[T]o capture the benefits of the LSAP you need a fuller model. One of the models currently used by the Federal Reserve Bank of Boston provides a relatively conservative estimate of the economic benefits of a hypothetical additional $750 billion LSAP. Based on historical experience, the model implies that such a purchase would lower long-term rates by 20 to 25 basis points, relative to not making the additional purchases. The impact of this large a reduction in long-term rates is a cumulative gain in real GDP, relative to the base, of 1.6 percent or $260 billion. In our model such a purchase also results in a decline in the unemployment rate of 0.25 percent or 400,000 jobs. Some of the models we run provide a larger impact to such purchases.

[Fed earnings] remittances averaged about $25 billion per year, or 0.2 percent of GDP, over the decade before the crisis. After the balance sheet is normalized, these remittances should return to a similar, modest share of GDP. From the standpoint of the sustainability of federal fiscal policy, remittances are not a first-order concern. That said, an extended period of zero remittances could certainly bring the Federal Reserve under criticism from the public and the Congress. The question is whether the Federal Reserve would permit inflation and thereby abandon its post in the face of such criticism. There is no reason to expect that to happen.

At our January FOMC meeting, we announced we will continue buying longer-term Treasury and mortgage-backed securities at a pace of $85 billion per month.23 Critically, we indicated we will continue these purchases until the outlook for the job market improves substantially, in the context of stable prices. I anticipate that purchases of mortgage-backed securities and longer-term Treasury securities will be needed well into the second half of this year.

I do believe that we're not going to see enough improvement in the very short term to claim victory on the substantial improvement idea, and therefore my recommendation would be to continue {asset purchases} through the end of the second half {of the year}.

Over time, the benefits of our asset purchases may be diminishing. For example, given how low interest rates currently are, it is possible that future asset purchases will not ease financial conditions by as much as they have in the past. And it is also possible that easier financial conditions, to the extent they do occur, may not provide the same boost to the economy as they have in the past.

In addition to the possibility that our policies may have diminishing benefits, they also may have some risks associated with them. I will mention four: credit risk, interest rate risk, the risk of adverse market functioning, and inflation risk. These and other risks are not easy to see or measure, but they need to be taken into account when setting monetary policy…

It is critical that we take these risks into consideration as we make our asset purchase decisions. To minimize some of these risks, we could aim for a smaller sized balance sheet than would otherwise occur if we were to maintain the current pace of asset purchases through the end of this year, as some financial market participants are expecting. This course of action would be all the more attractive if the economic outlook continues to improve, as I expect it will.

To explain this more clearly, if you could picture two lines, one sloping downward, representing the diminishing benefits of our policy actions, and one line sloping upward, representing the rising costs of those actions, we need to think carefully about where those lines will intersect. Those lines will cross at the point where the costs and benefits are equal, and where further policy actions might cause more harm than good. Reasonable people will differ on where that point of intersection may lie, especially given that many of the policy tools we are using are unconventional…

I will conclude by saying that the FOMC’s actions in the current economic cycle have been needed, understood, and generally supported. Going forward, we must take care to balance the costs and benefits of our monetary policy actions, so that we don’t introduce more uncertainty and create problems that hamper our ability to provide a balancing weight to our economy if needed down the road.

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

The Federal Reserve will likely have to continue with its bond buying efforts into the second half of this year but needs to watch out for the possible formation of asset price bubbles, a key central bank official said Tuesday.

"It's something we have to watch out for, particularly for reasons of financial stability," Federal Reserve Bank of Atlanta President Dennis Lockhart told journalists after giving a speech in the Spanish capital.

Mr. Lockhart, who isn't a member of Federal Open Market Committee this year, said there are currently no signs that asset price bubbles are forming. He said that some have pointed to the recent rise of the value of farm land and stock markets as evidence that these assets are no longer rationally valued. "I don't think you can make that claim," he said. "But I think the recent history of our housing bubble suggests we have to be vigilant about that."

As reported by Dow Jones News

Richard Fisher, president of the Federal Reserve Bank of Dallas, said he favors reducing the pace of central bank asset purchases as the U.S. economy gains momentum this year.

“As you approach your goals and things get better, you reduce purchases,” Fisher said in an interview with Kathleen Hays on Bloomberg Radio’s “The Hays Advantage.” “I wouldn’t go from Wild Turkey to cold turkey” in monetary stimulus. “I wouldn’t have favored spiking the punch bowl to the degree we have,” though it would be too abrupt to stop purchases all at once.

Fisher, who doesn’t vote on monetary policy this year, said he opposed the Federal Open Market Committee decision last week to continue purchasing securities at the rate of $85 billion a month. Policy makers have pushed the benchmark interest rate close to zero and expanded Fed assets to more than $3 trillion to spur growth and reduce unemployment.

Fisher said he agreed with St. Louis Fed President James Bullard, who said Feb. 1 he expects the U.S. economic expansion to pick up enough to allow the Fed to reduce purchases by the middle of the year. A reduction in purchases could be motivated by either an assessment that quantitative easing hasn’t been effective or that the economy gained momentum, the Dallas Fed leader said...

“I would not advocate just stopping the program,” he said. Slowing purchases “allows the market to adjust.”

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

"We need some substantial improvement" in the jobless rate to consider a major shift in the Fed's purchases of Treasury and mortgage debt, Federal Reserve Bank of Boston President Eric Rosengren said in an interview with Dow Jones Newswires.

Compared to the current 7.8% unemployment rate, the official said once a 7 1/4% rate is achieved, central bankers would need to have a "full discussion" about the utility of pressing forward with bond buying.

…

Mr. Rosengren also said in the interview he doesn't believe the Fed's very aggressive policy is creating new financial market imbalances.

"I am not seeing strong evidence there is collateral damage" from Fed actions, and "I'm not seeing anything more generally that would pose a macroeconomic concern at this time." For those who believe historic low yields in the bond market represent a bubble, Mr. Rosengren said "the lower interest rates are exactly what we intended on doing," adding "these rates won't stay in place" forever.

We’re at the limits of our understanding of how monetary policy affects the economy… Sometimes when you test the limits you find out where the limits are by breaking through and going too far.

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

The bottom line is that I suspect that mortgage purchases may confer more macroeconomic stimulus dollar-for-dollar than Treasury purchases.

If we are going to purchase more assets, it would be better to purchase Treasury securities rather than agency mortgage-backed securities. Buying MBS rather than Treasuries may reduce borrowing rates for conforming home mortgages, but if so, it will raise interest rates for other borrowers and thus distort credit flows. This is an inappropriate role for the Fed.

Some observers have argued that a long period of low rates can create incentives among market participants (such as banks, insurance companies, and pension funds) to reach for yield by taking on higher levels of risk with adverse consequences for stability. These concerns should be taken very seriously, and a lot of work at the Fed is devoted to monitoring such risks. A short summary would be that there is some qualitative evidence of reaching-for-yield behavior in certain segments of the market, but that we are not seeing anything quantitatively alarming at this point. Of course, the worry is that one often sees only the tip of the iceberg in these kinds of situations, so one needs to be cautious in interpreting the data.