My preferred policy would be one where we are even clearer in what our intentions are on the federal funds rate and monetary policy.

Let me outline how this balanced policy approach might work in practice. The Fed could sharpen its forward guidance by pledging to keep policy rates near zero until one of two events occurs.

First, this policy would account for the liquidity trap risk by communicating that we intend to keep the federal funds rate at exceptionally low levels as long as the unemployment rate is above a 7 percent threshold.

Reductions in the unemployment rate below this level would represent meaningful progress toward the natural rate of unemployment and might be a reason to lessen policy accommodation. Second, this policy would account for the risk of higher inflation —that is, we would be committed to pulling back on accommodation if inflation rises above a particular threshold.

I would argue that this policy’s inflation-safeguard threshold needs to be above our current 2 percent inflation objective. My preferred threshold is a forecast of 3 percent over the medium term.

I do not believe that establishing an inflation target is inconsistent with a commitment to both parts of the dual mandate. On the contrary, it can help with thinking about and achieving both of our mandated objectives. For example, if having an explicit numerical target for inflation helps anchor inflation expectations over the longer run, then monetary policy will have greater flexibility to pursue the goal of maximum employment in the shorter term.

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.

Inflation is terribly important as a central bank goal and I think we owe the public a commitment to an announced objective for inflation.

 The Fed could sharpen its forward guidance in two directions by implementing a state-contingent policy. The first part of such a policy would be to communicate that we will keep the funds rate at exceptionally low levels as long as unemployment is somewhat above its natural rate. The second part of the policy is to have an essential safeguard — that is, a commitment to pull back on accommodation if inflation rises above a particular threshold. This inflation safeguard would insure us against the risks that the supply constraints central to the structural impediments scenario are stronger than I think. Rates would remain low as long as the conditions were unmet.

 Furthermore, I believe the inflation-safeguard threshold needs to be above our current 2 percent inflation objective — perhaps something like 3 percent...

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.

These changes in the dashboard readings suggest that, in the scenario that the economy evolves in 2012 as the Committee expects, the Committee should reduce the level of monetary accommodation over the course of 2012.

How would the Committee accomplish this reduction? Right now, the Committee is projecting that it will keep its target short-term interest rate extraordinarily low for at least six to seven quarters. In my view, it would be simplest to reduce the level of accommodation by changing that estimate to a shorter period of time.

Two months earlier, Kocherlakota had rejected the idea of changing the guidance because it undermine future precommitment efforts.

The FOMC should do more than simply decide at each meeting whether or not to buy more assets or to keep interest rates low for longer. Any current decision is based on the FOMC’s forecast of the future, and no forecast can be perfect. The Committee should provide a public contingency plan—that is, provide clear guidance on how it will respond to a variety of relevant scenarios.

I believe that public contingency planning will have many benefits. Let me mention two. First, in recent statements and speeches, I have described why the FOMC actions in August and September seemed inconsistent with the evolution of the macroeconomic data in 2011. This kind of inconsistency is much less likely to occur once the FOMC has formulated an explicit public contingency plan. Second, I’ve heard from businesses that policy uncertainty is curbing their incentive to hire or invest. Similarly, I’ve heard from consumers that policy uncertainty is curbing their incentive to spend. A public FOMC contingency plan can help reduce the level of policy uncertainty being created by the Fed.

We could do more in both [balance-sheet expansion and communication] directions. For instance, we could elaborate on our forward commitment to keep short-term rates low. Indeed, I believe it would be desirable if the committee were able to provide additional guidance as to the economic conditions that the committee would expect to see before raising interest rates.

Let me admit that in the midst of the financial crisis in the fall of 2008 one could fairly say that we did not spend sufficient time explaining to the public the unique and extraordinary actions being taken. All I can say is that in the midst of the crisis there was a focus on solutions, and given the severity of the situation, this resulted in our spending less time communicating well about what we were doing and why. Though no excuse, reacting to a crisis in real time effectively requires something else “give” – and we were frankly so preoccupied with extinguishing the fire we did not explain as well as we should have what we were doing and why. At the Fed we have tried since to explain precisely what we did and why, but we are still some distance from being understood, or fully trusted for that matter.

I think the Fed has learned from this.

“Greater transparency should be achievable for us,” Lacker said in response to a question about the Fed’s internal deliberations on communication policy. “For a long time I have advocated an explicit numerical inflation objective.”

“One of the difficult things with President Evans’ proposals is that it only gives a little bit of information about our reaction,” Williams told reporters after his speech. “Personally I would like to see -- if we can and this is hard -- a fuller description of our policy reaction function.”

“I would be favorably inclined if we could communicate our future path of where we think interest rates are going and what factors influence that,” he said.

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.

The Committee should provide a public contingency plan—that is, provide clear guidance on how it will respond to a variety of relevant scenarios.

I believe that this kind of public contingency planning will have many benefits. Let me mention two. First, in recent statements and speeches, I have described why the FOMC actions in August and September seemed inconsistent with the evolution of the macroeconomic data in 2011. This kind of inconsistency is much less likely to occur once the FOMC has formulated an explicit public contingency plan. Second, I’ve heard from businesses that policy uncertainty is curbing their incentive to hire or invest. Similarly, I’ve heard from consumers that policy uncertainty is curbing their incentive to spend. A public FOMC contingency plan can help reduce the level of policy uncertainty being created by the Fed.

No contingency plan can ever be definitive. Inevitably, the FOMC will learn things that it did not expect to learn, and events will occur that it did not expect to occur. And so there may be conditions that force the FOMC to deviate from a chosen plan. However, having a public plan, and couching its decisions against the backdrop of that plan, will enhance Federal Reserve transparency, credibility, accountability and consistency.