I am closely monitoring how slowing growth, high levels of overcapacity and high levels of debt to GDP in advanced economies outside the U.S. might be impacting economic conditions in the U.S. I am also closely tracking how these issues might be affecting the slope of the U.S. Treasury yield curve as well as measures of tightness in financial conditions.

In light of these challenges, I have been suggesting that removal of accommodation should be done in a gradual and patient manner, based on a realistic assessment of economic conditions. I am also very cognizant that, from a risk management point of view, our monetary policies have an asymmetrical impact at or near the zero lower bound.

SHELBY: Madam Chair, the FOMC's target for the fed funds rate has been at one-half percent or lower since December, 2008. A report last year from the Bank of International Settlements found that the prolonged period of low interest rates may be damaging the U.S. economy resulting in, and I'll quote, "Too much debt and too little growth." In addition the report states, "The low rates may in part have contributed to costly financial booms and busts."

Do you agree that persistently low interest rates can have negative long-term effects on the U.S. economy and could you explain?

YELLEN: Well, I believe that persistent low interest rates we've had have been essential to achieving the progress, but of course low rates can induce households or banks or firms to reach for yield and can stoke financial instability and we are very attentive to that possibility and I would not at this time say that the threats from low rates to moderate to financial stability are elevated. I do not think they're elevated at this time, but it is of course something that we need to watch because it can have that impact. You mention debt, I don't think we're seeing an (inaudible) build up of debt throughout the economy.

Given my outlook and risk assessment, I judge that a cautious and gradual approach to policy normalization is appropriate. Moreover, caution is also called for because of our limited ability to reduce the policy rate to respond to adverse developments, recognizing that we could also use forward guidance and balance sheet policies to provide additional accommodation if that proved warranted.

Empirical work done at the Fed and elsewhere suggests that QE worked in the sense that it reduced interest rates other than the federal funds rate, and particularly seems to have succeeded in driving down longer-term rates, which are the rates most relevant to spending decisions.
Critics have argued that QE has gradually become less effective over the years, and should no longer be used. It is extremely difficult to appraise the effectiveness of a program all of whose parameters have been announced at the beginning of the program. But I regard it as significant with respect to the effectiveness of QE that the taper tantrum in 2013, apparently caused by a belief that the Fed was going to wind down its purchases sooner than expected, had a major effect on interest rates.
More recently, critics have argued that QE, together with negative interest rates, is no longer effective in either Japan or in the euro zone.That case has not yet been empirically established, and I believe that central banks still have the capacity through QE and other measures to run expansionary monetary policies, even at the zero lower bound.Empirical work done at the Fed and elsewhere suggests that QE worked in the sense that it reduced interest rates other than the federal funds rate, and particularly seems to have succeeded in driving down longer-term rates, which are the rates most relevant to spending decisions.
Critics have argued that QE has gradually become less effective over the years, and should no longer be used. It is extremely difficult to appraise the effectiveness of a program all of whose parameters have been announced at the beginning of the program. But I regard it as significant with respect to the effectiveness of QE that the taper tantrum in 2013, apparently caused by a belief that the Fed was going to wind down its purchases sooner than expected, had a major effect on interest rates.
More recently, critics have argued that QE, together with negative interest rates, is no longer effective in either Japan or in the euro zone.That case has not yet been empirically established, and I believe that central banks still have the capacity through QE and other measures to run expansionary monetary policies, even at the zero lower bound.

Current estimates of the natural rate of interest in the United States are subject to a fair amount of uncertainty, but most are clustered at or just above zero. This is well above the actual real funds rate, which has been running below negative one. So at this point, estimates of the natural real rate of interest do not suggest that the zero lower bound is impeding the Fed’s ability to attain its 2 percent inflation objective. In fact, this perspective would bolster the case for raising the federal funds rate target.

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

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

The feedback loop between market expectations of divergence between the United States and our major trade partners and financial tightening in the United States means that material restraint to U.S. conditions is already in place. Looking ahead, a further weakening of foreign growth could pose downside risks to the U.S. outlook. Under normal circumstances, policy in the United States could adjust to signs that spillovers from developments abroad were affecting activity in the United States. But with policy rates in the United States at the lower bound, the ability to offset spillovers from adverse developments in foreign economies with conventional policy is constrained, suggesting greater caution than normal.

I don’t think [negative interest rates are] a question that’s on the table right now because I think the economy is growing above trend and the issue is really a question of when are we likely to raise short term interest rates, not whether we are going to lower short term interest rates below zero. Now the one thing that we have seen over the last year or so is other countries have moved to negative short term interest rates and I would say that on balance the unintended consequences of moving to those negative short term interest rates is it’s probably been less than what people had feared, but they’re doing it in a totally different institutional set up than we have in the United States and so it’s not obvious that just because it’s working relatively okay there that you would necessarily want to import it here.

We have a very different system in terms of how our money markets work and I think you’d have to ask yourself the question is the benefit of going to negative interest rates -- obviously in a very different environment than we are in today -- is that does that outweigh the potential cost in terms of unintended consequences. Obviously, as we went through the financial crisis that was an option and we decided not to pursue that option because of fears that the benefits were not sufficient to outweigh the potential costs.

The decline in the long-run neutral real interest rate increases the likelihood that the economy will run into the lower bound on nominal interest rates. Accordingly, there is an enhanced risk that the Federal Open Market Committee (FOMC) will undershoot its maximum employment and 2 percent inflation objectives. Fiscal policymakers can mitigate this risk by choosing to maintain higher levels of public debt than markets currently anticipate. I want to be clear at the outset that I am not saying that it is appropriate for fiscal policymakers to increase the long-run level of public debt. I am simply pointing to one benefit associated with such an increase: It allows the central bank to be more effective in mitigating the impact of adverse shocks to aggregate demand.

Well I think being at the zero lower bound is not a very comfortable place to be because, one, the tools of monetary policy at the zero lower bound are more limited.

Number two, you also have some consequences for the economy. I think one of the things that makes me less happy is the fact that the crisis was really about debtors. And then the monetary policy response has really been hard on savers. So getting out of the zero lower bound would also be a good thing for savers. So I think my view is I want to get off the zero lower bound as soon as I think it's appropriate because I think being there is just uncomfortable. And I think it's also it would be nice to actually for savers actually to get a positive return.

We have in the past seen sort of false dawns, periods in which we thought our growth would speed, pick up and the labor market would improve more quickly. And later events have proven those hopes to be -- to be, unfortunately, over-optimistic. So we are watching very carefully, especially when short-term, overnight rates are at zero, so we have no ability to lower them further.

We need to be careful to make sure that the economy is on a solid trajectory before we consider raising interest rates. And I think the forward guidance that we have provided and the policies we have -- we have put in place are providing a great deal of accommodation to the economy to make sure that it is on a sound trajectory.

"Should large-scale asset purchases be a standard tool of monetary policy at the [zero-lower bound], and, if so, how should they be implemented?" Mr. Williams asked in the paper, which he was scheduled to present and discuss Thursday at an event organized by the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution, a Washington think tank.

He said this and other questions need more study because being stuck at the so-called zero-lower bound is a serious problem that policymakers are likely to confront again.

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

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

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

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

As the first nation to experience the zero bound in modern times, Japan was an early pioneer in developing unconventional tools and strategies. Its experiences, both good and bad, along with lessons from other periods such as the Great Depression, have helped to inform the policies adopted by the United States (U.S.) and other nations in recent years. The evolution of policy in Japan, in turn, has been informed, in part, by the experience of the U.S. and other nations.

So what have we learned to date? Let me highlight six key points.

First, and most importantly, managing expectations is critical in the execution of monetary policy at the zero bound...

Second, in managing expectations, good communication is essential...

Third, actions speak louder than words alone. Thus, there is an important role for asset purchases that ease financial conditions to support growth and keep inflation expectations well anchored.

Fourth, the policy instruments interact so that policy as a whole exceeds the sum of its parts.

Fifth, at the zero lower bound, risk management becomes extremely important. In particular, because the costs of getting stuck in a liquidity trap with chronic deflation are high, a central bank should put substantial weight on avoiding this outcome.

Sixth, the constraints imposed by the zero bound limit what monetary policy can accomplish by itself. This increases the importance of complementary fiscal, financial, and structural policy actions. Credible fiscal policies, actions to ensure a healthy financial system, and structural reforms that lift the potential for growth are very important.