines between monetary and fiscal policy. Thus, as the economic recovery gains strength and monetary policy begins to normalize, I would favor our beginning to sell some of the agency mortgage-backed securities from our portfolio rather than relying only on redemptions of these assets. Doing so would help extricate the Fed from the realm of fiscal policy and housing finance. It will take some time for the Fed's portfolio to return to its pre-crisis composition, but we should begin taking steps in that direction sooner rather than later.

I’ve never been a big fan of ‘extended period.’ I don’t like that language. I would rather have language that is more conditional on the state of the economy, and less upon some arbitrary time frame. At some point we’re going to have to get rid of it. We’ve had it for over a year now. Different people interpret it differently. We are certainly thinking hard about how would you extricate yourself form this language at some point. I’m not sure it’s the right language. That is why two or three statements ago we did have this language where we talked about interest rates could stay low as long as the economy was weak, unemployment was high, inflation was low and inflation expectations were contained. That’s a much better way to begin to communicate what matters.

WSJ:  On another issue, I would be a little bit uncomfortable restarting the Supplemental Financing Program [with the U.S. Treasury]. Treasury debt is going to hit the limit again next year, so the Treasury might be in a position where it might need to draw it down right as you are withdrawing reserves from the financial system.

Plosser:  I’d just as soon get rid of that tool. I don’t think we ought to be relying on the Treasury in that way. It gives them too much discretion over our monetary policy and our balance sheet. I’d just as soon not have it. But it hasn’t been high on anybody’s agenda.

It's important that our policy rule be robust enough to work in a variety of economic conditions or stages of the business cycle, that it perform well in a variety of economic models, and that it recognize that economic data are measured imprecisely and are subject to revision. These criteria lead me to support a rule based on deviations of inflation from the policymakers' inflation target and on the growth rate of output, rather than on the output gap commonly used in many variants of the well-known Taylor-rule.

It depends on a number of things. It’s not clear what we mean by normal. We’re in a different world than we were before the crisis. In particular we’re now paying interest rates on reserve. With interest on reserves we’re moving toward a desirable system which is a corridor system (with interest on excess reserves as the lower bound and discount rate as the upper bound). We’ve got to restrict the volume of excess reserves. We’ve got so many excess reserves floating around the system we could never get fed funds above the lower bound until we get reserves down.

There was this whirl of conversation that we were going to raise the discount rate again. I don’t see us getting greatly involved in that discussion until we have a better idea of how we want to think about our operating procedures.

In response to a question about how quickly the discount rate could be normalized.

I don’t think we’ve decided yet. There are different views on this. I’m not as reluctant to sell MBS partly because I think we need to get our balance sheet back to more Treasurys and less MBS. I’m not afraid of selling MBS before we raise interest rates. I think the concern that some people have is the potential impact that might have on mortgage rates directly. My view is that if we thought that during the crisis markets were not functioning right and that it made sense to target specific assets to try to control or reduce spreads of various kinds, that may have been relevant in a crisis when markets weren’t functioning. But that’s not true anymore. Markets are functioning pretty well right now. So the ability for us to target specific assets and the consequences they have for prices of those assets is a lot less. Given the market functioning, I don’t anticipate that selling MBS at a reasonable pace, that that’s going to have a tremendous impact on mortgage rates per se.

In response to a question about whether the Fed might start to sell MBS

My focus is building confidence that real growth is underway and sustainable. Because when that happens, when real growth picks up, if we don’t change policy in the face of that, then we are actually loosening policy. Because as real growth rates pick up, demand for loans is going to pick up, banks are going start converting their excess reserves into lending–which is not necessarily a bad thing, but they could do that very quickly and then all that liquidity starts flowing into the economy. That is the fuel for inflation.

Another risk to the forecast is the recent developments in Greece, where concerns over unsustainable fiscal deficits have led to downgrades of Greek sovereign debt and potential contagion to other countries with similar deficit problems, such as Portugal, Spain, and perhaps others. Renewed financial market turmoil could retard the recovery in the U.S., and we are following developments in Europe closely.

[A] provision in the Senate Banking Committee bill would restrict the Federal Reserve's supervisory authority to about 50 of the largest financial firms with $50 billion or more in assets. This would undermine the effort to end too big to fail, since the markets will likely interpret this provision as signaling that these firms are unique and will not be allowed to fail.

[I]t's true that things could happen that could change the pace of the exit strategy but I don't see them happening yet.  How the crisis in Europe develops will dictate how we respond.

My own view is that we should begin to sell some of our non-Treasury assets sooner rather than later. Despite recent volatility in markets due to fiscal deficit problems in Europe, financial markets are now functioning much better than they were during the height of the financial crisis, and I believe the Fed could begin to liquidate its positions gradually without market disruption.

Plosser told reporters he has been “uncomfortable with the ‘extended period’ language for some time.” The Federal Open Market Committee “has to be prepared to move when the time comes,” he says, and the “extended period” language should “not be perceived to stand in the way.”

“Even if the target was increased to 1 percent, policy would remain very accommodative,”

Let me first talk about market-based mechanisms as a form of prompt corrective action. I think that we have to acknowledge that heavy-handed regulation that focuses on what activities institutions can and cannot do runs the risk of firms devising ways of getting around the rules, forcing activities into the unregulated sector and creating risks elsewhere. Regulators can also find themselves behind the curve as financial markets evolve and innovation changes the way firms function. Discretionary supervision and regulation alone are not sufficient to prevent excessive risk-taking or prevent future crises. Thus, I think reform must seek ways to strengthen market discipline rather than seeking to override or replace markets in controlling risk-taking.

Talk of new efforts to stimulate the economy are premature right now... I don’t think the data have been sufficiently compelling one way or another.

I haven’t changed my forecast very much [recently.]  I’m waiting for some of the noisiness in the data to sort of clear up over the course of the rest of the summer and early into the fall.

 Having a single mandate for price stability, like the ECB’s, can make it easier for central banks to make credible policy commitments. Inflation targeting is another way to increase the credibility of monetary policy. Articulating an explicit inflation target and committing to keeping inflation near that target over some specified time period is a form of pre-commitment.

I have some concerns that holding securities with risky payoffs on the Fed’s balance sheet creates the potential for moral hazard. If market participants believe that the Fed is immune to the poor payoffs from these assets and the Fed’s plans for these assets is not clear, the economics of moral hazard suggest that the central bank may have incentives to take on excessive risks at the expense of taxpayers.

Paying IOR is another tool that has given greater discretion to the Fed, yet greater discretion is not without cost. A central bank may be motivated to pay IOR to overcome restrictions that hinder efficiency in financial markets. Yet, many overlook that paying IOR ties together the central bank’s balance sheet and the government’s budget constraint, since the interest is financed by government revenues.¹⁵ This may come at the cost of central bank independence.

Were deflationary expectations to materialize — and let me repeat, I do not see much risk of this — I would support appropriate steps to raise expectations of inflation, including, perhaps, aggressive asset purchases coupled with clear communication that our goal is to combat deflationary expectations. But for such a strategy to be successful, the public must believe that the Fed can and will act to combat those expectations. The Fed must be credible. Protecting that credibility is why, based on my current outlook, I do not support further asset purchases of any size at this time. As I said earlier, asset purchases in our current economic environment can do little if anything to speed up the return to full employment. But if the public believes that they can and is disappointed, it may have less confidence that the Fed will act to raise inflationary expectations if needed. Because I see little gain at this point, and some costs, I would prefer not to engage in further asset purchases at this time.

Instead of more regulation, we need better-designed regulation that recognizes incentives and tries to address moral hazard so that market discipline can work. Overly proscriptive regulation is counterproductive - it increases the incentives to evade it, which ultimately defeats it. Financial innovation spurred by the desire to evade regulation and relocating activities outside of regulation’s reach are not productive, but they are an expected outcome if regulations are not well designed. Market discipline is an essential part of our market-based economy, and regulation should be designed to enhance it, not thwart it.

This requires scaling back some of the safety net subsidies that have risen over the years and increasing capital requirements.

"Since I am less concerned about deflation risks than some of my colleagues...then I am less inclined to want to follow a policy that is highly concentrated on raising inflation," Plosser told reporters after giving a speech at the Union League of Philadelphia.  

Plosser, a longtime proponent of inflation targeting, added that his view might change if his inflation forecast did.
"There are risks to this strategy," Plosser said of the bond purchase idea.  "I am dubious that the benefits outweigh costs."

"The unemployment problem is a terrible problem," he said, "but it's less obvious to me that it's amenable to monetary policy solutions at this point."

From various press reports

Some even worry that the economy might fall into a deflationary trap. I am not one of them.

"Bubble, Bubble, Toil and Trouble: A Dangerous Brew for Monetary Policy"

 ...

Sound policymaking requires us to understand the limits of what we know. I doubt we could find enough agreement among policymakers or economists about the interpretation of asset-price movements to allow for stable, rule-based policymaking. In the absence of such a clearly stated rule, we risk uncertainty about central bank policy itself as well as its effect on the economy... Humility in policymaking requires that we respect the limits of our knowledge and not overreach, particularly when it involves over-riding market signals with policy actions.

Another challenge in addressing asset-price bubbles in practice is that contrary to many economic models, in reality there are many assets, not just one. And these assets have different characteristics. For example, equities are very different from homes. Misalignments or bubble-like behavior may appear in one asset class and not in others. But monetary policy is a blunt instrument. How would monetary policy go about pricking a bubble in technology stocks in 1998 and 1999 without wreaking havoc on investments underlying other asset classes?

...

Indeed, I believe that we are discussing the question of asset prices and monetary policy today, at least in part, because Fed policy during mid-2000s “went off track.” John Taylor has argued forcefully that the Fed kept interest rates too low for too long from 2003 to 2005. As an erstwhile member of the Shadow Open Market Committee, I stood in this very room in 2003 and 2004, expressing concerns that the fears of deflation were excessive and that policy was probably too accommodative. The error may not have been that policymakers failed to pay attention to the fast upward rise in asset prices, but that they deviated from a systematic approach to setting nominal interests.

I am still somewhat skeptical that we will see much of a stimulative effect from the new round of purchases. The Fed’s first purchase program worked to lower interest rates, although estimates vary quite a lot. Some studies suggest that the effect was 30 to 60 basis points. Others found a much smaller impact. Yet, these purchases were done at a time when financial markets were highly disrupted and asset risk premiums were extremely elevated. But markets are no longer disrupted, so we cannot expect the same effect this time. Even if we did, it is not clear to me that a further reduction in long-term interest rates will do much to speed up the reduction in the unemployment rate to more acceptable levels.

I am still somewhat skeptical that we will see much of a stimulative effect from the new round of purchases. The Fed’s first purchase program worked to lower interest rates, although estimates vary quite a lot. Some studies suggest that the effect was 30 to 60 basis points. Others found a much smaller impact. Yet, these purchases were done at a time when financial markets were highly disrupted and asset risk premiums were extremely elevated. But markets are no longer disrupted, so we cannot expect the same effect this time. Even if we did, it is not clear to me that a further reduction in long-term interest rates will do much to speed up the reduction in the unemployment rate to more acceptable levels.

Even with the best of intentions, if we don’t act aggressively and promptly, we may find ourselves behind the curve and at risk for substantial inflation. I think we need to bear in mind this future potential complication when considering further expansion of the Fed’s balance sheet.

“If the growth rate of the economy continues to strengthen and looks sustainable, then I am going to be looking for the Fed to react to that,” Plosser said today in an interview on Bloomberg Radio’s “The Hays Advantage,” with Kathleen Hays.   “That may be to cut back on the degree of accommodation in a gradual way. One way would be to begin stopping some of the purchases or slowing them down.”

Asked how he would have voted, Plosser said, “It would have been a close call. The stronger the economy gets, the more attention I am going to be paying” to whether to “begin reducing the amount of accommodation.”

...

Plosser, in an interview at the Philadelphia bank, forecast that the U.S. economy will expand 3 percent to 3.5 percent next year, with inflation accelerating to as much as 2 percent.
“The economy is still in the midst of a modest recovery,” Plosser said. “My confidence in the fact that it is sustainable is growing and has been over the course of the year. In a fundamental way, I think it is sustainable, but it is not going to go like gangbusters.”

If the economy begins to grow more quickly and the sustainability of this recovery continues to gain traction, then the purchase program will need to be reconsidered along with other aspects of our very accommodative policy stance. We are a year and a half into a recovery, although a modest one. The aggressiveness of our accommodative policy may soon backfire on us if we don’t begin to gradually reverse course. On the other hand, if serious risks of deflation or deflationary expectations emerge, then we would need to take that into account as we adjust our policy stance.

I wish we hadn't done [QE2], but that doesn't mean I want to stop it right now.

Well, I think the judgment has been-- and the reason policy has been what it is is that judgment has been that for the sake of the economy as a whole that we're willing to tolerate if you will, that. But it's certainly true that low interest rates of close to zero are punishing savers, there's no question to that. But that-- the idea policy of that is to sort of get people to quit saving and start spending. So that's kind of one of the objectives.

But it is, the people who are on fixed incomes-- I think there are some real risks that-- if they can't get a return on their savings they start liquidating their assets, liquidating their wealth in order to live. Well, that means that in future generations who would have inherited some of that wealth from their parents let's say, aren't going to get it, it's going to be gone.

I'm looking for GDP over the course of 2012 and 2013 to be only about 3%. Which is a little above trend-- it's not an outrageous forecast by any stretch of the imagination. Many people are a little below that, maybe at 2.5%, but you know, frankly the difference between 2.5% and 3%, our ability forecast with that degree of accuracy is pretty poor.

...

We've seen unemployment fall almost a full percentage point in the last year. The last time that happened was 1995. And it never fell a full percentage point in a year after the 2001 recession. So I'm a little more optimistic I mean, I think we we will be by the end of 2012 and I think unemployment will be close to 8% and on my better days maybe even a little shy, little below that.

...

STEVE LIESMAN: There's a lot of talk about the distortions that out there that Fed policy is really punishing savers. Do you agree with that and is it something that you think is useful or warranted for the overall health of the economy?

CHARLES PLOSSER: Well, I think the judgment has been-- and the reason policy has been what it is is that judgment has been that for the sake of the economy as a whole that we're willing to tolerate if you will, that. But it's certainly true that low interest rates of close to zero are punishing savers, there's no question to that. But that-- the idea policy of that is to sort of get people to quit saving and start spending. So that's kind of one of the objectives.

But it is, the people who are on fixed incomes-- I think there are some real risks that-- if they can't get a return on their savings they start liquidating their assets, liquidating their wealth in order to live. Well, that means that in future generations who would have inherited some of that wealth from their parents let's say, aren't going to get it, it's going to be gone.

STEVE LIESMAN: I've also had portfolio managers complain to me about the Federal Reserves saying, "You're forcing me into a risk profile I do not want to be in." How do you respond to that?

CHARLES PLOSSER: Well, I think there's some cases where that's probably true. I've talked to money managers and financial managers and private equity people in the financial markets. And a lot of them do share the view that somehow in the stretch for yield many people are taking unwise risks. Now, of course the Fed has made it very clear that at times we're trying to force people to take some more risk, but we can't control how that happens.

And so by trying to push people into riskier assets as we're trying to do with Operation Twist or with an Asset Purchase Programs, we don't know the full consequence with that. And we could, could-- I don't want to say we are, we could be breeding some problems for us down the road if we don't exit in the right time. And then we go past the exit and we have another credit bubble of some kind.

Given the extraordinary economic environment and the extraordinary actions taken, we find ourselves operating outside the usual and comfortable policy framework, with less consensus among economists about the right actions to take to promote sustainable growth and price stability. As a result, it is not surprising that debates about policy have been robust, with bright and talented people on every side. Thus, it should not be surprising — indeed, it should be reassuring — that debates within the FOMC are similar to many that are carried out in more public forums.

I stumbled upon a quote by the not-so-well-known French essayist Joseph Joubert from two centuries ago, but since I liked the quote, I thought I’d share it with you even if he isn’t a household name: “It is better to debate a question without settling it than to settle a question without debating it.”

Debate serves to enhance the Fed’s credibility and transparency as an institution. We should acknowledge the debate as a healthy process that analyzes the costs and benefits of various policy choices and ultimately leads to more informed and well-thought-out decisions. Communicating the thoroughness of those discussions is a vital part of the accountability we owe the public.

When I joined the Federal Reserve four-and-a-half years ago, I do not recall the phrase “managing financial crises” being anywhere in my job description.

Surging oil prices are now on the front burner as unrest in the Middle East has driven a surge in those costs. Plosser said he doesn't see much of an economic threat to the U.S. thus far, saying those disruptions are "less likely to be a problem for our economy than perhaps the challenges in Europe" generated by the government debt crisis there...

But he did allow he was monitoring the commodity situation, and said "oil would have to rise significantly more [than current levels] and stay there for a while to have dramatic effects on GDP growth."

From the press Q&A session, as reported by Dow Jones

Last November, after considerable deliberation, the FOMC decided to purchase an additional $600 billion of longer-term Treasury securities. This asset purchase program has been commonly referred to as QE2. Based on my reading of the economic outlook and challenges that the economy faces, I have expressed some doubts that the benefits outweigh the costs of this policy. However, I supported continuation of the policy in January because it is generally a good practice for a central bank to do what it says it is going to do unless circumstances significantly change. To do otherwise would undermine the institution’s credibility.

When the asset purchase program was adopted, the Committee also said that it would review its planned purchase program on a regular basis, and I take that promise to review seriously. Policy, after all, must also be dependent on the evolution of the economy so when the outlook for the economy changes in an appreciable way, so should policy.

Should economic prospects continue to strengthen, I would not rule out changing the policy stance to bring QE2 to an early close. Thus, I will continue to look at the data and consider revising my forecast and preferred policy path as we gain more information on economic developments in the coming months. If the growth rates of employment and output begin to accelerate or if inflation or inflation expectations begin to rise, then it may be time to begin taking our foot off the accelerator.

...

 The question is not can we do it, but will we do it at the right time and at the right pace. Since monetary policy operates with a lag, the Fed will need to begin removing policy accommodation before unemployment has returned to acceptable levels. Will we have the fortitude to exit as aggressively as needed to prevent a spike in inflation and its undesirable consequences down the road?

My own view is that except for the period when markets were severely impaired, early in the crisis, the asset purchase programs had, at best, marginal effects on asset returns and economic activity. Given that market functioning has returned to normal, I believe asset sales are unlikely to have a significant impact as market participants’ demand for risk and duration rise.

Others have suggested that we simply rely on raising interest rates and allowing the balance sheet to decline only slowly over time through the natural run-off of maturing securities. In my view, this alternative has several drawbacks. No one knows how fast the Fed might have to raise rates to restrain the huge volume of excess reserves from flowing out of the banking system. Rates might have to rise very quickly and in larger increments than otherwise to offset the accommodative impact of the large balance sheet. This could prove quite disruptive, yet failing to do so could risk much higher inflation levels.

The second element of the plan would be to announce that at each subsequent meeting the FOMC will, as usual, evaluate incoming data to determine if the interest rate on reserves and the funds rate should rise or not. Monetary policy should be conditional on the state of the economy and the outlook. If the funds rate and interest on excess reserves do not change, the balance sheet would continue to shrink slowly due to run-off and the continuous sales. On the other hand, if the FOMC decides to raise rates by 25 basis points, it would automatically trigger additional asset sales of a specified amount during the intermeeting period. This approach makes the pace of asset sales conditional on the state of the economy, just as the Fed’s interest rate decisions are. If it were necessary to raise the interest rate target more, say, by 50 basis points, because the economy was improving faster and inflation expectations were rising, then the pace of conditional sales would also be doubled during the intermeeting period.

Some fear that the strong rise in commodity and energy prices will lead to a more general sustained inflation. Yet, at the end of the day, such price shocks don’t create sustained inflation, monetary policy does.

Signs that inflation expectations are beginning to rise or that growth rates are accelerating significantly would suggest that it is time to begin taking our foot off the accelerator and start heading for the exit ramp. I would add that we should not be too sanguine in believing that such a time is a long way off or that the process will only be gradual. A stronger rebound in the economy or inflation than some now expect could require policy actions to be taken sooner and more aggressively than many observers seem to be anticipating. Allowing monetary policy to fall behind the curve can only result in greater inflation and more economic instability in the future.

[T]he Fed should adopt an explicit numerical inflation objective. Moreover, in my view, now is an opportune time to do so. The apparent strengthening of the U.S. economy suggests that, in the not-too-distant future, monetary policy will have to begin reversing course from a very accommodative policy stance. As we choreograph that exit, I believe that the Fed should do all it can to underscore its commitment to maintaining price stability.

...

Some people may argue that there is no need to articulate a numerical inflation objective because the Fed has established a strong record of maintaining low and stable inflation over the last two decades. But this is not an argument against an explicit target. It is an argument against commitment.

Less than a year ago the prevailing concern was not that inflation was becoming too high but that it was becoming too low. Indeed, some feared that the U.S. economy was on the verge of a deflationary spiral. I was not one of them; nor do I believe that we are in imminent danger of a strong acceleration in inflation. Yet the swing in views does concern me. It suggests that the public’s confidence in the Federal Reserve’s commitment to maintain price stability is not as firmly established as I would like.

If that forecast [of gradual recovery over the rest of the year] turns out to be the right forecast, then it certainly is not inconceivable to me that we would have to take our foot off the accelerator before the end of the year.

MR. LIESMAN: Teach us a little bit about your outlook on the economy. We've had a lot of first-quarter weakness here. It started off robustly. People thought it was going to be a 4 percent first quarter. And now it feels like we'll be lucky to hit 2. What happened?

MR. PLOSSER: Well, I think the first quarter is going to be weaker than a lot of people sort of thought it was. My forecast had been for about 3. But I still think that three and a half percent is not out of the range of possibility over the course of the year. So, yeah, there's been some weakness. But I still think the underlying fundamentals of the economy that's been the basis of this sort of gradual recovery are still kind of in place. We've just got some, I think, short-term weakness, but I think the fundamentals are still there.

MR. LIESMAN: What's the source of the short-term weakness?

MR. PLOSSER: Well, we certainly had a bad winter in terms of January. We know that affected the numbers. We've had uncertainty about Japan and the Middle East and the consequences for oil prices and so forth and how will the turmoil and the tragedy in Japan affect supply chains. And I think -- so I think a lot of that will work itself out. It'll take some time. But I think those are the major reasons why there's a little less confidence and a little less certainty about what's going to happen this first quarter.

MR. LIESMAN: Do you think higher oil prices are already hitting the economy?

MR. PLOSSER: Well, I think they are somewhat, surely.  Individuals and companies are having to pay more for oil and gasoline.  They do hit the economy. But again, I think that we haven't yet gotten to where we were in 2008, and so I think there are some reasons to be optimistic that they won't dramatically affect the economy.

If the economy continues to make progress, then monetary policy will need to exit from its extraordinary accommodation in the not-too-distant future. As always, we will study the incoming information on the state of the economy. While my expectation is that oil price increases will level off and that the currently elevated inflation measures will reverse, the risks to the inflation outlook are tilted to the upside. In this environment, we must have a plan in place to begin normalization of monetary policy. Depending on how economic conditions evolve, we must be prepared to act as aggressively as necessary if we are to promote effectively our long-run goals of price stability and maximum employment.

Committing to a stated goal to keep inflation low and stable can help to reduce market uncertainty and enhance the credibility and transparency of our central bank. That is why I have advocated for nearly 20 years that the Fed make explicit its commitment to a numerical inflation objective in support of all its mandates. I believe announcing an explicit numerical inflation objective would go a long way toward increasing our credibility and accountability. This would be an opportune time, in my view, to make such a commitment.

Speaking to reporters after the speech, Plosser said the Fed is “actively discussing” its next steps and that a third round of quantitative easing, or QE3, is unlikely. Plosser said that the FOMC may “go on hold” to assess the economy.

“We’ve made pretty clear there’s no QE3 on the table right now,” he said, “unless something dramatic happens.”

In late March 2011, I outlined a proposal for a systematic, rule-based approach that would involve the Fed’s selling assets from its portfolio as it increased its policy rate, with the pace of sales dependent on the state of the economy.

The first step of the normalization process would be to increase the interest rate paid on reserves and the targeted federal funds rate away from the zero bound, perhaps to 50 basis points. The Federal Open Market Committee would also announce its intention to stop re-investing the proceeds from maturing agency and Treasury securities. These decisions would initiate the normalization process and begin to raise the funds rate and shrink the balance sheet from the start.

Sales of assets between meetings beyond those maturing would also be tied to economic conditions, just as policy rate decisions are. The Fed would announce a pace of sales, which would increase when the Committee chose to increase the policy rate. Since the amount of securities to be sold between meetings would be determined in advance, the public and markets would see the Fed shrinking its balance sheet in a predictable manner.

“Somewhat tighter monetary policy is possible by the end of the year,” he said today at a press conference, after speaking at an event organized by the Bank of Finland in Helsinki. “We will have to begin exiting from our policies long before the unemployment rate is down to what people would like to have. That’s going to be a difficult decision.”

If we are to exit from this period of extreme monetary accommodation in a way that neither leads to higher inflation nor risks undermining the recovery, the public’s confidence in the Fed’s commitment to price stability will be crucial. For this reason, it would be highly desirable for the Federal Reserve to publicly commit to a clear and explicit inflation objective.

Expectations are well-anchored until they are not. So it is somewhat troubling to me that expectations of inflation in the medium to longer term are moving up and down as much as they are. It suggests that the public and the markets may not have as much confidence in the Fed’s ability, or willingness, to deliver on its price stability mandate.

I believe, as part of its communications, the Federal Reserve would do well to adopt an explicit numerical inflation goal, just as the Bank of England and many other central banks do.

I expect to see modest declines in the unemployment rate, to about 8½ percent by the end of this year, and then to a range of 7 to 7½ percent by the end of 2012.

A very downbeat description of the economy would not do much to engender confidence in the business community or the consumer community. And I was worried that we were playing into that.

But I was also concerned that the action that was taken, which was to change the extended period language to a date, was poorly designed and was inappropriate. Policy should not be dependent on the calendar. It should be depending on the economy.

We're reacting too quickly here.

I think there are three elements to my concern. One was I thought that our description of the economy was overly pessimistic, that our language we used was not as optimistic as it might have been.

And I also think that the signal we send about 2013 signaled that we were pretty pessimistic for some time to come. I thought that was not appropriate.

I didn`t think the data justified it at this point. But even if we did justify that in terms of the outlook, I was concerned that now was not the time to make a policy decision.

The data had been very volatile. The stock market had been very volatile, and that it was inappropriate to react on a very short-term basis.  Monetary policy needs to be focused on the intermediate to longer term.

And I thought we were overreacting to the events. So I would prefer us to sort of sit tight for a little longer, let the data come in to get a better handle on the outlook and forecast.

I think we need to be clear about conditioning our actions on how the economy evolves. And I think by changing the language, I thought it was inappropriate for us to do that.

It used the calendar. And while the language itself was conditional in the sense that this was the likely outcome, we already had that as the likely outcome through our extended period language.

So I didn`t think it was a well-crafted communication strategy that we used.

"I am really doubtful that monetary policy is a tool that is going to help us very much" to help spur demand and improve hiring in an economy where many households and companies are still looking to cut borrowing levels, rather than to increase them, Federal Reserve Bank of Philadelphia President Charles Plosser said in an interview with Dow Jones Newswires and The Wall Street Journal.

Plosser said he sees a high bar to new Fed action. "Broadly speaking, there are two things the Fed should respond to," he said. "If there were some kind of financial crisis, like Europe, it would be appropriate for us to step in" and be the lender of last resort. Also, if deflationary fears "became a real threat again, that would be a justification for the Fed to step in again."

When we do things that don't have much effect...we are undermining the credibility of the institution.

I dissented from these decisions because I believe that they will do little to improve the near-term prospects for economic growth or employment and they do pose risks. Policy actions should never be considered free and should be evaluated based on the costs and benefits. Based on our experience with Operation Twist in the 1960s and with last year’s QE2, the reduction in long-term rates is likely to be less than 20 basis points for the 10-year Treasury yield, which is currently only 2 percent. The pass-through to the rates at which consumers and businesses actually borrow is likely to be much less. Thus, I am skeptical that this will do much to spur businesses to hire or consumers to spend, given the ongoing structural adjustments occurring in the economy and the uncertainties posed by the fiscal challenges both here and abroad.

Plosser said to reporters after the speech that he “retains an open mind” on the idea of lowering the 0.25 percent rate the Fed pays financial firms on excess reserves.

“Reducing the interest rate on excess reserves at least in my mind would be a more traditional monetary policy action,” Plosser said. The Fed may not want to take such a step because of the uncertain effects from lowering the rate to zero, including possible damage to overnight lending markets, he said.

In my view, the actions taken in August and September tend to undermine the Fed’s credibility by giving the impression that we think such policies can have a major impact on the speed of the recovery. It is my assessment that they will not. We should not take certain actions simply because we can.

Based on our experience with Operation Twist in the 1960s and with last year’s QE2, the reduction in long-term rates from our actions in September is likely to be less than 20 basis points for the 10-year Treasury yield, which is currently only 2 percent. The pass-through to the rates at which consumers and businesses actually borrow is likely to be considerably less. Thus, I am skeptical that this will do much to spur businesses to hire or consumers to spend, given the ongoing adjustments occurring in the economy and the uncertainties posed by the fiscal challenges both here and abroad.

Economic theory and historical experience tell us that a central bank’s ability to maintain price stability and promote economic growth hinges on its credibility. Actions that undermine credibility can put at risk the effectiveness of a central bank’s ability to achieve its objectives. In my view, the actions taken in August and September risk undermining the Fed’s credibility by giving the impression that we think such policies can have a major impact on the speed of the recovery. It is my assessment that they will not. We should not take actions simply because we can.

It is time for the Fed to explicitly adopt the flexible inflation targeting framework and in doing so take three steps to strengthen its approach to policymaking. First, clarify and make explicit that our long-run inflation objective is 2 percent year-over-year PCE inflation. Second, publish information about the individual FOMC participants’ assessments of the appropriate monetary policy that underlie their economic projections in the FOMC’s Summary of Economic Projections. Third, provide information on the FOMC’s reaction function. That is, communicate policy decisions in terms of changes in the economic conditions that the FOMC is using to formulate policy.

Plosser said he did back efforts by the Fed to communicate more clearly with markets and the public. He said he supported including FOMC members’ projections for the path of interest rates along with their forecasts for the economy that are released four times a year.

This would be “a better way for the committee to communicate more clearly to the public about how the committee thinks,” Plosser said.

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.

Mr. Plosser said the new disclosures aren’t really forecasts, in the way that an economist might forecast where he thinks unemployment or inflation will be in 2012 or 2013. As Mr. Plosser described it, the interest rate numbers the Fed is making public are projections by policy makers of where they think interest rates should be, not forecasts of where they will be.

...

The nuance might be especially relevant for people like Mr. Plosser, who tend to be outside of the Fed consensus. The Fed has said it doesn’t expect to raise short-term interest rates until at least mid-2013. Mr. Plosser said he thinks it might need to raise rates sooner. He’s not going to write down what he thinks the Fed will do. He’s going to write down what he thinks it should do.

He adds that he thinks rates should be going up, “sooner than some of my colleagues do.”

...

Moreover, Mr. Plosser says the public shouldn’t look at these numbers as a commitment or a decision about interest rates, or as something that will be static. As views change about how the economy works and how it is performing, the interest rate projections will shift around, capturing the changing views inside the Fed’s policy making committee.

“The value is going to come as we watch these views change,” Mr. Plosser says.

STEVE LIESMAN: Let's talk about these interest rate forecasts that you're now publishing. There seems to be a lot of-- there's some disagreement between the statement which says that you expect it to remain-- low through mid-- through late 2014 and the forecast that came out later in the day. Which should the markets believe?

CHARLES PLOSSER: Well, I think two things. One is that interest rate projections in the SEP are not forecasts, people have to remember that they are projections of what each individual committee member thinks is appropriate policy, that is what should policy be, not what will policy be. And so they're making individual assumptions about the path of policy. And that reflects how over time that will reflect how policy evolves and the views of how the committee evolves.

In terms of the statement, the statement is a statement of policy, a statement by the committee. And it's reinforced by a vote of the FOMC. There's information content in both of those. If you look at the SEP projections of interest rates in the policy decisions you will see that there's a huge mass of people in and around 2014 and some beyond and some people sooner.

So it's not clear that the statement didn't reflect the modal view of what the committee and participants thought. But they are different exercises and so I think it's very important we understand the differences in our projections and the policy statement.

STEVE LIESMAN: If you watched the way the market reacted, they thought great at 12:30 when you said you expected it to remain low through 2014. But then we learned at 2:00 that there's not very much support for that later date on the board. Which is the right one?

CHARLES PLOSSER: Well, I think the fact of the matter is the statement's pretty clear although not as clear as it could be, that this is two-thousand-- late 2014 is contingent, it is conditional on the evolutions of the economy. Now, I think that we don't make that clear enough.

A lot of people have been reading the statement as if it was a commitment and it is not a commitment. And when you look at the SEP projections you-- it's pretty clear that everybody doesn't agree that this is a firm commitment. So it's not a commitment and it shouldn't be interpreted as a commitment. It's a conditional statement and I think revealing the projections in the SEP makes that even clearer that this is really not a commitment.

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STEVE LIESMAN: So Charlie, let's go back over this idea. If there's a conflict, and there was, but if there's a conflict between this policy statement of the calendar date and the SEP which one prevails?

CHARLES PLOSSER: Well, it's not clear that you want one dominate the other. One, the SEP projections are in fact the range of views of the committee. If you look at the policy statement of late 2014 and you looked at the modal value of the range of views it was probably pretty close. The idea is for them not to be.

You would think that the range of views would be captured in... I think having a calendar date in the statement is bad policy, I've said that over and over again. And by getting rid of the calendar date in the policy statement-- because I think it's bad communication, I think the SEP projections speak for themselves, they give you the view about where people currently stand.

What's important about that is that you will see over time when the next quarter comes and we do another SEP projections and you have the appropriate policy rates in there, you may very well see that change. It may go out further or it may actually begin to pull in. That's really a more informative way to think about forward guidance as we call it, from my perspective.

“I worry about this accelerationist view that we have to go ever faster on the pedal of monetary policy,” Plosser said. “You run the risk of runaway inflation, distortions in the marketplace, bubbles and so forth.”

Rates near zero are “punishing savers” and could be leading portfolio managers to take “unwise risks,” Plosser said. While the Fed’s goal has been to encourage a move to riskier assets, “we don’t know the full consequences of that,” he said.

“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.

Despite the extraordinary steps taken to support the economy, many argue that monetary policy should do more. The argument is that while inflation may be close to our target, unemployment remains elevated, and thus, monetary policy must act more aggressively if it is to meet its mandated employment objective.

I disagree and believe that doing so would lead us down a very treacherous path — one that would be ever more difficult to navigate and one that would increase the already substantial risk of higher inflation. But the problem is not just inflation risk down the road. Prolonged efforts to hold interest rates near zero can lead to financial market distortions and the misallocation of resources.

Monetary policy is sometimes criticized for such “go-stop” policies. Policymakers step on the accelerator aggressively, only to slam on the brakes in order to change course. Such an approach to policy can be highly destabilizing, creating added volatility for financial markets and the economy... It is an approach most often driven by an excessive focus on the short run and perhaps some hubris that we will be able to successfully avert the risks such a strategy poses for the economy over the longer run.

When the Fed engages in targeted credit programs that seek to alter the allocation of credit across markets, I believe it is engaging in fiscal policy and has breached the traditional boundaries established between the fiscal authorities and the central bank. Indeed, some of these actions have generated pointed criticisms of the Fed.

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.

I believe the Federal Reserve should do a more comprehensive monetary policy report four times a year. Currently, the Chairman testifies before Congress twice a year — in fact, he is doing so today — and that testimony is accompanied by a written report. In addition, the Chairman holds press briefings four times a year to summarize the SEP. I think there is an opportunity to combine these efforts in a more comprehensive report on monetary policy. Most central banks that have adopted an inflation target have also sought to improve communication and transparency through the publication of a regular policy report. In the U.K., for example, the Bank of England issues a quarterly Inflation Report. Other countries produce a Monetary Policy Report that discusses the central bank’s forecasts and the longer-term context of policy.

Economic theory and practice teach us that monetary policy works best when it is clear about its objectives and systematic in its approach to achieving those objectives. Granting vast amounts of discretion to our central banks in the expectation that they can cure our economic ills or substitute for our lack of fiscal discipline is a dangerous road to follow.

Our balance sheet should not be viewed as a new independent instrument of monetary policy in normal times. The exit principles also indicated the Committee’s desire to return the Fed’s balance sheet to an all-Treasuries portfolio. This re-establishes the idea that the Fed should not use its balance sheet to actively engage in credit allocations.

The Fed may need to raise interest rates as soon as the end of 2012 or early next year, Plosser said in response to questions from reporters.

“I believe monetary accommodation is still called for, but I do not believe it should be as accommodative or aggressive as it was at the height of the crisis, when unemployment was over 10 percent and inflation was just 1 percent,” said Plosser, who doesn’t vote on the FOMC this year. “Current conditions do not warrant further accommodation.”

I suspect that the FOMC participants are not ready to agree on a specific policy rule or reaction function because they use different models and have different loss functions. In the meantime, it does seem feasible that participants could agree on a set of economic variables to which monetary policy should react. The academic literature suggests using rules that respond aggressively to deviations of inflation from the central bank’s target and less aggressively to deviations of output from some concept of “potential output” or some alternative measure of resource utilization. If we choose a consistent set of variables and systematically use them to describe our policy choices, the public will form more accurate judgments about the likely course of policy — thereby reducing uncertainty and promoting stability.

While I believe monetary accommodation is still called for, in the absence of some shock that derails the recovery, we may well need to begin to gradually scale back the level of accommodation well before the end of 2014.

Yet the economy has now grown for 11 consecutive quarters. To be sure, growth is not robust. But growth in the past year has continued despite significant risks and external and internal headwinds. Natural disasters in Japan, a sovereign debt crisis and banking problems in Europe, turmoil in North Africa and the Middle East that led to a steep increase in oil prices, and our own debt ceiling fiasco, all made growth difficult. But I also remind you that the U.S. economy has a history of being remarkably resilient.

“From a policy perspective, the assumption that a central bank can always and everywhere credibly commit to its policy rule is, I believe, also questionable,” Plosser said at a conference sponsored by Germany’s Bundesbank and the Philadelphia Fed.

“In practice, I seek ways to make policy more systematic and more credible,” Plosser said. Still, “commitment is a luxury few central bankers ever actually have, and fewer still faithfully follow.”

My current assessment of the both the economy and effectiveness of QE is that I don’t think it really meets the cost-benefit analysis.

My assessment is that the appropriate policy is likely to be tighter going forward than anticipated by the Committee at this point. Thus, I do see some risks to inflation in the longer run given the current stance of monetary policy.

In my view, we are unlikely to see much benefit to growth or to employment from further asset purchases. If I am right, then conveying the idea that such action will have a substantive impact on labor markets and the speed of the recovery risks the Fed’s credibility. This is quite costly: If the public loses confidence in the central bank, our ability to set effective monetary policy in the future will be harmed and households and businesses will feel the consequences.

While these risks are very hard to quantify, it is clear that the larger the Fed’s portfolio becomes, the higher the risk and the potential costs when it comes time to exit. And based on my economic outlook, that time may come well before mid-2015.

It is clear that the larger the Fed’s portfolio becomes, the greater the risk and the potential costs when it comes time to exit. And based on my economic outlook, that time may come well before mid-2015. In my view, to keep the funds rate at zero that long would risk destabilizing inflation expectations and lead to an unwanted increase in inflation. In fact, some are interpreting the FOMC’s statement that we will keep accommodation in place for a considerable time after the recovery strengthens as an indication that the Fed is focused on trying to lower the unemployment rate and is willing to tolerate higher inflation to do so. This is another risk to the hard-won credibility the institution has built up over many years, which, if lost, will undermine economic stability. We know that monetary policy can control inflation, but its ability to manage the unemployment rate is far more dubious. Chasing an elusive goal for unemployment could well risk losing control over inflation. That was the lesson of the Great Inflation during the 1970s.

Finally, I also opposed September’s decision to purchase additional mortgage-backed securities. In general, central banks should refrain from allocating credit toward one sector or industry. Those types of credit-allocation decisions rightfully belong to the fiscal authorities, not the central bank. Engaging in such actions endangers our independence and the effectiveness of monetary policy.

I believe we could take further steps to improve our communications and reduce uncertainty over the path of monetary policy and reduce moral hazard. One enhancement would be to articulate a more rule-like approach to our decision-making process. This means making policy decisions based on available information in a consistent and predictable manner. One cannot know what the future holds or what future policy decisions will be. Policy will be data dependent, but the data should feed into a decision-making process in a mostly systematic or rule-like way.

The Federal Reserve's recent adoption of new monetary policy guidance is "a step in the right direction," but it fails the test of being a systematic approach to action…

"This is not what I would have put in place," Federal Reserve Bank of Philadelphia President Charles Plosser told reporters on the sidelines of the American Economic Association annual gathering in San Diego. But compared to the Fed's calendar-based interest-rate commitments, it is an improvement, the official said.

…The central banker said one of his biggest beefs with the new threshold regime is that it leaves unresolved what action the Fed will take once those levels are achieved. As the thresholds are not triggers a tightening is not automatic, he observed, but markets may believe otherwise. Mr. Plosser said the thresholds do not achieve the systematic approach he has long called for.

…As he has for some time, he reiterated his opposition to Fed bond buying efforts. "The efficacy of asset purchases is not very high" and the risks created by continuing forward are rising, Mr. Plosser said, adding "I would have stopped earlier" with the purchases.

…The officials cautioned central bank watchers not to read to much into the December FOMC meeting minutes, released Thursday, which saw policy makers speculating over the time frame Fed asset buying might run. Mr. Plosser noted officials have different definitions about the level of progress the central bank will need to make on the jobs front before paring back the bond buying.

As reported by the Wall Street Journal

“Financial stability should not be an explicit objective of monetary policy...”

“Price stability should be the number one objective of the central bank, and our record” over the central bank’s century of existence “has not been stellar,” Mr. Plosser said.

Instead, the Fed should deal with markets on a separate track, and promote a stable financial system by using “its regulatory and supervisory power,” the official said.

As reported by the Wall Street Journal

The Fed may need to slow or halt bond buying this year as the economy makes “modest progress,” Plosser said in a Bloomberg Television interview.

“Given where we are, I think I would not be surprised if we face the choice of having to rein in the purchases sometime during this year."

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.

[O]ptimal forward guidance requires policymakers to commit to making policy in a way that is different from what policymakers would want to do when the time comes. Economists would say that policymakers are trying to commit to a policy that is not time-consistent. Put another way, former Fed Chairman William McChesney Martin used to say that monetary policy’s job “is to take away the punch bowl just when the party is getting good.” Yet, these models tell us that at the zero lower bound, forward guidance should convey the opposite. That is, it should promise that monetary policy will not remove the punch bowl but allow the party to continue until very late in the evening to ensure that everyone has a good time. But what will make the public believe that policymakers in the future will deviate from past practices in this way? And will policymakers or the public be willing to tolerate the future inflation when it comes and believe that it is only temporary?

Federal Reserve Bank of Philadelphia President Charles Plosser said he expects the unemployment rate to decline close to 7 percent by the end of this year, warranting a reduction in the Fed’s monthly bond purchases.

“If my forecast is right, then I think we should at least have begun backing off on our asset purchases,” Plosser told reporters yesterday after delivering a speech in Stanford, California. “As a practical manner, we will taper” bond buying before halting the quantitative easing program, he said.

As reported by Bloomberg News

In my view, a case can be made that we have seen sufficient improvement to begin tapering our asset purchase program with the objective of bringing it to an end before year-end.

If asset purchases continue at current levels, reserve balances could grow to $2.25 trillion or more. That may require the Fed to sell assets at a somewhat faster pace than contemplated in the principles adopted in 2011.

In March 2011, I shared some principles I thought should guide the Fed's eventual exit from this period of extraordinary monetary policy and its attempts to normalize policy. I said at the time that an effective exit strategy had to begin by deciding on our destination — what monetary policy operating framework we will use after exit — and then articulating a systematic approach to getting there. I was gratified that in June of the same year, the Federal Open Market Committee (FOMC) adopted a similar set of exit principles.

…

In addition to stopping asset purchases, the Fed should take two other steps as precursors to exit. First, we should seek to normalize the spread between the discount, or primary credit, rate, the rate at which banks borrow from the central bank, and the target federal funds rate... More than three years later, the crisis has passed and the other temporary lending programs the Fed initiated during the height of the crisis have disappeared. Thus, it may be a reasonable time to restore the spread to a more normal level.

Second, another step that might be taken before exit begins is to rethink our reinvestment strategy. There are no longer any short-term Treasuries in the Fed's portfolio. Rather than reinvesting maturing assets and prepaid assets into longer-term assets, it might be prudent to begin reinvesting in shorter-term assets. That would provide more flexibility in managing our balance sheet as we move forward.

If we do not stop purchases soon, one part of the exit strategy that might need to be reconsidered is asset sales… Determining the optimal pace of normalization from a very large and long-duration balance sheet is a complicated task that will depend on the speed with which interest rates rise and the size of the balance sheet when normalization commences. One factor to consider is the fiscal implications... Over time as the economy improves, interest rates will rise. Since the Fed's portfolio holds predominantly longer-term securities, interest received will not rise appreciably, but the interest paid on reserves will have to go up. Roughly speaking, if reserves total $2 trillion, remittances to the U.S. Treasury will fall by $20 billion for each 100-basis-point rise in the IOR…

In addition, should the Fed choose to sell long-term assets in a rising interest rate environment, it could experience capital losses. This would further reduce remittances to the Treasury. The more aggressively the Fed sells off its assets, the higher the losses and the more likely remittances to the Treasury could turn negative for a number of years. Although negative remittances would not impair the Fed's ability to implement monetary policy, they may impose significant political risk for the institution.

“I would like to see us begin to scale this thing back beginning even as early as the next meeting” of the Federal Open Market Committee, Plosser said to reporters after a speech today in New York. The committee is scheduled to meet June 18-19.

Based on the stated views of the Committee regarding the flexibility in pace of purchases, I believe that labor market conditions warrant scaling back the pace of purchases as soon as our next (June 18-19) meeting. Moreover, unless we see a significant reversal in current trends that jeopardizes my forecast of near 7 percent unemployment rate by the end of this year, then I anticipate that we could end the program before year-end.

Plosser said a strategy he’d favor would be “rather than trying to push our balance sheet up at the rate of $85 billion a month, maybe we could only push it up at the rate of 70, or 75, or 65 that is still trying to provide some accommodation, but at a slower pace and begin to sort of wean our way out.”

In August 2011, the Committee began using dates to signal when the policy rate might increase, but it changed those dates at subsequent meetings. The FOMC then opted to formulate its forward guidance in terms of thresholds for unemployment and inflation. This is preferable to calendar dates because it is state contingent. Yet, the FOMC has specifically said that the thresholds are not triggers — they are not firm commitments and they may change. The Committee has repeatedly opted for language that allows a great deal of discretion to behave as it chooses, depending on the circumstances. But effective forward guidance demands commitment. When the Committee stresses the general flexibility of its policy decisions or makes vague references to data dependency, it does little to clarify the FOMC's intentions about future policy, even though clarity is what the FOMC wants to provide to the markets through its forward guidance. Thus, there is a fundamental tension between wanting to provide clarity as to the forward course of policy and wanting to maintain complete discretion. The Committee has failed to address this tension, which undermines the effectiveness of its policy.

I would add that this tension is not new. The Committee has typically preferred discretion over systematic policy. Yet, in normal times, the conduct of policy was more predictable and the public had come to expect policy to play out in mostly understandable ways. Since the crisis, the old "rulebook," so to speak, has been thrown out, but we haven't replaced it with anything except some vague promises that have changed over time. This naturally leads to a lack of clarity in the eyes of the public and undermines the effectiveness of the forward guidance the Committee offers.

In my view, rather than try to maintain discretion, policymakers would achieve better economic outcomes and greater clarity by taking a systematic approach to policy. But how do we get there from here? I think we could vastly improve policy going forward by doing three things, which would begin to normalize monetary policy.

• The first step is to wind down our asset purchases by the end of the year in a gradual and predictable manner. As I said, I see little if any benefit from these purchases, and growing costs.
• The second step is for the FOMC to commit to its forward guidance on the fed funds rate path, that is, to begin treating the 6.5 percent unemployment rate and the 2.5 percent inflation rate in the guidance as triggers rather than thresholds.
• The third part of the strategy is to provide information on how our interest rate policy will evolve after the trigger is reached. A commitment to a robust policy rule, perhaps consistent with the way policy was conducted prior to the crisis, would provide needed clarity on how the Committee intends to vary its policy in response to changes in economic conditions.

In my view, rather than try to maintain discretion, policymakers would achieve better economic outcomes and greater clarity by taking a systematic approach to policy. But how do we get there from here? I think we could vastly improve policy going forward by doing three things, which would begin to normalize monetary policy.

• The first step is to wind down our asset purchases by the end of the year in a gradual and predictable manner. As I said, I see little if any benefit from these purchases, and growing costs.
• The second step is for the FOMC to commit to its forward guidance on the fed funds rate path, that is, to begin treating the 6.5 percent unemployment rate and the 2.5 percent inflation rate in the guidance as triggers rather than thresholds.
• The third part of the strategy is to provide information on how our interest rate policy will evolve after the trigger is reached. A commitment to a robust policy rule, perhaps consistent with the way policy was conducted prior to the crisis, would provide needed clarity on how the Committee intends to vary its policy in response to changes in economic conditions.

These steps form part of a systematic approach to policymaking. They embody clarity and commitment. By helping the public and market participants form more accurate judgments about the future course of policy, systematic policymaking can improve the efficacy of monetary policy.

“I don’t want to do it all at once, but I think we should begin to taper very soon and hopefully end it by the end of this year,” Plosser said today in an interview in Jackson Hole, Wyoming. “That would be a healthy thing for the economy. We can do it gradually.”

Fed Chairman Ben S. Bernanke said last month the Fed is on track to begin reducing its bond buying later this year and halt the program by around mid-2014 if the economy performs in line with central bank forecasts. Plosser, who doesn’t vote on monetary policy this year, has repeatedly spoken out against additional easing by the Fed.

“I’d like for us to start in September” to taper the purchases, Plosser said in the Bloomberg Television interview with Michael McKee to air July 15. “We don’t want to create another housing boom,” and “we have to be careful of the unintended consequences of our policies.”

Let me point out that the instructions from Congress call for the FOMC to stress the long run growth of money and credit commensurate with the economy's long run potential. There are many other things that Congress could have specified, but it chose not to do so. The act doesn't talk about managing short-term credit allocation across sectors; it doesn't mention inflating housing prices or other asset prices. It also doesn't mention reducing short-term fluctuations in employment.

Many discussions about the Feds mandate seem to forget the emphasis on the long run. The public, and perhaps even some within the Fed, have come to accept as an axiom that monetary policy can and should attempt to manage fluctuations in employment. Rather than simply set a monetary environment commensurate with the long run potential to increase production, these individuals seek policies that attempt to manage fluctuations in employment over the short run.

The decision to maintain the pace of purchases in September and await more evidence of sustained economic progress came as quite a surprise to the public, generating widespread public debate about the FOMC's communications surrounding its policy intentions.

Not dissuading the public from its expectation of a tapering and then not taking action undermines the credibility of the FOMC and reduces the effectiveness of forward guidance as a policy tool…

In my view, this whole episode also demonstrates how difficult it is to fine-tune our open-ended asset purchases and our forward guidance about them. We cannot continue to play this bond-buying game by ear and risk the Fed's credibility while creating lingering uncertainty about the course of monetary policy.

We need to define simple, clear dimensions to "right-size" the program. This will reduce policy uncertainty and move the economy forward. My preference would be for the FOMC to announce a fixed amount for QE3, just as we did for the two prior rounds of asset purchases…

We are still learning how asset purchases affect the economy, but many believe it is the ultimate size and composition of the assets, rather than the flow of purchases, that influences interest rates and thus the economy. This was the premise of the early rounds of purchases.

Setting the ultimate size of our asset purchase program will lead us away from trying to fine-tune our decision about purchases based on the latest numbers and creating uncertainty from meeting to meeting about the FOMC's next step... By specifying a fixed amount, we would help the public understand that reducing the pace of asset purchases does not signal a change in our policy rate. Indeed, even an end to purchases only stops the efforts to increase accommodation. It is not a tightening of policy. As I said, after our purchases stop, policy will remain highly accommodative. An end to the purchase program does not imply that increases in the policy rate are imminent. We will simply set our policy rate consistent with promoting the FOMC's goals of price stability and maximum employment.

The first institution was the brainchild of our first Treasury secretary, Alexander Hamilton. His efforts led to the creation of the First Bank of the United States, which was awarded a 20-year charter by Congress in 1791. Although the First Bank's charter was not renewed, the War of 1812 and the ensuing inflation and economic turmoil convinced Congress to establish the Second Bank of the United States, which operated from 1816 to 1836. However, it too did not win a renewed charter, with President Andrew Jackson leading the opponents in a heated political debate. I believe that both these institutions failed because they were unsuccessful in overcoming the public's mistrust of centralized power and special interests. Indeed, without public confidence in these institutions, they were doomed. After the first two attempts, it took nearly 80 years before Congress tried again to establish a central bank. The outcome was a new central bank with a governance structure designed to decentralize authority and promote public confidence a decentralized central bank. This structure helped overcome political and public opposition that stemmed from fears that a central bank would be dominated either by political interests in Washington or by financial interests in New York. Yet even this structure, which has now lasted a century, has evolved, and the balance of power has shifted over time in response to economic events and legislation. I believe that the fundamental concept of a decentralized central bank has great merit, in part, because it helps to preserve the independence and maintain the public trust in the institution. Independence is essential if a central bank is to play its fundamental role in preserving the purchasing power of a fiat currency. History is replete with examples of governments using the power to print money as a substitute for making tough fiscal choices, and the results were disastrous.

Philadelphia Fed President Charles Plosser told CNBC on Friday that it's probably time to "gracefully exit" the central bank's quantitative easing bond purchases because the November jobs report was more evidence of a strengthening economy.
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"It's pretty positive clearly. We continue to make solid progress," he said, but warned that investors should not to make too much of one month's report.
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Acknowledging that he's no fan of the current QE buying, Plosser said "it would be wise if we began to get rid of this program." He continued, "I don't think it's doing very much good for us. It has a lot of unintended consequences and risk for the economy down the road."
When Plosser was on "Squawk Box" last month, he said the Fed "clearly missed" a chance to begin tapering in September when central bank had primed the financial markets for action.
Plosser had also said the Fed should put specific dollar limits on the size of the central bank balance sheet—an assertion he stood by on Friday.
But he added: "I think we need to go back to where we were in the earlier rounds of QE where we set a total amount, ... bought that purchase and then we stopped. Then we re-evaluated to whether or not we should go on."

The Federal Reserve could well consider cutting its bond-buying by more than a $10 billion monthly increment in the future, Philadelphia Fed President Charles Plosser said on Saturday, floating $25 billion as a hypothetical amount. The U.S. central bank trimmed its quantitative easing program to $75 billion per month, from $85 billion, at a much anticipated policy meeting last month, reducing its extraordinary support for the U.S. economy. "It's good that we did it," Plosser, a hawkish Fed official, told reporters on the sidelines of a conference. But "if the economy continues to grow and strengthen I think that there's no reason why we shouldn't want to consider speeding the process up if we can," he said. "I have no problem with gradually unwinding it, but my preference would be to move a little quicker and end it sooner rather than later," Plosser added.

The constant revision of estimates of potential output and thus of the output gap also underscore one of the difficulties policymakers have in trying to use gaps as a guide to policymaking in real time. Indeed, Athanasios Orphanides and Simon van Norden have argued that a major problem that gave rise to the great inflation of the 1970s was the mismeasurement of the perceived output gap. They explained how the Fed consistently relied on estimated output gaps that were subsequently revised and ended up being much smaller than initially thought. They argue that policymakers' reliance on estimated gaps led to overly expansionary monetary policy and the resulting high rates of inflation.

A different conceptual approach to defining a gap is implied by a class of economic models in wide use today the new Keynesian dynamic stochastic general equilibrium, or DSGE, models. DSGE models explicitly posit that firms have some pricing power; that is, there is imperfect competition so that a firm can choose to sell more of its output by lowering its price or to sell less of its output by raising its price, and the firm will set its price at a markup over marginal cost to maximize its profits. DSGE models also assume that firms are able to only adjust prices infrequently. This form of sticky prices, together with imperfect competition, allow monetary policy to have real effects in the short run, while remaining neutral for the real side of the economy in the long run. The sticky prices generate distortions that mean allocations and output can be inefficient in the face of shocks. In these models, the efficient level of output is the level of output that would prevail in the absence of the sticky prices and other market imperfections that allow deviations from perfect competition. In this framework, the relevant output gap to be addressed is the difference between the efficient level and that level generated by the distortion introduced by the sticky prices and market imperfections. The behavior of the efficient level of output is unlikely to be a smooth or a slowly evolving series like the CBO concept. In fact, it could be quite volatile and may bear little or no resemblance to the traditional concept of potential used by the CBO and others. Efficient output would be altered by changes in technology that affect productivity or changes in agents' preferences. The role of monetary policy in these models is to react to economic conditions in a way that minimizes the potential for distortions arising from the price stickiness or other market imperfections. The general policy prescription is to minimize the gap between output and the efficient level of output. In the absence of unexpected events that lead firms to change their desired markups over marginal cost, or other real rigidities like real wage rigidities, this would be equivalent to stabilizing inflation.

Chairman Ben Bernanke indicated in his December press conference that if we are making progress in terms of inflation and continued job gains, then the program would be concluded late in 2014. The December employment report has not changed my belief that the economy has already met the criteria of substantial improvement in labor market conditions. So my preference would be that we conclude the purchases sooner than this, but I am glad that we have taken the first step on the path to ending the program. 

I believe the economy has already met the criteria of substantial improvement in labor market conditions, and the economic outlook has improved as well. So my preference would be that we conclude the purchases sooner rather than later.

Although the FOMC has indicated that it doesn't anticipate raising rates when the economy crosses that threshold, I do believe that we will have complicated our communications if we are still purchasing assets at that point.

The Federal Reserve needs to follow the Bank of England and ditch “irrelevant” forward guidance on monetary policy linked solely to the US unemployment rate, Charles Plosser, president of the Philadelphia Fed, has told the Financial Times.

Becoming the latest member of the Federal Open Market Committee to push for a change in forward guidance at the March meeting, Mr Plosser added that the Fed’s guidance was “a journey and it’s likely to be evolving over time”. Janet Yellen, Fed chairwoman, is among those who have hinted at a move to qualitative guidance rather than numerical.

Stressing the urgency of a decision to change the Fed’s current unemployment threshold of 6.5 per cent for considering a rate rise, given that the rate in January stood at 6.6 per cent, Mr Plosser said: “We can’t keep putting 6.5 per cent in the statement when we’ve reached [the threshold] . . . we are going to have to figure out something else to communicate.”

“It’s not a once and for all decision,” he said of the language the FOMC has already been considering. “One of the challenges we face is not to do something we regret later.”

He said the most important improvement to the guidance he would like to see was to give a broader indication of how the Fed was likely to respond to incoming economic data. “The old language is now for all intents and purposes irrelevant . . . it didn’t say anything about the post-threshold policy,” he said.

Having spent time at the BoE this week, he said on Thursday that the bank’s recent move away from linking monetary policy to the unemployment rate was a step in the right direction. “I would like to see us – at the Fed – move in that direction,” Mr Plosser said.

A noted hawk on the Fed's largely dovish board, Plosser said he believes interest rates should hit 3 percent by the end of 2015 and 4 percent in 2016.

"It's a little bit puzzling that the market would react the way it did," Plosser said on CNBC's "Squawk Box." "I don't think the Fed changed its position. In fact, it tried to say very explicitly in its statement that we believe forward guidance or the expectations have not changed as far as we're concerned."

Yellen later clarified her comments on interest rates, which she said may rise six months after the Fed ends its bond-buying stimulus programs, Plosser said…

Still, Plosser told CNBC it's more productive to talk about economic conditions rather than timing. He said Yellen's comments were in line with data and surveys that the Federal Open Market Committee used to measure the economy.

"There was a lot of evidence and a lot of surveys that suggest six months wasn't a wildly unexpected timeframe," Plosser said. "But it is better to get away from talking about timeframes. Talking about economic conditions is a much better way to think about it."

Plosser added: "I was surprised the market reacted as much as it did ... I don't count months. It's silly for us to contemplate raising rates until we stop purchases."

In my view, the proper role for monetary policy is to work behind the scenes in limited and systematic ways to promote price stability and long-term growth. Since the onset of the financial crisis, central banks have become highly interventionist in their efforts to manipulate asset prices and financial markets in general as they attempt to fine-tune economic outcomes. This approach has continued well past the end of the financial crisis. While the motivations may be noble, we have created an environment in which "it is all about the Fed." Market participants focus entirely too much on how the central bank may tweak its policy, and central bankers have become too sensitive and desirous of managing prices in the financial world. I do not see this as a healthy symbiotic relationship for the long term.

If financial market participants believe that their success depends primarily on the next decisions of monetary policymakers rather than on economic fundamentals, our capital markets will not deliver the economic benefits they are capable of providing. And if central banks do not limit their interventionist strategies and focus on returning to more normal policymaking aimed at promoting price stability and long-term growth, then they will simply encourage the financial markets to ignore fundamentals and to focus instead on the next actions of the central bank.

I hope we can find a way to make monetary policy decision-making less interventionist, less discretionary, and more systematic. I believe our longer-term economic health will be the beneficiary.

The FOMC also noted, based on its assessment of these factors, that it likely will be appropriate to keep its target federal funds rate near zero for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the 2 percent goal and longer-term inflation expectations remain well anchored. My own view is that, as we continue to move closer to our 2 percent inflation goal and the labor market improves, we must be prepared to adjust policy appropriately. That may well require us to begin raising interest rates sooner rather than later.

Economists have come to understand that expectations about monetary policy can play an important role in determining economic outcomes, such as real economic growth and inflation. For example, todays decision to save or to spend is influenced by the current interest rate as well as tomorrows expected future consumption. In turn, tomorrows expected future consumption is influenced by next periods interest rate and next periods expected future consumption. Therefore, the entire expected path of interest rates, not just the current interest rate, influences todays consumption. This is not only true for personal consumption, but also business investment decisions, and the setting of prices and wages.

One of the most important ways to support credibility and thus the effectiveness of forward guidance is to practice it as part of a systematic policy framework. I believe that indicating how the evolution of key economic variables systematically shapes current and future policy decisions is critical to such a policy framework. Indeed, a commitment to a policy framework that is systematic and rule-like provides the foundation for establishing expectations for the future path of policy and thus forward guidance...

Systematic policies that provide important information about the policymakers reaction function combined with other information, such as the policymakers economic forecasts, can sharpen forward guidance in ways that reduce policy uncertainty and enhance economic performance. Thus, well-designed communications are valuable, and behaving systematically has the added advantage of making those communications easier for the public to understand.

In any event, it will be important that the signals conveyed by balance sheet policies are consistent with the forward guidance about future interest rate policies. This has been a difficult communications challenge at times for the FOMC. And it will likely remain a communications challenge as the Committee coordinates the unwinding of the Feds balance sheet with the gradual increase in the policy rate.

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.

The science of monetary policy has not progressed to the point where we can specify the optimal rule for setting monetary policy. The reason is that optimal rules, that is, those that maximize economic welfare, are highly dependent on the particular model from which they are derived, and there is no broad-based consensus for the right model. More relevant is the finding that the optimal rule for one model can produce very bad outcomes in another model. In addition, optimal rules can often be quite complex, thus making them difficult to implement and to communicate to the public. In other words, they may not be very transparent.

However, these limitations to implementing optimal policy rules should not deter us from efforts to adopt a more systematic rule-like approach to the conduct of policy. There has been a great deal of progress made in identifying simple rules that appear to perform well in a variety of models and environments. Such robust rules can form a basis for developing more systematic, rule-like policymaking.

One important and desirable characteristic of a systematic and rule-like approach to policy relates to communication. In particular, it is an approach that is easily communicated to the public and thus greatly improves the transparency and predictability of monetary policy, which reduces surprises. The public and markets are more informed about the course of monetary policy because they understand how policymakers are likely to react to changing economic circumstances. Equally important in my view is that greater clarity about the policymakers' reaction function strengthens accountability and thus can serve to preserve the central bank's independence.

Given model uncertainty and data measurement problems, there are, of course, limitations to the use of a simple rule. The rule is basically intended to work well on average, but central banks look at many variables in determining policy. There inevitably will be times when economic developments fall outside the scope of our models and warrant unusual monetary policy action. Events such as 9/11, the Asian financial crisis, the collapse of Lehman Brothers, and the 1987 stock market crash may require departures from a simple rule. Having articulated a rule guiding policymaking in normal times, however, policymakers will be expected to explain the departures from the rule in these unusual circumstances. With a rule as a baseline, departures can be quantified and inform us how excessively tight or easy policy might be relative to normal. If the events are temporary, policymakers will have to explain how and when policy is likely to return to normal. Thus, a simple rule provides a valuable benchmark for assessing the appropriate stance of policy. That makes it a useful tool to enhance effective communication and transparency.

My overall view of the economy is fairly optimistic. After a first quarter buffeted by winter storms, I believe we are poised to grow at a rate somewhat above trend for the remainder of this year and next before reverting back to trend, which I see as about 2.4 percent. Steady employment growth and healthier household balance sheets will support consumption activity. The current data suggest economic strength is fairly broad based, as evidenced by recent indicators and the optimism expressed by firms in both the manufacturing and service sectors

My own submission for economic growth was generally in line with my colleagues. But my forecast for unemployment was a bit lower in the near term. Specifically, I think the unemployment rate may reach 5.8 percent by the end of this year and 5.6 percent by the end of 2015. My view of inflation is that it will stabilize at about 2 percent in 2015.

Some market participants and commentators have focused on the so-called dot charts and the movement of the implied median funds rate for 201416. I would remind everyone that the dots are not a forecast of what policymakers think the Committee will actually do, but they are a reflection of the policymakers' views of appropriate policy.

Some have noted that the median path steepened ever so slightly. This should not come as a particular surprise as it likely just reveals greater confidence that the economy is improving. The rebound after the bad winter seems to be progressing, the outlook for unemployment is a bit better, and the inflation rate appears to be firming. The changes in the dots thus simply tell us something about individual policymakers reaction to the change in economic conditions. The FOMC statement notes that the Committee will adjust future funds rate decisions based on the progress toward our objectives. So, it is entirely reasonable that the expected path of "appropriate policy" should adjust as we close in on those objectives. Indeed, it would be surprising if they did not behave in such a manner.

I believe that we are closing in on our goals perhaps faster than some people might think. So, while I supported the recent policy statement, I have growing concerns that we may have to adjust our communications in the not-too-distant future. Specifically, I believe the forward guidance in the statement may be too passive, given underlying economic conditions.

My own assessment {in December 2013} was that the economy would gradually recover. I projected that by the fourth quarter of 2014 the unemployment rate would decline to 6.2 percent, and year-over-year PCE inflation would rise to 1.8 percent. Consistent with that view of gradual economic recovery, I believed that an appropriate monetary policy would require the funds rate to rise to 1.25 percent by year-end 2014.

With the economy having already reached my year-end 2014 forecast for inflation and unemployment, and appearing to be well on its way toward achieving my 2015 forecasts approximately a year ahead of schedule, the funds rate setting remains well behind what I consider to be appropriate given our goals.

“We may not need the reverse repo facility at all, because if we raise interest rates and the funds rate goes up with it, why would we need to introduce other dimensions?” said Philadelphia Fed President Charles Plosser in a Bloomberg Radio interview with Kathleen Hays in Jackson Hole, Wyoming.

“I think it’s presumptive to say that we will” need to utilize the reverse repo facility, “because I don’t think we know whether we will or not,” Plosser said. “I think many members are worried about the reverse repo program becoming too big an intervention into money markets, and to the plumbing of our money-market system. We want to be cautious about creating a facility that we can’t get ourselves out of.”

[I]f monetary policy waits until it is certain that the labor market has fully recovered before beginning to raise rates, policy will be far behind the curve. One risk of waiting is that the Committee may be forced to raise rates very quickly to prevent an increase in inflation. In so doing, this may create unnecessary volatility and a rapid tightening of financial conditions — either of which could be disruptive to the economy.

This would represent a return of the so-called "go-stop" policies of the past. Such language was used to describe episodes when the Fed was viewed as providing lots of accommodation to stimulate employment and the economy — the go phase — only to find itself forced to apply the brakes abruptly to prevent a rapid uptick in inflation — the stop phase. This approach to policy led to more volatility and was more disruptive than many found desirable.

For these reasons, I would prefer that we start to raise rates sooner rather than later. This may allow us to increase rates more gradually as the data improve rather than face the prospect of a more abrupt increase in rates to catch up with market forces, which could be the outcome of a prolonged delay in our willingness to act.

Monetary policymaking is conducted by committee, and divergent views can and often do exist. While this can be clumsy at times, such governance mechanisms have great strength in preventing institutions from lapsing into groupthink by ensuring that various views are heard in an environment that promotes better decisions and outcomes, and they help to preserve the central bank's independence and accountability.

Open dialogue and diversity of views leads to better policy decisions and is the primary means by which new ideas are gradually incorporated into our monetary policy framework. Thus, I believe diversity of thought is a sign of thoughtful progress. I have often quoted the famous American journalist Walter Lippmann who said, "Where all men think alike, no one thinks very much." I think it is healthy for the American public to know that we debate some of the same issues that those outside the Fed debate. Hiding such debate behind a unanimous vote does nothing to promote true transparency.

Monetary policy should be data dependent, not date dependent.

I am not suggesting that rates should necessarily be increased now. Our first task is to change the language in a way that allows for liftoff sooner than many now anticipate and sooner than suggested by our current guidance. Raising rates sooner rather than later also reduces the chance that inflation will accelerate and require policy to become fairly aggressive with perhaps unsettling consequences. Thus, I believe that our forward guidance should be adjusted to reflect economic realities and to give us the flexibility to respond sooner and more gradually to the evolution of the economy.

While the Committee retained the "considerable time" language, it added clarity by stressing the fact that the decision to lift the interest rate target would be driven by the data. The Committee explicitly noted that should the economy make faster progress than anticipated toward its goals, liftoff could occur earlier, and if progress was slower than anticipated, liftoff could be delayed. From my perspective, this is the operative language and it makes clear that the Committee intends for policy to be data-dependent.

In particular, my views on the appropriate funds rate setting are and continue to be informed by Taylor-type monetary policy rules that depict the past behavior of monetary policy in response to deviation from its desired inflation target and economic activity from its natural or efficient level. I find such rules useful for benchmarking my policy prescriptions. These rules have been widely investigated and have been shown to be robust in that they deliver good results in a wide variety of models and circumstances.

The guidance I take from such robust rules is that we should no longer consider monetary policy as being constrained by the zero lower bound In fact, maintaining a funds rate target near zero is unprecedented under such circumstances and, as such, could pose risks to the economy in the years ahead, including higher inflation and financial instability.

The unemployment rate continues to improve more quickly than many had expected. We are now approaching the rate that many policymakers view as a long-run sustainable value. Further, numerous labor market indicators continue to show broad improvement and inflation is not appreciably below our 2 percent goal.

Beginning to raise rates sooner rather than later reduces the chance that inflation will accelerate and, in so doing, require policy to become fairly aggressive with perhaps unsettling consequences. Waiting too long to begin raising rates especially waiting until we have fully met our goals for maximum employment or attained our inflation target of 2 percent is risky because doing so could put monetary policy behind the curve. Such policies could lead to a return to abrupt go-stop policies, which in the past have led to unwelcome volatility. Finally, delay is likely to increase the risk of overstaying our welcome at the zero bound, thus fostering unintended consequences for financial stability.

"There are many indicators that tell us interest rates are too low," Plosser told CNBC from the UBS European Conference in London. There is no precedented history to have rates at zero. I think we are really behaving in a way which is outside of historical norms and that should make us nervous," he added.

While the expected neutral funds rate is something that may be relevant, estimating and communicating a value with any confidence would be challenging. Measuring longer-run trends is a difficult and delicate issue. Because expectations about monetary policy are important, particularly in financial markets, it may be useful for the FOMC to indicate what ranges are likely for the neutral federal funds rate. But given the uncertainties, this may be difficult and conveying a false sense of precision may prove to be counterproductive.

So, I believe, adjustments to the perceived neutral funds rate should be done with great care and discipline. They should not be done in response to the typical cyclical fluctuations in real rates. Our ability to truly assess a significant shift in the longer-term real rate is quite limited, and, in the presence of such uncertainty and measurement error, one should be careful not to confuse the public.

Unfortunately, it is unlikely that policymakers will adopt a specific reaction function in the near term. Yet, there are numerous examples of such systematic approaches or reaction functions that can help us to gauge the stance of policy I frequently consider such reaction functions as I think about policy. These are typically Taylor-like rules named for the Stanford University economist John Taylor who first proposed them in the early 1990s. These policy rules typically call for the targeted funds rate to respond to deviations of inflation from some desired target and to deviations of output from some measure of potential sometimes referred to as economic "slack" or the "gap." Sometimes such gaps are translated into deviations from full employment.

These policy rules can offer useful guideposts for policymakers and the public in assessing the stance of monetary policy, and communicating more about such guideposts would enhance transparency and help make policy more systematic. Thus, there is no need to mechanically follow any particular rule, and judgment will always be required. Yet, policymakers and the public should be very cautious when they call for policy rates to deviate in important or significant ways from these guideposts. Making such judgments should require careful analysis, and the justification for deviating from such guidelines should be clearly communicated to the markets and to the public.

A monetary policy strategy such as I have just described could be communicated through a regular Monetary Policy Report, perhaps published quarterly. The report would offer an opportunity to reinforce the underlying policy framework of the Committee and how it relates to current and expected economic conditions.

Publishing a Monetary Policy Report with an assessment of the likely near-term path of policy rates, in conjunction with its economic forecast, would also provide added discipline for policymakers to stick to a systematic, rule-like approach. Communication about that path, in turn, gives the public a much deeper understanding of the analytical approach that guides monetary policy, thus making policy more transparent and predictable.

By stating that the new language is consistent with prior guidance, the statement makes no change in forward guidance despite the significant economic progress. I do not view this as appropriately data-dependent policy.

The time-dependent language also risks limiting the Committee's flexibility to act in a more timely manner in response to an improving economy. I am afraid the Committee is not leaving itself the flexibility to respond to the data if we continue to see an improving economy.

Many metrics for assessing the appropriate stance of monetary policy suggest that the federal funds rate should be lifting off from zero soon and should be significantly above zero in June 2015. The Committee's forward guidance strongly suggests that such a policy path is highly unlikely. I believe that waiting too long to initiate a gradual increase in rates could result in the need for more aggressive policy in the future, which could lead to unnecessary volatility and instability.

The failure to adjust forward guidance to reflect the improvement in the outlook for the economy and its continued reliance on the passage of time as a governing factor in the decision to increase rates were the underlying factors warranting my dissent.

I don't believe that we need to follow rules mechanically. Judgment will always be required. Yet, policymakers and the public should be very cautious when they call for policy rates to deviate in significant ways from these guideposts. Making such judgments should require careful analysis, and the justification for deviating from the guidelines should be clearly communicated to the markets and to the public. Thus, policymakers will still be able to exercise discretion, but using rules as guideposts will enhance transparency and effective communication.
...
[P]ublishing a monetary policy report with an assessment of the likely near-term path of policy rates, in conjunction with its economic forecast, would be a useful exercise and enhance communications. It would also provide added discipline for policymakers to stick to a systematic, rule-like approach. And it would force policymakers to think more deeply and systematically about policy and the justification for significant deviations from the guideposts.

Q: Given the low level of inflation, what's so dangerous about pressing for faster growth?

A: It may work out just fine, but theres a risk to that strategy, and the risk is that we wait until the point where markets force us to raise rates and then we have to react quickly and aggressively. I believe that if we wait too long, then we run the risk of falling very far behind the curve or disrupting the economy by rapid rate increases. I would prefer us not to be in that bind because then we really will be between a rock and a hard place. Theres no way at the end of the day that we can change policy without having some volatility. But I would prefer us trying to be a little more I guess Greenspan would have called it pre-emptive but monetary policy works with pretty long lags sometimes and so I think we have to be prepared. Id prefer us acting a little earlier and being able to go gradually than having to wait a long time and having to go rapidly.

Q: O.K., now for the way that the Fed communicates. How should the Fed describe its plans?

A: I would like us to focus more on describing how monetary policy reacts to data. We need to talk about, This happens and were going to do this, that happens and were going to do that." And in doing so you begin to communicate more to the public about, How does the F.O.M.C. think?" And you try to provide some consistency and then the public and the markets learn from that how were likely to act in the future. To me thats better than forward guidance. Why do we want to make commitments about the future when we dont know what it holds?

WSJ: Were all a little consumed right now with the word patient in the policy statement, which Im sure really pleases you. What will it mean when the Fed removes patient from its statement?

PLOSSER: It could mean different things to different people. The chair has articulated what she means. I think it is fair to say that once the committee chooses to remove patient that they are making a different statement about the likelihood and timing of rate increases. More precisely what that means, it will depend on economic conditions. We would save ourselves a lot of headaches and you guys writing a lot of words if we didnt use (words like patient). Ive been only marginally successful in reducing our efforts to do that.

WSJ: The Fed added new words to its policy statement in January, a reference to international developments.

PLOSSER: Our statement is a bit like Hotel California. Words check in and they never check out. We have way too many words. I think our statement is too long. I think it is too confusing. I think it needs a thorough rewrite. Ive suggested that before. Over the course of this unusual period of time, the statement has gotten longer and longer and policy has gotten more and more complex. Im not sure that all of the extra words and all of the complexity have necessarily improved our communication particularly. At times I think it has gotten more confusing and not less confusing.

"We're getting to the point where it's hard to justify not raising rates," said Mr. Plosser, who will retire next month. "There's a good justification for increasing rates earlier."

Mr. Plosser repeated in his interview his long-held belief that the course of economic data suggests the Fed should be raising rates now, or very soon. Mr. Plosser also said the Feds new commitment to be patient when it comes to the timing of rate increases was a bad idea that complicates the central banks other commitment to change rates in reaction to incoming data.

MCKEE: Well how do you shrink the balance sheet? Is the market big enough to absorb Fed sales?

PLOSSER: I think absolutely. Well that doesn't mean -- obviously we are not going to sell them all at once, but I think we can begin a process. I would have argued we should begin letting them stop reinvesting would be the first step, so quit buying. But I think we can let them run off and sell small quantities month by month without disrupting the markets. We bought them without disrupting the markets, so there's no particular reason why we shouldn't be able to sell them without disrupting the markets.

MCKEE: Well you have treasuries and mortgage bonds. Would you sell both?

PLOSSER: Yes. I would tend to want to sell both. I think we have a problem with all the mortgage-backed securities and agency debt that we have. As you know, I have sort of been a -- not been a big fan of that sort of fiscal policy, sort of tax strategy of us helping one market at the expense of the others. So I would be getting rid of both. We -- our long run should be to get back to something that looks like an all-treasuries portfolio.

BARTIROMO: Let's talk about the balance sheet of the Federal Reserve right now. It has grown enormously. How are you going to unwind that balance sheet without impacting global markets?

PLOSSER: Well, I think that's a question we don't know yet. We're in uncharted territory, we've never had to do this. I think the Fed's inclination will be to allow the balance sheet to shrink very slowly, if we can, but policy choices may face us where we may have to raise interest rates more rapidly or sell off assets in the balance sheet.

We don't know what's going to happen, so we need to be prepared for that and I think it's still one of the looming risks of our sort of unconventional policies that we took over during this last eight years.

BARTIROMO: Let me turn your attention to the Federal Reserve firing back at people like Rand Paul. Senator Paul wants this legislation out there, audit the Fed legislation, and he would like Congress to have more oversight over the central bank, which a lot of people feel is going to get more traction with a GOP-led Congress. What do you think?

PLOSSER: Well, I think this is a risky strategy for monetary policy. The Fed is already audited; we publish our balance sheet every week. This is not about financial auditing; this is about policy audits, if you will. And I think it would be very dangerous for the Fed to become ever more politicized by Congress and the government second-guessing policies that they there made.

Mr. Plosser, speaking to reporters, again argued in favor of the Fed raising short-term rates off of their current near zero reading sooner rather than later. He also said the Fed needs to remove from its official policy statement its current commitment to be patient on the timing of rate rises.

Mr. Plosser also told reporters that he could see the Feds overnight target rate rising to 1% to 1.5% by years end. He noted that it would be better to get started on rate rises soon so that they can be gradual.