John Williams

"Even though we have achieved liftoff, we are by no means rocketing to the moon," he said. While current economic growth rates are "respectable and improving," he said, the recession slashed output so deeply that it still has a long way to go.

As reported by Reuters

The economist said he's not concerned with "too much inflation, but rather too little".

As reported by Bloomberg News

"Even though we have achieved liftoff, we are by no means rocketing to the moon," he said. While current economic growth rates are "respectable and improving," he said, the recession slashed output so deeply that it still has a long way to go.

As reported by Reuters

The economist said he's not concerned with "too much inflation, but rather too little".

As reported by Bloomberg News

The economy today faces many pitfalls, but I don’t believe that runaway inflation is one of them.

Based on econometric analysis and model simulations, I estimate that these longer-term securities purchase programs will raise the level of GDP by about 3 percent and add about 3 million jobs by the second half of 2012. This stimulus also probably prevented the U.S. economy from falling into deflation.

The world changes if the Fed is willing to pay a high enough interest rate on reserves... Classical monetary theory would take it as given that the enormous growth of excess reserves of the past few years would spur inflation. But if all those reserves aren't lent out, and all they do is sit at the Fed gathering interest, then the classical conclusion no longer holds water.

“Make no mistake -- the Federal Reserve doesn’t have a magic wand that will allow the economy to get through a crisis of this magnitude unscathed,” the regional bank chief said in the text of a speech in Salt Lake City. “A federal default must be avoided,” he said.

At our August meeting, the FOMC took a step in that direction, issuing a statement that we are likely to keep the federal funds rate at exceptionally low levels at least through mid-2013. In one respect, this wasn’t such big news. Even before the announcement, financial market participants generally didn’t expect the Fed to raise rates much earlier than mid-2013. But it was news in the sense that it removed uncertainty and helped financial markets better understand our intentions. In response to the FOMC statement, financial market expectations of future interest rates and U.S. Treasury yields fell. Note also that we are not tying our hands by making this announcement. We haven’t made a guarantee. We will alter our policy as appropriate if circumstances change.

Looking ahead, I expect inflation to ease to about a 1½ percent annual pace next year. This is somewhat below the 2 percent level that I see as the appropriate medium-term goal. My expectation that inflation will fall reflects the fact that the economy is performing so far below its potential. Such economic slack tends to depress inflationary pressures. It means that workers have very limited ability to demand higher wages and businesses can’t push through price increases that will stick. For example, the latest report showed that wages grew around 2 percent over the past year, hardly a prescription for high inflation. In addition, surveys show that expectations for inflation remain stable.

The estimated effects [of LSAPs on asset prices] typically lie in the neighborhood of 15 to 20 basis points. Generally, the estimates are reasonably precise. Although some might argue that 15 to 20 basis points is small, keep in mind that the typical response of the 10-year Treasury yield to a 75 basis point cut in the federal funds rate is also about 15 to 20 basis points. I’ve never heard anyone argue that a 75 basis point cut in the funds rate is small potatoes!

"Right now, we’re at an appropriate place for policy,” the regional bank chief told reporters today after a panel discussion in Santa Clara, California. “We just took two pretty strong policy actions."

This afternoon, I will aim to make three basic points: First, despite serious reforms to strengthen our financial system, significant risk remains that another asset bubble could develop. Moreover, the financial system and the economy are still vulnerable to such an event. Second, financial stability should not be thought of as a distinct goal from macroeconomic stability and, therefore, inherently separate from traditional monetary policy. Instead, risks to financial stability are first and foremost risks to future economic activity and inflation. Third, the framework used to analyze the relationship between monetary policy, financial instability, and the macroeconomy needs to be revamped. That framework must take more fully into account the life cycles of asset, credit, and leverage bubbles, and it should consider the role monetary policy plays in feeding or restraining these bubbles.

Additional monetary policy accommodation -- either in the form of additional asset purchases or further forward guidance on our future policy intentions -- may be needed to bring us closer to our mandated objectives of maximum employment and price stability.

“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.

In this environment, monetary policy alone would take a very long time to bring about the desired outcome of maximum employment. Fiscal policy actions that reduce uncertainty and stimulate recovery are badly needed. What would be especially helpful at this juncture are fiscal policy actions that work in tandem with monetary policy to stimulate the economy.

"Asset purchases ... we have done in these big lumps," Williams said. "The way I guess I prefer to think about it is where do we need financial conditions to be" and "how, given how much additional stimulus you may need what's appropriate amount of additional asset purchases to make."

"It would be beneficial to have an asset purchase program, if we were to do one, that had more consistency over time" and that would "allow us to adjust as the outlook changes ... as opposed to announcing an amount."

Fiscal policy actions that reduce uncertainty and stimulate recovery are badly needed.  What would be especially helpful at this juncture are fiscal policy actions that work in tandem with monetary policy to stimulate the economy.  One example of such a policy is the recently announced U.S. government initiative to make it easier for underwater homeowners to take advantage of very low rates and refinance their mortgages.  This will trim monthly payments for some households and could reduce foreclosure rates.  And it could also eventually provide a modest boost to consumer spending.  Other actions that address the continuing problems in the housing market could help spur recovery and enhance the effectiveness of monetary policy as well. 

Williams told reporters that given his forecast for lower inflation than predicted by private forecasters, “there’s a strong argument for buying more mortgage-backed securities.” That suggests a need for policy that is “more stimulative.”

The final force I want to mention is the depressing effect on spending and investment caused by uncertainty. By almost any measure, uncertainty is high. Businesses are uncertain about the economic environment and the direction of economic policy. Households are uncertain about job prospects and future incomes. Political gridlock in Washington, D.C., and the crisis in Europe add to a sense of foreboding. I repeatedly hear from my business contacts that these uncertainties are prompting them to slow investment and hiring. As one of them put it, uncertainty is causing firms to “step back from the playing field.” Economists at the San Francisco Fed calculate that uncertainty has reduced consumer and business spending so much that it has potentially added a full percentage point to the unemployment rate.

The broadest barometer of economic conditions is gross domestic product, which measures the nation’s total output of goods and services. My forecast calls for GDP to rise nearly 2½ percent this year and about 3 percent in 2013. That’s an improvement from 2011, when I estimate GDP grew about 1¾ percent. Unfortunately, such moderate growth will not be enough to take a big bite out of unemployment. The unemployment rate is currently 8.5 percent. I expect it to remain over 8 percent well into next year and still be around 7 percent at the end of 2014.

There’s “only so much headroom to do further Treasuries” beyond the short term, Williams said. He said that he’s in a “close-call space” in seeking a third round of quantitative easing, which will depend on “risks to the forecasts.”

“Right now, my baseline forecast” for the economy “is not a satisfactory forecast,” he said. “Just based on the forecast, you’d want to boost the economy.” Still, it’s not a slam dunk” and “you’d want to weigh the costs and benefits,” he said.

This is a situation in which there’s no conflict between maximum employment and price stability. With regard to both of the Fed’s mandates, it’s vital that we keep the monetary policy throttle wide open.

I need to see significant deterioration in the economy and some threat of deflation or inflation moving significantly below our inflation target before I would consider more QE.

Housing is a major factor in the deep downturn and sluggish recovery we’ve experienced in recent years. It’s not the only headwind. But it’s one of several factors weighing on aggregate spending by consumers, businesses, and government. An aggregate-demand shortfall is something monetary policy can be, should be, and is addressing.

If the economy does need more stimulus, restarting our program of purchasing mortgage-backed securities would probably be the best course of action.

We are far short of maximum employment. And I expect inflation to fall this year below the 2 percent level that we view as consistent with our mandate. This is clearly a situation in which we have to keep applying monetary policy stimulus vigorously… Under current economic circumstances, most Fed policymakers judge that near-zero short-term interest rates will be appropriate well into 2014.

“The probability of needing to do additional stimulus is lower,” Williams told reporters after delivering a speech in San Francisco today. “Relative to a few months ago, I think that the downside risks to the U.S. economy have lessened.”

I’ve heard Europe’s policy described as kicking the can down the road. But the risk is that Europe might be rolling an ever-growing snowball down a hill.

Economists in the structural camp argue that the natural rate has risen substantially.

I’m not convinced. Research at the San Francisco and New York Feds suggests that job mismatches are limited in scope. Over the longer term, mismatches and other labor market inefficiencies may have raised the natural unemployment rate from about 5 percent to around 6 to 6½ percent.7 So, in my view, the nation remains far from the Fed’s goal of maximum sustainable employment.

“One threshold [for another round of asset purchases] for me, in my own thinking, would be if we see economic growth slow to the point where we’re not seeing further progress in bringing the unemployment rate down,” Williams said today on a panel in Beverly Hills, California. Stimulus might also be needed if inflation dropped “significantly” below the Fed’s 2 percent goal, he said. 

Those aren’t “the circumstances I currently expect,” said Williams, who votes on the policy-setting Federal Open Market Committee this year. If additional rounds of bond buying are warranted, the Fed may purchase more mortgage-debt, or extend its program to push out the average-maturity of its holdings, dubbed Operation Twist, he said.

If the outlook for growth worsens to the point that we no longer expect to make sustained progress on bringing the unemployment rate down to levels consistent with our dual mandate, or if the medium-term outlook for inflation falls significantly below our 2 percent target, then additional monetary accommodation would be warranted. In such circumstances, an effective tool would be further purchases of longer-maturity securities, potentially including agency mortgage-backed securities. Past purchases have succeeded in lowering borrowing costs and improving financial conditions, thereby supporting economic recovery.

[M]y forecast calls for real gross domestic product to expand at a moderate pace of about 2¼ percent this year and about 2½ percent next year. I expect the unemployment rate to remain at or a bit above 8 percent for the remainder of this year, and then gradually decline to a little above 7 percent by the end of 2014.

The European sovereign debt crisis threatens banks in that continent, and, by extension, elsewhere. Clearly, it represents a significant threat to financial stability. In the worst case, the European crisis could undermine the financial improvements in North America and Asia. But this crisis is by no means the only risk. Economic trends in many parts of the world appear to be deteriorating. Although growth in the United States remains moderate, Europe looks to be in recession. And, in China, recent indicators point to a marked deceleration in growth. Many large global financial institutions remain highly leveraged and rely on volatile wholesale funding. Others are still working through troubled loan portfolios. Efforts by regulators to close loopholes exposed by the crisis remain a work in progress. They will take years to complete.

"in a world where the Fed pays interest on bank reserves, traditional theories that tell of a mechanical link between reserves, money supply, and, ultimately, inflation are no longer valid. In particular, the world changes if the Fed is willing to pay a high enough interest rate on reserves. In that case, the quantity of reserves held by U.S. banks could be extremely large and have only small effects on, say, the money stock, bank lending, or inflation."

"if the economy improved markedly, inflationary pressures could build. Under such circumstances, the Federal Reserve would need to remove monetary accommodation to keep the economy from overheating and excessive inflation from emerging. It can do this in two ways: first, by raising the interest rate paid on reserves along with the target federal funds rate; and, second, by reducing its holdings of longer-term securities, which would reverse the effects of the asset purchase programs on interest rates."

We are falling short on both our employment and price stability mandates, and I expect that we will make only very limited progress toward these goals over the next year. Moreover, strains in global financial markets raise the prospect that economic growth and progress on employment will be even slower than I anticipate. In these circumstances, it is essential that we provide sufficient monetary accommodation to keep our economy moving towards our employment and price stability mandates.

If further action is called for, the most effective tool would be additional purchases of longer-maturity securities, including agency mortgage-backed securities. These purchases have proven effective in lowering borrowing costs and improving financial conditions.

At the Fed, we take our dual mandate with the utmost seriousness. This is a period when extraordinary vigilance is demanded. We stand ready to do what is necessary to attain our goals of maximum employment and price stability.

"When you weigh the costs and benefits ... it's at the point where it is definitely tilting toward taking further action,"

"It seems like if we have the tools to move us faster toward our goals, we should use them."

QE3 is "a very big step. ... The hurdle to taking this step is relatively high. In my view, we have reached that hurdle."

Williams has previously suggested that the Fed, if it embarks on QE3, should consider an open-ended program. With the first two rounds of quantitative easing, the Fed stated how many dollars worth of bonds it would buy and over what time frame. In an open-ended program, the Fed would leave both parameters open and say that it plans to continue buying mortgage or Treasury bonds until the economy improves. The Fed could also be more specific and continue buying until GDP or unemployment reaches a certain level. Williams said it "would be useful" to give some type of "benchmarks or guideposts." But reaching and communicating a consensus on this issue could be difficult.

Although we can’t know exactly what the natural rate of unemployment is at any point in time, a reasonable estimate is that it is currently a little over 6 percent. In other words, right now, an unemployment rate of about 6 percent would be consistent with the Fed’s goal of maximum employment.

The Fed should consider keeping interest rates low until unemployment falls "somewhat below" 7 percent, Williams told Reuters in an interview, adding that he would tolerate a rise in inflation to 2.5 percent before he would see a need to reconsider the Fed's current zero-interest-rate policy.

"It's very desirable to try to explain our policy in terms of thresholds," Williams said… "As long as inflation stays within half a percentage point of a 2 percent objective, I think you could argue for a lower unemployment rate" than the 7 percent threshold that Evans has proposed.”

I should stress that our recently announced purchase program is intended to be flexible and adjust to changing circumstances. Unlike our past asset purchase programs, this one doesn’t have a preset expiration date. Instead, it is explicitly linked to what happens with the economy. In particular, we will continue buying mortgage-backed securities until the job market looks substantially healthier. We said we might even expand our purchases to include other assets. But, if we find that our policies aren’t doing what we want or are causing significant economic problems, we will adjust or end them as appropriate.

In closing, I’d like to make a point about the Fed’s dual mandate. We are unusual among central banks in that, since the 1970s, we’ve been charged with both employment and inflation goals. Both aspects of the mandate are important. But which is the most pressing concern has changed over time. From the late 1960s through the early 1990s, inflation was consistently running well above 2 percent. Naturally, during that period, much of the discussion about monetary policy centered on inflation and how to bring it down.

Today the situation is very different. Since the early 1990s, inflation has been consistently low, averaging right around 2 percent, and, most recently, even less than that. At the same time, the unemployment rate has remained far above the maximum employment level for over four years straight. Thus, unemployment is—and should be—a central focus of monetary policy right now. This concentration on getting unemployment down in no way represents a lessening of the importance of price stability. Quite the opposite. Consider that, if the recovery loses steam, inflation could fall too low—well below our 2 percent goal.

“We should continue the MBS purchases into next year and continue the Treasury purchases,” Williams said to reporters today after a speech in Salt Lake City.

The purchases will be warranted until there’s evidence of “a sustained, significant improvement in the labor market,” such as a pace of payrolls growth more than 200,000 jobs a month, Williams told reporters.

“If you talked about 200,000 or 190,000 or that kind of thing, that’s not enough of an improvement,” Williams said. “I would want to see a measurable decline in the unemployment rate and a significant, sustained, well above 200,000 jobs a month on payrolls, and coherence across lots of indicators. Not one that’s strong, but all of them pointing in the same direction.”

“It should be at least that big but I would think it would probably be bigger given my view on how slow the economy is going,” Williams said, referring to his Aug. 31 comment that the Fed should purchase $600 billion in bonds in a third round of asset purchases.

Finally, although it’s not our main intention, these unconventional policies have also had an effect on the dollar versus foreign currencies. When interest rates in the United States fall relative to rates in other countries, the dollar tends to decline as money flows to foreign markets with higher returns. One estimate is that a $600 billion program like QE2 causes the dollar to fall by roughly 3 or 4 percent. That helps stimulate the U.S. economy by making American goods more competitive at home and abroad.

I expect it will be some time until the job market makes substantial progress towards our congressionally mandated maximum employment goal. Therefore, I anticipate that we will need to continue our purchases of mortgage-backed securities and longer-term Treasury securities past the end of this year and likely well into the second half of next year in order to best achieve our mandated goals. As I noted, the ending date for these programs will hinge on the performance of the economy.

Consistent with these findings, my estimate of the current natural rate of unemployment is about 6 percent, roughly 2 percentage points below the current unemployment rate. This 6 percent figure is consistent with many other estimates, including the most recent median estimate of the Survey of Professional Forecasters.

Fortunately, many of the influences that have elevated the natural rate of unemployment since the crisis and recession should fade over time. In fact, this process is already under way. The extended unemployment insurance programs have been scaled back and are affecting fewer and fewer people. Eventually these programs will be phased out. In addition, measures of mismatch between workers and available jobs are receding. And, at least so far, we are not seeing permanent scarring effects of long-term unemployment. I expect that, in coming years, the natural rate will return to a more historically typical level of about 5½ percent.

The Fed’s dual mandate from Congress is to pursue maximum employment and price stability. We are missing on both of these goals.

Forward guidance works by influencing the public’s expected path of short-term interest rates. Expectations of low yields on short-term assets for a prolonged period make investors more willing to purchase and hold longer-term securities. That, of course, increases their prices and reduces their yields. To give you a sense of the impact of this tool, the unexpected extension of our forward guidance in August 2011 lowered yields on longer-term Treasury securities by about 0.2 percentage point. That’s comparable to a cut in the funds rate of ¾ to 1 percentage point. When we cut the funds rate that much, financial markets sit up and take notice.

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.

The Fed has stated that it will continue its bond buying until it sees substantial improvement in labor markets, but it has not defined what that improvement would look like. Mr. Williams noted there's some "purposeful ambiguity" around the terminology, but added he'd like to see sustained monthly job gains over 200,000 a month, joined with a rise in the labor force participation rate.

As reported by Dow Jones News

I’m looking for convincing evidence of sustained, ongoing improvement in the labor market and economy. The latest economic news has been encouraging. But it will take more solid evidence to convince me that it’s time to trim our asset purchases. An important rule in both forecasting and policymaking is not to overreact to what may turn out to be just a blip in the data. But, assuming my economic forecast holds true, I expect we will meet the test for substantial improvement in the outlook for the labor market by this summer. If that happens, we could start tapering our purchases then. If all goes as hoped, we could end the purchase program sometime late this year.

It’s important to note that tapering our purchases and even ending the purchase program doesn’t mean that we are removing all the monetary stimulus that comes from our longer-term securities holdings. Instead, even as we cut back our purchases, we’re still adding monetary accommodation and exerting greater downward pressure on interest rates. Economic theory and real-world evidence indicate that it’s not the pace at which we buy securities that matters for influencing financial conditions. Rather, it’s the size and composition of the assets we hold on our balance sheet. So, even when we stop adding to our portfolio, it doesn’t mean we’re tightening policy.

There is indeed little doubt that the economy is on the mend. The clearest evidence can be found in housing, by far the sector hit hardest during the recession. Mortgage rates have fallen to levels rarely, if ever, seen before. Typical fixed-rate mortgages are around 3.5 percent, putting them in reach of millions of households. Affordable mortgages fuel demand for homes, and that pushes up sales and prices. Year-over-year, house prices are rising at around a double-digit rate.

The recovery in home prices has all sorts of beneficial effects. Increasing numbers of underwater homeowners are finding themselves on dry land again. Their properties are now worth more than their mortgages, making them less likely to default. Meanwhile, other homeowners find their mortgages have dropped below the critical 80-percent-of-home-value barrier. That makes it easier to refinance at today’s low rates, freeing money to spend on other things.

...

I expect the unemployment rate to decline gradually over the next few years. My forecast is that it will be just below 7½ percent at the end of this year, and a shade below 7 percent at the end of 2014. I don’t see it falling below 6½ percent until mid-2015. This forecast of a gradual downward trend in the unemployment rate reflects the combined effects of expected solid job gains and a return of discouraged workers to the labor force.

...

It’s clear that the labor market has improved since September. But have we yet seen convincing evidence of substantial improvement in the outlook for the labor market, our standard for discontinuing our securities purchases? In considering this question, I look not only at the unemployment rate, but also a wide range of economic indicators that signal the direction the labor market is likely to take...  [M]ost of these indicators look healthier than they did in September. What’s more, nearly all of them are signaling that the labor market will continue to improve over the next six months. This is good news. But it will take further gains to convince me that the “substantial improvement” test for ending our asset purchases has been met. However, assuming my economic forecast holds true and various labor market indicators continue to register appreciable improvement in coming months, we could reduce somewhat the pace of our securities purchases, perhaps as early as this summer. Then, if all goes as hoped, we could end the purchase program sometime late this year. Of course, my forecast could be wrong, and we will adjust our purchases as appropriate depending on how the economy performs.

[T]he Committee’s policy statements have specified that we expect to keep the federal funds rate exceptionally low at least as long as, one, “the unemployment rate remains above 6½ percent”; two, “inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal”; and three, longer-term inflation expectations remain in check.

With this forward guidance in place, members of the public can adjust their expectations for future Fed policy as new information on the economy becomes available. They don’t need to wait for the Fed to issue a new statement. For example, a slowdown in economic growth might cause the public to think that the prospect of reaching a 6½ percent unemployment rate was falling further back in time. They would then expect the Fed to wait longer to raise the federal funds rate, which would prompt them to push long-term interest rates down. And those lower long-term rates would help us achieve our monetary policy goals.

“Even if we do adjust downward our purchases, it doesn’t mean we’re now in some autopilot of moving in the same direction,” Williams, 50, said in an interview yesterday in San Francisco. “You could even imagine a scenario where we adjust it downward based on good data and then adjust it back” if the economy weakened.

“We can adjust it down some, watch how things progress from there, and then adjust it again one way or the other,” Williams, who doesn’t vote on monetary policy this year, said at the San Francisco Fed. A slowing or end of the purchases also “doesn’t mean we’re going to start tightening policy anytime soon,” he said.

With continued “good signs” on jobs and confidence in a “substantial improvement” I could see as “early as this summer some adjustment, maybe modest adjustment downward, in our purchase program,” he said today in Stockholm. The program “is doing this great job of helping the economy gain momentum, and I would want to see that continue well into the second half of this year, but if things, again if they go well, you could imagine ending the program by the end of the year.”

I would like to emphasize three points regarding the potential timeline for adjusting our asset purchase program.  First and foremost, any adjustments to our purchase program will depend on the new economic data that come in.  In other words, we will modify our plans as appropriate if economic developments turn out differently than we currently expect.

Second, reducing or even ending our purchases does not mean the Fed will be tightening monetary policy.  Not at all.  The amount of stimulus our purchase program creates depends on the size of our securities holdings, not the amount we buy each month.  Even if we start reducing our purchases later this year, our balance sheet will continue to grow, providing an increasing amount of stimulus.  That is, as long as we are adding to our holdings of assets, we are adding monetary stimulus to the economy.

Third, future adjustments to our asset purchases in no way alter or undermine our approach of maintaining the current very low federal funds rate at least as long as the unemployment rate is above 6½ percent and the other conditions regarding inflation and inflation expectations are met.  Indeed, as the FOMC projections released last week show, a large majority of Committee participants don’t expect the first increase in the federal funds rate to occur until 2015 or later.  And the median projected value of the federal funds rate at the end of 2015 is only 1 percent.

This analysis highlights three important insights for monetary policy under uncertainty. First, even in the presence of considerable uncertainty about the effects of monetary policy, the optimal policy nevertheless responds strongly to shocks: uncertainty does not imply inaction. Indeed, in the estimated model, the optimal conventional and unconventional policy responses in the current situation are quite strong, just not as strong as would be called for absent uncertainty. Second, one cannot simply look at point forecasts and judge whether policy is optimal or not. One needs to evaluate policy in the context of the distribution of forecasts that accounts for uncertainty. Indeed, once one recognizes uncertainty, some moderation in monetary policy may well be optimal. Third, in the context of multiple policy instruments, the optimal strategy is to rely on the instrument with the least uncertainty and use other, more uncertain instruments, only when the least uncertain instrument is employed to its fullest extent possible.

“The decision when and if to taper later this year will depend on the data, and specifically are we still seeing signs of positive momentum,” Williams said. “I’m not going to speak about what meeting or not, but I do think that if the data continue to progress as we’ve seen, then I do agree that we should edge down or taper our purchases later this year.”

Some investors “were thinking the Fed was going to keep buying forever, QE infinity,” Williams said today in a CNBC television interview from Jackson Hole, Wyoming. “We had always communicated that that’s not what our plan was.”

“Some of the adjustment in the bond market probably was kind of bringing people back to reality that this was a program that wasn’t going to continue forever,” he said. “And I think that, maybe, eliminates some of the froth in the bond market.”

Clearly, the unemployment rate plays an important role in our thinking and communication about future policy. Therefore, an important issue is whether it is giving an accurate read on where things stand relative to our maximum employment mandate. The unemployment rate measures the percent of the labor force that is out of work and looking for a job. It has a number of advantages as a measure for summarizing the state of the labor market. For one thing, over time it has proven to be a reasonably stable and predictable barometer of whether labor market conditions are too hot, too cold, or just right in terms of creating inflationary pressures. Although structural changes in the labor market affect the unemployment rate, most of the variation in unemployment over time reflects cyclical factors, that is, whether the economy is too hot or too cold. And, second, the rate closely tracks other indicators of how much slack there is in the labor market, such as data from surveys on the share of households that finds jobs hard to get and the share of businesses that say it’s hard to fill openings. This adds to our confidence in its reliability.

All the same, there are reasons to worry that the unemployment rate could now be understating just how weak the labor market is. In particular, during the recovery, the share of the working-age population that is employed has increased very little, even as the unemployment rate has fallen. Taken at face value, the very low ratio of employment to population suggests that the labor market has improved far less than what’s implied by the decline in the unemployment rate.

So should we stop using the unemployment rate as our primary yardstick of the state of the labor market in favor of the employment-to-population ratio? My answer is no. Although the unemployment rate is by no means a perfect measure of labor market conditions, the employment-to-population ratio blurs structural and cyclical influences. That makes it a problematic gauge of the state of the labor market for monetary policy purposes…

…

What does that mean for monetary policy? First, the unemployment rate and a number of other labor market indicators, such as payroll job gains, point to continued progress in the labor market. Clearly, we are getting closer to meeting our test of substantial improvement in the labor market.

Second, any changes in policy will depend not only on labor market conditions, but also on inflation. In our July statement, the FOMC noted that inflation persistently below 2 percent could pose risks to economic performance. That means we will also take into consideration whether inflation is moving closer to our target. Third, any adjustments to our purchases are likely to be part of a multistep gradual process, reflecting the pace of improvement in the economy.

As I noted earlier, Chairman Bernanke has laid out a timetable for our securities purchases, which includes reducing them later this year and ending them around the middle of next year, assuming our forecasts for the economy hold true. I haven’t significantly changed my forecast since then, and I view Chairman Bernanke’s timetable to still be the best course forward. However, I can’t emphasize enough that when and how we adjust our purchases will depend crucially on what the incoming data tell us about the outlooks for the pace of improvement in the labor market and movement towards our inflation goal.

The evidence to date provides support for the view that financial markets are segmented and that asset purchase programs affect interest rates and other asset prices. There have been numerous studies of the effects of our asset purchases on longer-term interest rates.3 This analysis suggests that each $100 billion of asset purchases lowers the yield on 10-year Treasury notes by around 3 to 4 basis points, that is between 0.03 to 0.04 percentage point. That might not sound like much. But consider the Fed’s so-called QE2 program in 2010-11 that totaled $600 billion of purchases. According to estimates, that program lowered 10-year yields by about 20 basis points. That’s about the same amount that the 10-year Treasury yield typically falls in response to a cut in the federal funds rate of ¾ to 1 percentage point, which is a big change.4 Applying the same logic to the current, much larger, asset purchase program, the implied reduction in longer-term interest rates is roughly 40 to 50 basis points.

We just saw a case study of how changes in expectations of the Fed’s asset purchases affect longer-term interest rates and financial conditions more broadly. The FOMC’s announcement on September 18 that it would not change the pace of asset purchases appeared to cause financial market participants to expect that the Fed would purchase more assets in the future than they had previously believed. As a result, in the minutes following the announcement, the yield on the 10-year Treasury note fell by 18 basis points. The effects didn’t stop there. The stock market rose about 1¼ percent and the value of the dollar against the euro fell by around 1 percent.

What do these asset purchases accomplish? Well, no surprise here, theoretical economists are of two minds on this issue. In a textbook world of perfect-functioning financial markets, LSAPs would have essentially no effect, positive or negative. According to this theory, the price of an asset depends solely on its expected future returns, adjusted for risk. Investors bid prices up and down so that risk-adjusted returns of different kinds of assets are equal. If the price of a specific asset deviated from this level, arbitrageurs would swoop in to take advantage of the discrepancy, knowing that the price would inevitably return to its proper level. So, under these assumptions, since asset purchases by the Fed don’t fundamentally change the risk-adjusted returns to assets, they wouldn’t do anything to asset prices or the economy more broadly.

In reality, financial markets don’t work nearly so seamlessly, which creates a potential role for asset purchases to have meaningful effects on the economy. Long ago, future Nobel laureates James Tobin and Franco Modigliani argued that certain financial markets are segmented. Some investors, such as pension funds, have strong preferences or even legal restrictions on where they put their money. Such “preferred habitats” for certain types of investments can interfere with the equalization of risk-adjusted returns to different assets…

Now, if the Fed buys significant quantities of longer-term Treasury or mortgage-backed securities, then the supply of those securities available to the public declines. As supply falls, the prices of those securities rise, and the yields on these assets decline. The effects extend to yields on other longer-term securities. Mortgage rates and corporate bond yields fall as investors who sold securities to the Fed invest that money elsewhere. Hence, our asset purchases drive down a broad range of longer-term borrowing rates. And those lower long-term interest rates stimulate the auto market, the housing market, business investment, and other types of economic activity.

A second form of forward guidance is the FOMC’s projections of the federal funds rate for the next few years. Four times a year, the FOMC participants submit their views on the appropriate future path for the federal funds rate, along with the associated projections for economic growth, unemployment, and inflation. The FOMC projections for the federal funds rate from our September meeting are shown in Figure 2. A large majority of FOMC participants—14 out of 17—expect the first federal funds rate hike to take place in 2015 or later. And after the first rate hike, most FOMC participants expect the funds rate to increase only gradually, with the median projection showing it rising to just 2 percent by the end of 2016.

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.

The aims of the Federal Reserve’s monetary policy are full employment and price stability. These goals are set down in law by Congress. In plain English, that means that there should be enough jobs for everyone and your paycheck should hold its value. These are laudable goals that I think everyone can support.

But there’s a lot of noise around monetary policy and our intent can get lost in the ruckus. And when we don’t explain what we’re doing and why, I’m afraid the “MSU principle” can take over. That is, people will just “make stuff up.” So we at the Fed have been making a concerted effort to bring greater clarity and transparency to the discussion.

Putting all of this together, with monetary policy continuing to provide needed stimulus, I expect economic growth to pick up somewhat next year. As the economy continues to get better, the highly accommodative stance of monetary policy will need to be gradually adjusted back to normal. The first step will be to slow the pace of asset purchases over time, eventually ending them altogether. This won’t be a slamming on the brakes, it will be an easing off the gas. And it will not be a fixed date on the calendar. Instead, it will be in response to economic developments and the progress we have made towards our dual goals of maximum employment and price stability.

…

In my own projection, even though I expect the unemployment rate to fall below 6½ percent early in 2015, I don’t currently expect that it will be appropriate to raise the federal funds rate until well after that, sometime in the second half of 2015.

Although individual estimates differ, this analysis typically suggests that $600 billion of Fed asset purchases lowers the yield on 10-year Treasury notes by around 15 to 25 basis points.1 To put that in perspective, that’s roughly the same size move in longer-term yields one would expect from a cut in the federal funds rate of ¾ to 1 percentage point.

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.

While {Williams} is not ready now to put a cap on the size of the Fed's third round of quantitative easing, he indicated he could support such a cap when the FOMC has sufficient evidence to start tapering.

"Maybe when we get to that point ... we may turn to a more specific roadmap at that point," he said.

"Maybe if we were ready ... to stop purchases (the FOMC could) just announce a plan to stop purchases over the next 10 months and finish with a certain amount of purchases," he went on. "Instead of leaving it out there in the open (the FOMC could) make it really clear ... that total purchases will be that (amount)."

Williams said such a finite description of the winding down of QE3 could be "a way to ease this communication challenge of tapering."

"If we needed to we could start the program again," he added.

The reversal of federal fiscal policy from stimulus to austerity in the intervening years has added to the factors holding back the economic recovery. On one side, we had income tax increases on upper-income Americans and the expiration of the Social Security payroll tax cut. These took a bite out of disposable income that could otherwise have been directed toward spending. On the other, budget austerity and sequestration have resulted in a drag on spending by the public sector. Overall, it is estimated that federal fiscal policy is subtracting 1½ percentage points from economic growth this year.

It is often said that when America sneezes, the world catches cold. This adage is a modern adaptation of the 19th century saying—attributed to Prince Klemens von Metternich—that, “When Paris sneezes, Europe catches cold.” Today, economic developments in China have obvious repercussions across borders as well, affecting everyone from small emerging economies to Europe and the United States. We live in a world where our economic fates are increasingly intertwined. Indeed, Metternich’s saying is now often heard with China as the proverbial sneezer.

In an interview with Reuters, John Williams, president of the San Francisco Federal Reserve Bank, said the central bank needed to do more to convince investors that rates will stay low long after the Fed stops buying bonds. It should not wait to twin that message with a decision on cutting back its bond-buying stimulus, he said.

But once the Fed decides the economy is strong enough for the Fed to reduce its $85 billion in monthly bond purchases, it should announce an end date and a purchase total for the program, Williams said.

For now, he said, the Fed must drive the message of continued support for the economy.

"My view would be that we would not be raising the funds rate even if the unemployment rate was below 6.5 percent as long as inflation continued to be low, for some time," Williams said. "We need to be communicating more about the post-6.5-percent world now, because it could be with us much sooner than we expect, and I don't want market participants to be surprised."…

The goal, he said, is that people understand the Fed is "not in a rush" to raise interest rates. For his part, he said, he does not expect rates to rise until the latter part of 2015.

…

Williams first publicly embraced the idea of capping bond buys in early November as a way to give investors clarity on the Fed's next steps, and the idea may be gaining traction. Philadelphia Fed President Charles Plosser, a hawk who opposed the Fed's current round of bond buys from the start, has also floated the idea of capping QE in order to shore up the Fed's credibility.

Williams is a strong supporter of the Fed's bond-buying program. On Tuesday, he said he believes that the Fed needs to do more to prove it is committed to keeping short-term rates low as long as needed to support the recovery.

Most importantly, he said, the Fed should give better guidance on what would induce it to raise rates once the U.S. unemployment rate falls to 6.5 percent, the level at which the Fed said has said it would consider an interest-rate hike.

…

"Most participants" at the Fed's latest policy-setting meeting thought lowering the rate was "worth considering at some stage," according to minutes of the meeting released last month.

Critics worry whether money markets can still function if rates fall to zero; indeed, over the years, the Fed has considered and rejected the idea of reducing the rate in part because of that very concern.

But a new central bank tool blunts that risk, Williams said on Tuesday.

Known as a fixed-rate full-allotment reverse repo facility, the tool has been touted as a way to mop up excess cash in the financial system once the Fed needs to start raising rates.

But it could also be helpful should the Fed decide to lower the rate it pays to banks, Williams said.

"We do have this ability through this reverse repo that's been tested by the New York Fed that basically makes sure we can control short-term interest rates even if we ... lowered the interest on reserves closer to zero,"

Our forecast has the unemployment rate only gradually coming down and the economy growing only about 3%. I can imagine a scenario where the economy is growing much faster than that, employment is improving much more quickly and unemployment coming down much sharper and we would want to step up the pace of reductions in the asset purchases by more than $10 billion per meeting, in a situation like that, to accelerate the end of the program.

"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.

Economists at the Federal Reserve Bank of San Francisco estimate that the rise in policy uncertainty over the past several years increased the unemployment rate by as much as 1¼ percent, as of late 2012.2 That translates into nearly 2 million lost jobs.

Although the decline in the unemployment rate in part reflects an increase in employment over the past few years, it can also be traced to an unusually large drop in the labor force participation rate. Now, the majority of that decline over the past six years is due to structural factors, rather than cyclical. These include the first wave of baby-boomers entering retirement and the growing number of disability claimants among the working-age population.
There is, however, some non-participation in the labor market that appears to be cyclical. For example, the number of people in school and not in the labor force rose considerably over the past several years. We also see a large number of people who have dropped out of the labor force but still say they want a job. Combined, these groups account for a good part of the increase in non-participation not related to retirement. It’s likely that many of these people will come back to the labor force as job-seekers as the market improves. We can therefore think of them as a source of labor market slack that is not reflected in the official unemployment rate, though I’d stress that we can’t say precisely to what extent.

Assuming the economy evolves more or less in line with our expectations—and, like the saying goes, it’s difficult to make predictions, especially about the future—the gradual tapering in the pace of asset purchases will continue. It is not locked in, but the bar for altering the path is high. In particular, it’s important for monetary policy to keep focused on the medium-term outlook for the economy and not overreact to month-to-month movements in the data.

Whenever we do make any change, participants are trying to divine what else that might mean. With the taper, I was surprised -- and disappointed even -- that the discussion around tapering was misconstrued as a sign of a more hawkish or tighter FOMC. I was thinking no, no, no -- we’re continuing a process that we tried to communicate. The taper is one step in this, but in no way does moving to the next step imply a change in the view of when we’ll start raising interest rates.

I think last year we learned that the communication hasn’t totally been absorbed by people. We put an emphasis on trying to separate those two things out: The taper is one decision, raising interest rates is one. We got back to a good place.

Now the discussion about when we’re going to raise interest rates and the pace at which we’re going to raise interest rates is stirring that same thing: If the Fed is talking about it, maybe they’re going to do it sooner than we thought. I think the lesson is that confusing the two is something that we have to make sure we explain.

In my view, we haven’t changed fundamentally. The statement had to evolve because the unemployment rate came down to 6.5 percent. Sure, you do see in the projections that the committee members forecast a little bit higher average interest rate in 2016, but to me that’s consistent with the fact that unemployment has come down a little bit. As we get toward the end of 2016, sure, we’re maybe normalizing monetary policy out there a little bit more than people thought in December. But that’s not a shift in monetary policy. That’s just a reflection that the economy has gotten a little bit better and interest rates might be just a little higher than people thought before.

In the big picture, the policy hasn’t changed. Any kind of standard way of thinking about monetary policy is, with unemployment lower, then down the road interest rates will normalize a little bit faster. We’re talking again about 2016. There’s no, to my mind, near-term change for monetary policy.

What does a "considerable period" [after ending asset purchases] mean? It’s not specific about a time frame. That was a conscious decision. My view is if the economy evolves the way I expect, I expect us to end the asset purchase program late this year -- when exactly that occurs will depend. I don’t expect us to start raising interest rates until the second half of 2015.

Any interest rates increases we do have in 2015 will be relatively gradual. Similarly for 2016, the central tendency of the group is to have interest rates 2 percent or a little bit above, which again is very low by any standard. In the FOMC statement, we specifically made note of that.
…
Eventually we’re going to raise interest rates. Understand that any interest rate increases we do are going to be in the context of a shallow glide path, or a gradual process over what looks like several years before we get back to a normal level.

The view is that we’re going to raise rates relatively gradually, so that at the end of 2016 my own view is that interest rates will be well below 4 percent. Even if 4 percent is the right number -- which, you know, who knows? -- it will take quite a long time before we get to that 4. Of course along the way we’ll be evaluating this and even actually reevaluating whether 4 percent is the right long-run number.

“We’re exactly on the right track” with current policy, Williams said in an interview yesterday in San Francisco, predicting unemployment will fall to 5.5 percent by the end of next year and inflation will accelerate to about 1.7 percent.
Trying to achieve the Fed’s goals sooner “would take policy actions that might have more negative effects,” he said.
Williams, who has consistently supported record stimulus, said the Fed will probably continue paring its asset purchases and end them late this year. Central bankers should take care not to change their forward guidance on the path of interest rates in a way that eases policy too much, he said.
“Adding more and more stimulus either through asset purchases or even trying to put even stronger forward guidance does create more risks about getting policy right on the exit,” said Williams… It also raises questions about whether the Fed is “contributing to potential risks with financial stability, excessive risk-taking.”

…
The San Francisco Fed chief said he doesn’t see the currently “very narrow spreads” in some corners of the credit market such as junk bonds and leveraged loans as “a big risk” to the economy or the financial system. Even so, “that is an issue, and that’s an issue that we need to keep watching.”

officials will need to rely more on their public speeches to get their messages across rather than cram all their ideas into a single FOMC statement, said Williams, 51. He said that he “liked what we did” with the new guidance announced last month, which he described as “very good.”
“As you get closer to your goals, there are so many factors” behind “when to raise rates and how fast to raise rates,” he said. “It’s impossible to describe it in a page without losing that ability to do policy in the best possible way.”

Fed officials will need to rely more on their public speeches to get their messages across rather than cram all their ideas into a single FOMC statement, said Williams, 51. He said that he “liked what we did” with the new guidance announced last month, which he described as “very good.”
“As you get closer to your goals, there are so many factors” behind “when to raise rates and how fast to raise rates,” he said. “It’s impossible to describe it in a page without losing that ability to do policy in the best possible way.”

Federal Reserve Bank of San Francisco President John Williams said the pace at which the Fed is reducing its asset purchases is “pretty much baked in the cake” and that central the bank shouldn’t start raising interest rates until the second half of next year.

“We’re closing in on the final stages of tapering,” Williams told reporters today following a panel discussion in Dallas. “I don’t see a lot of benefit to modifying” the pace unless there’s a “dramatic change” in the economic outlook, he said.

Now, thankfully, the extraordinary is turning back into the ordinary, and we are starting down a path towards normalization, both for the economy and monetary policy. Well venture down this path slowly, and monetary policy will remain highly accommodative for some time. But I am happy to say that we are on the road back to normal.

Despite all this good news, there is one area of concern, which is housing. Historically, most recessions have been followed by housing revivals, which significantly boosted the early stages of recovery. I therefore expected housing to be a much stronger tailwind by now. While home construction and sales showed substantial momentum in 2012 and the first half of 2013, the wind has been taken out of the sails since then. Much of the slowdown in housing-market activity appears to be due to last years jump in mortgage interest rates. Although that is unlikely to reverse, other factors driving this sector should improve and I remain cautiously optimistic about the outlook for housing over the next few years.

As I said, employment has been growing at a good clip. In fact, the number of private-sector jobs is back above its pre-recession peak. Overall employment, which includes the public sector, will probably reach its previous peak in another month or so. But thats the number of jobs. In the interim, the population has been growing, bringing more potential workers into the fold. At the same time, the first round of baby boomers is headed into retirement, which means people being taken out of the labor pool.

Its hard to know precisely what the natural rate is, but I put it around 5 to 5 percent. To put things in perspective, the current unemployment rate of 6.3 percent is still well above the natural rate. My forecast is for the unemployment rate to gradually decline over the next two years, reaching the natural rate sometime in 2016.

One indication that unemployment is still higher than its natural rate is that growth in workers pay has been pretty modest. In fact, wage growth has averaged only about 2 percent over the past few years, and there are few signs of any acceleration in wages. That said, I expect that once the unemployment rate gets even closer to its natural rate, wage growth should pick up.

Youll sometimes hear people assigning a liberal slant to quantitative easingbut it was actually proposed by Milton Friedman. In 2000, he was asked what more the Bank of Japan could do to combat deflation, since they were constrained by the zero lower bound. Friedman said, Its very simple. They can buy long-term government securities. Which is exactly what the Fed has been doing.

At this point, it would take a substantial shift in the economic outlook to derail the tapering process.

I say this a lot, because its an important message to get across: The taper does not reflect a tightening of monetary policy. Were not putting out the fire, were just gradually adding less and less fuel. Its just one small step towards policy normalization, when the economy has sufficient heat on its own. A real tightening of policywhich would mean raising the fed funds rateis still a good way off.

[I]ts important that federal fiscal policy gets done. But I dont believe that the Fed is, in the parlance of pop-psychology, an enabler of what most characterize as Washingtons intransigence on fiscal policy. This position argues that the Fed is somehow too reliable; that because we have the tools to manage a crisis, other institutions will avoid their own areas of responsibility because they can rely on us to pull an economic rabbit out of our hat. If theres no urgency, they can avoid action on politically volatile legislation, and the can gets kicked further and further down the road.

Let me be clear that us doing our jobs doesnt absolve anyone of the responsibility to do theirs. Decisions about taxes, spending, and entitlement programs will always collectively be a political third rail, and monetary policybe it accommodative or fully normalizedwont change that. The idea that the Feds propping up of the economy is letting Congress avoid decision-making doesnt hold; that implies that the only prompt to action would be an economy in freefall, something no one wants. Congress has many reasons to act on fiscal policynot least of which being a growing population and shifting demographics that will see the largest generation in our history moving into old ageand nothing we do to interest rates will alter that reality.

The enabling argument is largely driven by an underlying concern that the Fed has somehow lost its independence, or that its becoming too active a player in the economy. But nothing could be further from the truth. We hold our independence as sacrosanct, because its necessary for us to make the best policy decisions we can. If we step out of our assigned role, we could endanger that independence, and that would fundamentally alter our ability to do our jobs.

There is a ring of truth to the idea that low interest rates might be acting as life support for companies that are destined to fail. The flip side of that coin, however, is that low rates gave good companies the ability to get back on their feet before they went bankrupt. Its important to provide an economic environment that allows fundamentally sound firms to thrive. That may provide a temporary crutch to some companies that will eventually go bankrupt, but over the longer term, the right companies will survive. Nothing in life is perfect, and in terms of a trade-off, Im happy with a few bad companies staying in the game for a while if it means a lot of good ones have a chance to survive, too.

Although theres general consensus that the measures we took in the immediate wake of the crisis were necessary, critics of the Feds policies believe that weve been too accommodative since then, and that after 2010, we shouldve stepped back and let the economy move on its own. I often hear that the economys recovering, so why is the Fed still intervening? Or, in other words: enough is enough.

Ending accommodative policy prematurely would have been a major mistake. In 2010, the economy wasnt yet back on trackin fact, it had barely begun to recover. When we initiated the second round of asset purchases, or QE2, in November 2010, the unemployment rate was around 9 percentonly slightly down from its peak of 10 percent.

The latest round of asset purchasesor QE3was announced in September 2012, when the economy was better, but still well short of healthy. At around 8 percent, the unemployment rate had improved, but was still very high by historical standards, and inflation was running below the preferred 2 percent longer-term goal. In both situations, the very real danger of the recovery stalling and the economy slipping into a state of prolonged stagnation called for additional monetary stimulus.

When you break a leg, you dont just snap the pieces back into place; you leave the cast on until the bone heals. Otherwise, you risk doing even greater damage. And in this case, the economy wasnt ready to walk on its own. Not doing anything, or not doing enough, would just have led to more pain and the need to take even stronger measures down the road.

I was recently in Japan, which offers a real-life example. They shied away from sufficiently aggressive policy and the Japanese economy remained mired in deflationary stagnation for 20 years. Only now are they starting to put more forceful policies into place, and, happily, theyre workingbut those policies are much more forceful than they wouldve been had they been instituted 15 or 20 years ago. In keeping with the patient analogy, you can keep the cast on for a few weeks and let it heal, or you can go without and require extensive surgery later. So if we take the longer view, the Feds actions are in line with people who prefer a light policy touch: were essentially doing less now to avoid having to do more later.

I am aware that not everyone is a fan of the Fed or of accommodative policy. Im not deaf to criticism, and reasonable people disagree on policy all the time. But the bottom line is, it has worked. And the asterisk is that its not permanent. We wont raise interest rates for some time, which is the real marker of tightening policy. However, weve already considerably reduced the pace of our asset purchases, which will likely end this year. Were moving towards normalization, and as the economy continues to improve, well take off the cast; when its able to move on its own, well take away the walking stick. The events of the past several years demanded strong policy action, and we were right to take it. But it doesnt reflect a fundamental shift in our goals or strategy.

Let me wrap this all into a forecast for the next few years. I see real GDP growth averaging a bit above 3 percent in 2015 and 2016, which should be enough to generate relatively strong job growth. I expect the unemployment rate to gradually decline, hitting about 6 percent at the end of this year, falling below 5 percent by the end of next year, and reaching my estimate of the natural rate by the first half of 2016.

“We look at a broad set of measures from different sources about the labor market and I think they're all telling a pretty coherent story of an improving labor market. I don't put all of my emphasis on one statistic or another, but all the indicators are saying things are improving...

“In terms of raising interest rates, actually tightening monetary policy from where we are now, I think it's really important to remember, although the economy has improved a lot and we're on a good track, there's still quite a bit of slack in the economy,” Williams said. “Unemployment is still quite a bit higher than its normal level and inflation is running below our preferred 2 percent target.” Williams said it’s not time yet to raise interest rates, adding that mid-2015 is his recommendation if the economy continues to improve...

“Right now I think our expectations, my expectations will be raising interest rates very gradually and not trying to upset or disrupt markets in the economy. We're going to take this at a nice measured pace,” he said.

Noting that wage growth has been “muted” in recent months, holding steady at barely 2%, Williams said communications with business leaders indicate wages may be moving higher.   “We're seeing some report of some uptick in wage growth relative to that 2% norm,” he said. “I think this is all a positive thing. More wage growth means more money in people's pockets, more consumer spending; that's going to help the recovery.”

“I'm not concerned about inflation at all,” he added. “You know, for a 2 percent inflation rate for prices we would expect to see wage growth around 3 percent, 3.5 percent. So, some improvement in wage growth from 2 percent up to 3 percent and 3.5 percent, that's desirable and consistent with our goals.”

And while I think the Bureau of Labor Statistics and Bureau of Economic Analysis do fantastic jobs of collecting and distilling inflation data, I also look atand point critics tomore straightforward assessments like the Billion Prices Project from the Massachusetts Institute of Technology.8 This tool scrapes the Internet for prices, giving a daily reading of, well, billions of prices of myriad products. It lacks the complicated adjustments and methods that characterize the government agencies models. Nonetheless, it does track pretty closely with the official numbers. Whats more, it gives an independent assessment of consumer prices that is helpful for those who may distrust official federal data. While the BPPs numbers run a tad higher on average than the official indices, it shows that price inflation remains low and shows no sign of taking off.

The signal from all these indicators, both government and independent, point to the same conclusion: Inflation trends are quite modest. As I said, I expect that we will be moving back toward our 2 percent longer-run goal over the next few years.

John Williams, president of the San Francisco Fed, said in an interview with Reuters that the first line of defense at the central bank, if needed, would be to telegraph that U.S. rates would stay near zero for longer than mid-2015, when he currently expects them to rise. If the outlook changes "significantly," with inflation showing little sign of returning to the central bank's 2-percent target, he said he would even be open to another round of asset purchases

"If we really get a sustained, disinflationary forecast ... then I think moving back to additional asset purchases in a situation like that should be something we should seriously consider," Williams said.
...
In the interview, Williams repeated he is comfortable with his call for a rate hike about nine months from now. But "if inflation isn't moving above 1.5 (percent) and we get stuck into that gear, that would argue for a later liftoff," he said. "If we don't see any improvement in wages, that would be a sign that we still have a lot of slack in the economy and we are not getting any inflationary pressure to move inflation back to 2 percent."

The Fed next meets on Oct. 28-29, when some policymakers are pushing to ditch a promise to wait a "considerable time" before raising rates, given a sharp drop in the U.S. unemployment rate to 5.9 percent. Williams wants to leave that phrase intact for now, but said the central bank could adjust it as the outlook evolves.

[W]hen gauged by the behavior of inflation since the crisis, inflation targeting delivered on its promise. Columns 2 and 4 of Table 1 report the average inflation rates and their associated standard deviations, respectively, since the beginning of 2008. Inflation rates stayed remarkably low and stable during this otherwise turbulent period. The crisis and economic downturns left virtually no traces in terms of the ability of central banks to maintain price stability. This is an important achievement in and of itself, but also because the stability of inflation provided many central banks with room to take aggressive actions to foster economic recovery.

What explains this impressive performance with regard to price stability? The key is the anchoring of inflation expectations before the crisis and the actions taken to maintain price stability, and thereby hold the anchor in place, during and after the crisis. Figure 1 shows the net change in survey measures of longer-run inflation expectations from the start of the crisis until today for a number of countries. In most cases, the anchor held firmly (to put these numbers in perspective, the inflation targets are typically between 2 and 3 percent). In a few cases, such as Japan and New Zealand, the observed shift represented a desirable move back toward the announced target. In only two other cases, Norway and the United Kingdom, do we see a nontrivial shift in inflation expectations. I will return to the case of Norway later.

With inflation expectations firmly anchored and the public apparently confident that central banks would hold the line on price stability, the transmission of economic turmoil to inflation was muted. Inflation (and, on the downside, deflation) proved to be the dog that didnt bite.

It has become a mantra in central banking that robust micro- and macro-prudential regulatory and supervisory policies should provide the first and second lines of defense for financial stability. Still, some are concerned that is not enough and call for including a financial stability goal in the monetary policy mandate as well. Doing so, however, raises the important issue of how one commits to taking financial stability into account while simultaneously preserving the nominal anchor. If financial stability and price stability goals are in conflict, there is a risk that price stability will be subordinated to the financial stability goal, with serious long-run consequences for economic performance.

This issue of the appropriate role of monetary policy in fostering financial stability at the potential cost to inflation goals has been playing out in policy debates and decision in two Scandinavian countries: Norway and Sweden These examples illustrate the tradeoff between price and macroeconomic goals on one hand, and financial stability goals on the other, when using monetary policy to mitigate risks to financial stability.

So far, its unclear how durable a slippage in inflation expectations resulting from a focus on financial stability concerns will prove to be. Nonetheless, it is an apt reminder of the potential long-run costs of losing sight of the price stability mandate. The steadfastness of the nominal anchor in most advanced economies has been, and continues to be, a key factor in many central banks ability to maintain low and stable inflation during and after the global financial crisis. It was forged over many years of consistent commitment to price stability and successfully taming the inflation dragon. If the anchor were to slip, it would wreak lasting damage to a central banks control over both inflation and economic activity, at considerable cost to the economy. This applies equally to deviations above and below the target.

These potential benefits of price-level and nominal income targeting are worthy of further careful study and discussion. It is too early to judge whether one approach or the other would provide a better framework than inflation targeting. In contemplating a shift away from inflation targeting, it is crucial to consider what unintended negative consequences these approaches might entail. For example, nominal income targeting could generate persistent deviations of inflation from target, which may interfere with the credible communication of the price stability objective. There are also practical considerations in the communication of policy decisions and goals that need to be fully analyzed. In weighing all the potential advantages, disadvantages, and risks of these and other alternative approaches, it is absolutely essential that any modification of approach not undermine the hard-fought achievement of price stability and well-anchored inflation expectations that have been of great benefit, especially during the recent challenging economic times.

Im not really worried about, right now, the risk of further disinflationary pressures beyond the energy price effects, and I am pretty confident that were on the right trajectory in terms of bringing inflation back to 2%, he said.

In fact, he said, the plunge in oil prices is a huge plus for U.S. consumers and businesses.

The story, if you will, for 2015 and 2016 is not so much just about the Fed and raising rates, blah blah blah, but really about the global environment, the fact that we have the two biggest central banks outside the Fed acting aggressively in one direction and were going to have the Fed, mostly likely, and maybe a few others working in the other. I think thats going to create some turbulence.

An initial rate increase coming in mid-2015 would be a reasonable guess, Federal Reserve Bank of San Francisco President John Williams said Monday.

The U.S. economy is improving, unemployments coming down and so we are getting closer to the point where I think itd be appropriate for us to think about the pros and cons of raising interest rates, Mr. Williams told reporters during the annual meeting of the American Economic Association in Boston.

But, he said, I see no reason whatsoever to rush to tightening. I dont see any upside risks to inflation. I think these financial stability concerns that people do raise are real things we want to take into account, but that doesnt argue for moving today or in the next few months relative to, say, later in the year.

Federal Reserve Bank of San Francisco President John Williams, who will vote on policy this year, said raising interest rates in June would be a close call amid strong momentum in the labor market and weaker wage gains.

I would expect by June that the argument pro and con for lifting off rates will be probably a close call assuming that inflation doesnt fall further, Williams said today in a telephone interview from his San Francisco office. Its a reasonable guess.
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"I think that sometime around the middle of the year we are going to be closer to a decision, at least I would think we would be closer to it being an appropriate timing to raise rates," San Francisco Fed President John Williams said at a meeting of the Bay Area Economic Institute.
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"It's going to be a very interesting year in terms of global events, so I'm going to watch the data, and decisions will be based on what actually happens, not just on what our forecasts are," Williams said.
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The Federal Reserve's decision on when to raise interest rates will be driven by economic data, a top Fed official said on Friday, shortly after expressing his own view that mid-year would be an appropriate time to consider a rate rise.

"Right now it's January. What we will do in June, September or whatever, later in the year, will really depend on what's happening in the economy, what's happening globally, in terms of our goals," San Francisco Fed President John Williams said at a Bay Area Council Economic Institute event. "I do not prejudge what that decision will be until we actually have those debates and discussions."

"I see us getting to full employment basically by the end of this year or before then, and in fact having a pretty strong labor market," Williams said, explaining that he assesses normal levels of employment to be about 5.2 percent.

Around midyear is a good guess for when we are getting around that point that raising rates will be appropriate, Mr. Williams told CNBC. Im not predicting it will be June or any particular meeting, but I think we are getting closer to that point when the Fed can start to act, he said.

We are coming at this from a position of strength, Mr. Williams said. As we collect more data through this spring, as we get to June or later, I think in my own view well be coming closer to saying there are a constellation of factors in place to make a call on rate increases, he said.

I dont see any reason at all that we should raise rates before June. Thats out, he said. Maybe in June it would be the time to contemplate raising rates. Maybe well want to wait longer, but at least it will be an option to decide on, he said. The Fed has a scheduled policy meeting June 16-17.

Mr. Williams said he would like the Fed to drop its commitment to be patient in deciding when to raise rates because it limits the central banks options on when to move. You would want to remove the patient language only to have the ability to make those data-dependent decisions later in the year, he said.
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Mr. Williamss confidence about the monetary policy outlook is rooted in what he sees as labor market strength. He believes weak inflation, which has undershot the central banks 2% target for more than two years, will rise to its desired level by the end of 2016.

He also said falling short on the inflation target wont necessarily stay the Feds hand on rate increases. Because Fed rate actions have to take account of their effect over the long run, its very likely we would start raising interest rates even with inflation below 2%, he said.

Mr. Williams said it is likely that the Fed will see a hot labor market that should in turn produce the wage pressures that will drive inflation back up to desired levels. He said much of the weakness seen now in price pressures is due to the sharp drop in oil prices, which he said isnt likely to last.

The cosmological constant is that if you heat up the labor market, get the unemployment rate down to 5% or below, thats going to create pressures in the labor market causing wages to rise, he said.

Mr. Williams said there is a disconnect between Fed officials and markets expectations for the path of short-term rates. He said he hopes that can be bridged by effective communication explaining central bank policy choices.

I have no desire to raise rates just to raise rates. Im not worried about financial stability, personally. Im not worried about risks of low interest rates on their own. I am focused on the very pedestrian issue of achieving the Feds employment and inflation goals, and will make policy with those factors in mind, Mr. Williams said.

He said that when the Fed does raise rates, he would prefer a gradual path, but he doesnt expect it to replay the series of steady, small rate increases seen a decade ago. He said he could see the Fed taking whatever action is needed at a given meeting, rather than putting rates on a steady upward path.

BARTIROMO: Before we go in and looking back at what Janet Yellen said this week, let's look forward. We have a jobs number out next Friday. And, of course, we know that the unemployment story has been improving a bit. Where are the jobs in this country? Where is the growth in jobs from your standpoint?

WILLIAMS: Well, first of all, last year was remarkable. We added something like over 3 million jobs. So, we're in a really good place in terms of the improvement in the labor market that we've seen in the last year.

I expect this year -- we'd also see very good improvement in the labor market, continuing good momentum there. So, I think, you know, we still have a ways to go. Unemployment is 5.7 percent. We need to get closer to 5 percent to be at full employment. We made a lot of progress. And I think this is the year, we're going to reach full employment by the end of the year. That's my own forecast.

Really what I see is a labor market that is getting stronger and stronger. And historically, when the U.S. economy strengthens, unemployment comes down, we see wage growth pickup. We see pricing power, if you will, among businesses rise. And, you know, that's the historical pattern. It's what we've seen in other expansions and that's what I expect happen over the next couple of years.

My forecast is for inflation to reach about 2 percent on our preferred measure by the end of next year.

WILLIAMS: And I have been in the Fed 20 years. I remember, you know, all the different measured phase (ph), considerable period, and considerable time.

BARTIROMO: Right, right, right.

WILLIAMS: So, we've always had this problem. My hope is, is that we'll be able to move away from the market looking for the Fed to tell them what we are going to do. And basically describe our policy strategy, our goals, how we view the economy, and let market participants come to their own judgments -- basically, when we're going to move, how much we're going to move by, and over what period.

So, you know, we have two get out of this being so explicit with our forward guidance, telling everybody what we're planning to do. That was really important in 2011, 2013, 2014, when we had the zero interest rates. It was a really powerful tool I think that helps us provide a combination, help us support the recovery. Now that we are getting back to the more normal period, I think we have to get away from being so explicit in what we're planning in doing, and let to be just data-dependent and let people try to understand that.

“Definitely my own forecast would be having us raise rates two times this year, but that would depend on the data," San Francisco Fed President John Williams told reporters at the bank's headquarters.

"I still believe this will be the year for liftoff, and I still believe that waiting too long to raise rates poses its own risks," Williams said in a speech earlier. "I see a safer course in starting sooner and proceeding more gradually."

I still believe this will be the year for liftoff, and I still believe that waiting too long to raise rates poses its own risks. I know not everyone agrees and there are those who believe we should wait until we’re nipping at the heels of 2 percent. My reasons for advocating a rise before that happens remain the same. Monetary policy has long and variable lags, as Milton Friedman famously taught us. Specifically, research shows it takes at least a year or two to have its full effect. We’re therefore dealing with my favorite analogy: The car speeding towards a red light. If you don’t ease up on the gas, you’ll have to slam on the brakes, possibly even skidding into the intersection. Waiting until we’re close enough to dance with 2 percent means running the very real risk of having to dramatically raise rates to reverse course, which could destabilize markets and potentially derail the recovery. I see a safer course in starting sooner and proceeding more gradually.

It is a tragedy for Greece that it finds itself on the brink of an even more severe financial crisis and further economic turmoil. But it can perhaps be heard as a soothing chorus that the direct exposure of foreign investors is relatively limited, and the European Central Bank appears to have the means and will to limit the financial fallout that could affect the rest of the euro area. While a worst-case scenario of a Greek exit from the euro leading to sizable financial and economic impacts on the global economy cannot be ruled out, it remains an unlikely tail risk.

“I still believe this will be the year for liftoff, and I still believe that waiting too long to raise rates poses its own risks,” Mr. Williams said.

“I can’t tell you the date of liftoff,” Mr. Williams said in reference to when Fed officials might boost rates off of their current near-zero levels. That said, “I see growth on a solid trajectory, full employment just in front of us, wages on the rise, and inflation gradually moving back up to meet our goal” of a 2% rise, he said.

Williams said that the September meeting “would be a very plausible time” to start raising interest rates.

The big headline is that the Federal Open Market Committee decided to hold off on raising interest rates this week. It was a close call in my mind, in part reflecting the conflicting signals we’re getting. The U.S. economy continues to strengthen while global developments pose downside risks to fully achieving our goals.

Looking forward, I expect that we’ll reach our maximum employment mandate in the near future and inflation will gradually move back to our 2 percent goal. In that context, it will make sense to gradually move away from the extraordinary stimulus that got us here. We already took a step in that direction when we ended QE3. And given the progress we’ve made and continue to make on our goals, I view the next appropriate step as gradually raising interest rates, most likely starting sometime later this year. Of course, that view is not immutable and will respond to economic developments over time.

This brings me to the question of how to gauge what a healthy, full-employment labor market looks like. The most common metric is the “natural rate” of unemployment—the optimal rate we can expect in a fully functioning economy. Before the recession, it was generally thought to be around 5 percent... My assessment is that there has not been any lasting, significant shift in either direction. My estimate of the natural rate of unemployment today is 5 percent, consistent with pre-recession estimates. With the current rate at 5.1 percent, we are very close.

I am starting to see signs of imbalances emerge in the form of high asset prices, especially in real estate, and that trips the alert system. One lesson I have taken from past episodes is that, once the imbalances have grown large, the options to deal with them are limited. I think back to the mid-2000s, when we faced the question of whether the Fed should raise rates and risk pricking the bubble or let things run full steam ahead and deal with the consequences later. What stayed with me were not the relative merits of either case, but the fact that by then, with the housing boom in full swing, it was already too late to avoid bad outcomes. Stopping the fallout would’ve required acting much earlier, when the problems were still manageable. I’m not assigning blame by any means, and economic hindsight is always 20/20. But I am conscious that today, the house price-to-rent ratio is where it was in 2003, and house prices are rapidly rising. I don’t think we’re at a tipping point yet—but I am looking at the path we’re on and looking out for potential potholes.

"On the global side, I’m not seeing any obvious signs that those risks that were on my mind and the minds of others, I don’t see signs that those have gotten worse,” Williams, a voting member on the Fed’s policy committee this year, said in Salt Lake City on Thursday. He was answering questions from the audience after delivering a speech.

“There’s always going to be risks, there’s always going to be uncertainties,” he said. Even so, “we’re going to have to take actions that we think are the appropriate ones given our goals.”

There are risks, as there always are in life. And there’s always the possibility of what British Prime Minister Harold Macmillan said when asked what worried him most: “Events, dear boy, events.” But all in all, things are looking up, and if they stay on track, I see this as the year we start the process of monetary policy normalization.

Williams said "we’re not going to get clarity, but we are getting some information,” about how the global economy is developing before the end of the year. Recent data from China show that the nation is on "a little bit of a bumpy part of their ride" but "seems to be able to get back onto growth that people were expecting before,” he told reporters.

San Francisco Federal Reserve President John Williams said on Friday that low neutral interest rates are a warning sign of possible changes in the U.S. economy that the central bank does not fully understand.

"I see this as more of a warning, a red flag that there's something going on here that isn't in the models, that we maybe don't understand as well as we think, and we should dig down deep deeper and try to figure this out better," he said during a panel discussion at the Brookings Institute in Washington.

Williams, who is a voting member of the Fed's policy-setting panel through the end of the year, has said the central bank should begin to raise interest rates soon but thereafter go at a gradual pace.

He added that the low neutral interest rate had "pretty significant" implications for monetary policy, and put more focus on fiscal policy as a response.

"If we could come up with better fiscal policy, find a way to have the economy grow faster or have a stronger natural rate of interest, then that takes the pressure off of us to try to come up with other ways to do it, like through a large balance sheet or having a higher inflation target," Williams said. "It also means we don't have to turn to quantitative easing and other policies as much."

At [the October 27-28] meeting, the Fed removed language it had inserted in its September statement expressing concern that global weakness could hinder U.S. growth and further depress inflation. Until China's surprise devaluation of its currency on Aug. 11 sent financial markets into a tailspin, the Fed had been expected to begin raising rates in September.

In his interview with the AP, Williams said the Fed had been correct to note these developments in its September statement. But since then, he said, markets have stabilized.

"What has happened in the last six weeks is that volatility has come down," Williams said. "I think the uncertainties, risks, seem to have ebbed."

The public or market perceptions were that we had completely moved off 2015, and I don’t think that was accurate. I think we’re okay now, but I think this is hard. This is going to continue to be hard. Everybody wants clarity.

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.”

My preference is sooner rather than later for a few reasons.

First, Milton Friedman famously taught us that monetary policy has long and variable lags.Research shows it takes at least a year or two for it to have its full effect.So the decisions we make today must take aim at where we’re going, not where we are. The economy is a moving target, and waiting until we see the whites of inflation’s eyes risks overshooting the mark.

Second, experience shows that an economy that runs too hot for too long can generate imbalances, ultimately leading to either excessive inflation or an economic correction and recession. In the 1960s and 1970s, it was runaway inflation. In the late 1990s, the expansion became increasingly fueled by euphoria over the “new economy,” the dot-com bubble, and massive overinvestment in tech-related industries. And in the first half of the 2000s, irrational exuberance over housing sent prices spiraling far beyond fundamentals and led to massive overbuilding. If we wait too long to remove monetary accommodation, we hazard allowing these imbalances to grow, at great cost to our economy.

Finally, an earlier start to raising rates would allow a smoother, more gradual process of normalization. This gives us space to fine-tune our responses to any surprise changes in economic conditions. If we wait too long to raise rates, the need to play catch-up wouldn’t leave much room for maneuver. Not to mention, it could roil financial markets and slow the economy in unintended ways.

My preference for a more gradual process also reflects that the economy, for all its progress, still needs some accommodation. We don’t need the extraordinarily accommodative policy that has characterized the past several years, but the headwinds we’re facing—the risks from abroad, for instance, and their impact on the dollar—call for a continued push. Not with a bulldozer, but a steady nudge.

Liesman: As a central banker do you feel difference being too far ahead of the pack here? Is there a limit to how much the fed can and will do this year because of the weakness overseas?

Williams: So you know, we talk about divergence between the U.S. and the rest of the economy. There's a divergence within the U.S. economy too reflecting that. And that specifically, our domestic demand – consumer spending, investment spending – is actually on a very good trajectory. Where we are getting hit hardest is in terms of our net exports. That's a big drag on our economy. So, you know, the way I see it over the next couple of years, we're going to need significant monetary accommodation, a very gradual pace of rate increases to keep our economy on this 2, 2.25% growth path given the headwinds we're facing, especially from abroad.

Liesman: So let's talk about the path for fed rate hikes this year. The median seems to suggest four this year. Is that also your forecast?

Williams: Well, I think that given the forecast they have for where the economy's going, what's happening with inflation – and inflation is the one thing that we're still struggling to get back to our 2% goal. That to me is the main focus. You know, I think something in that 3 to 5 rate hike range makes sense, at least at this time. But we're data dependent. We continue to be data dependent so the data's suggesting that gradual pace of rate hikes makes sense. But we'll have to re-evaluate that, reassess that, based on where we see inflation and other indicators that kind of are factors in inflation and how we see economic growth over the next year.

"I am unconvinced that monetary policy should be used as an explicit tool" for stabilizing financial markets, Williams said at the American Economic Association. "The tradeoffs are not favorable at all" in terms of reaching the Fed's goals of stable inflation and full employment, and indeed, targeting financial stability with rate policy could end up undermining the Fed's credibility on its inflation goal.

Compared with the pre-recession “normal” funds rate of, say, between 4 and 4.5 percent, we may now see the underlying r-star guiding us towards a fed funds rate of around 3–3½ percent instead. In fact, some estimates, including those based on my own research with Thomas Laubach, indicate it could even be below 3 percent.

We have made clear in our communication—and let me reiterate—that we still have a ways to go before we start to unwind it. For the time being, we’re maintaining its size through reinvestment, so that the first steps in removing monetary accommodation occur slowly and gradually, via the funds rate only. This will continue until normalization of the funds rate is well under way. After that, our plan is to shrink the balance sheet “organically,” if you will, through the maturation of the assets. It’s likely going to take at least six years to get the balance sheet back to normal, which is in keeping with the overall approach to removing accommodation gradually.

“If you were to ask me what keeps me up at night, or what are the shocks that could cause a recession, I would say almost all of them are outside the U.S. borders,” Williams said Friday on a panel discussion in San Francisco. “I’m actually feeling a little bit more positive around Europe,” he said, but “China’s the wild card.”

During the panel, he said that he will “stick with the view that right now it’s going to take a gradual three-year process to get interest rates back to normal.”

“Global growth has slowed” and China’s economy is moving to a slower pace, he said in a panel discussion in San Francisco. “We have a strong domestic economy and we can basically offset that. If it weren’t for these headwinds, the economy would easily be growing at 3 percent a year.”

"Standard monetary policy strategy says a little less inflation, maybe a little less growth ... argue for just a smidgen slower process of normalizing rates," Williams said.

"We got a little stronger dollar, some mixed data on the economy, some weakness in (fourth-quarter U.S. GDP growth), all of those coming together kind of tell me that we probably need a little bit more monetary accommodation this year than I was thinking in the middle of December."

I’d also like to stress the “above or below” part. Many people think that Fed policymakers’ concern lies disproportionately with inflation that’s too high. They think we view inflation lower than 2 percent as sort of “not great,” but see inflation above 2 percent as catastrophic. That’s not the case. In my view, inflation somewhat above 2 percent is just as bad as the same amount below.

Of course, I am aware of, and closely monitoring, potential risks. But I want to be clear what that means. It’s often said that the economy isn’t the stock market and the stock market isn’t the economy. That’s very true. Short-term fluctuations or even daily dives aren’t accurate reflections of the state of the vast, intricate, multilayered U.S. economy. And they shouldn’t be viewed as the four horsemen of the apocalypse. Remember, the expansion of the 1980s wasn’t derailed by the crash of ’87, and we sailed through the Asian financial crisis a decade later. I say “remember”—some of you here will actually remember and others will remember it from your high school history class.

From a policymaker’s perspective, my concern isn’t as simple as whether markets are up or down. Watching a stock ticker isn’t the way to gauge America’s economic health. As Paul Samuelson famously said, the stock market has predicted nine out of the past five recessions. What’s important is how it impacts jobs and inflation in the U.S.

At the risk of puncturing some of the more colorful theories about what drives the Fed, I lay before you the cold, hard truth: Fed policymakers are even more boring than you think. Because all we see is our mandate. How does this affect American jobs and growth? What does this mean for households’ buying power?

I spend a lot of time talking about being data dependent. I literally made T-shirts that say, “Monetary policy: It’s data dependent.” But there’s some confusion, because a lot of people take this to mean that I’m just waiting for the next employment or inflation report. This is what happens when a Fed official tries to substitute economistese with real English. What I actually mean is that being driven by the data is about having a policymaking strategy. It’s about implementing consistent and predictable behavior that is driven by the economy’s performance relative to our goals.

So why don’t we just abandon these simple rules and embrace optimal control?

The answer is that, for all our intellect—and I’ll admit, economists are very sure their collective intellect is almost too much for the world to handle—there’s a limit to how much we truly know about the future. We have forecasts, which are based on sound data and analysis. But they’re only forecasts, and the unexpected can always erupt. I don’t have a 100 percent degree of certainty where housing prices are going. I don’t know for sure what’s going to happen with China. I wouldn’t bet my life on what the ECB or Bank of Japan is going to do. We may think we have it all figured out, but sometimes economists’ track records leave something to be desired. So there is a risk with the optimal control approach that we’ll believe our theories and our models too much, and that can lead us astray. There is a need for humility and to recognize our limitations.

Any discussion about the costs and benefits of forward guidance must take place in the context of the situation in which it is being used. This brings me to my first case study, the Fed’s use of explicit time-based guidance starting on August 9, 2011. Despite extraordinary monetary stimulus—over 2½ years of near-zero short-term interest rates and QE1 and QE2—the unemployment rate had come down only 1 percentage point from its recession peak, to 9 percent, and the economic recovery remained tepid. Given the weakness in the economy, the FOMC repeatedly stated that it intended to keep rates exceptionally low “for an extended period.” Nonetheless, public expectations were glued to the idea that the Fed would start to raise rates in about a year.

It was against that backdrop that the FOMC decided to take dramatic action to shift public expectations using time-based forward guidance. The August 2011 FOMC statement said “The Committee currently anticipates that economic conditions—including low rates of resource utilization and a subdued outlook for inflation over the medium run—are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.” Three comments are in order. First, this statement, as well as subsequent FOMC statements that used forward guidance, clearly put the economic outlook front and center as the determinant of policy. The outlook defines the guidance. Second, it was the lower bound that tied the hands of policymakers, not the introduction of date-based guidance. Third, this action was taken after weighing the concerns around the costs of time-based guidance discussed in Feroli et al. (2016); the conclusion then was that the benefits from stimulating the economy outweighed the potential cost.

The evidence bears out this judgment. The issuance of the statement dramatically shifted public expectations of future Fed policy. This is seen in private economists’ forecasts of the length of time until the Fed would raise rates, which jumped following the statement. Compared to the gentle taps of the hammer of previous FOMC verbal guidance that appeared to have little effect on expectations, the time-based guidance was like a sledgehammer.

Mr. Williams does not vote on rates this year, but he is a key player in the debate. He argued that worries about an impending recession or financial crash circulating in Wall Street were misguided, in much the same way that economists had been wrongly convinced back in 2006 on the eve of the subprime implosion that the US economy was robust.

He said the story today had become that the US was “hyper-fragile” or that it faced a period of so-called secular stagnation, as argued by Larry Summers, formerly US Treasury secretary. “We are always on the verge of collapse; I just don’t think it is supported by the data,” Mr. Williams said.

The Federal Open Market Committee unusually decided not to offer a statement of how the risks balanced out in January, and Mr. Williams argued that may in any case be “a better place to be” than trying to issue one-sentence statement on risks. The Fed, he said, should not load too much into its post-meeting statements.

Interest-rate forecasts the U.S. Federal Open Market Committee is set to publish after its March meeting could differ “slightly” from those issued at the end of last year, according to Federal Reserve Bank of San Francisco President John Williams.

There “could be a tweak here or there” in projections known as the dot plot, Williams told reporters Wednesday in San Ramon, California.

The world’s largest economy is doing "quite well," Williams said Monday in an interview on CNBC, citing stable inflation and strong employment growth. The U.S. economy grew at a faster pace than expected in the fourth quarter, with a 1.4 percent increase. That compared with a prior Commerce Department estimate of 1 percent, figures issued Friday show.

"The real issue is the global financial and economic developments. There’s uncertainty about what’s happening around the world and how that feeds back to the dollar and the U.S. economy," Williams, who doesn’t vote on monetary policy this year, told CNBC. "We understand that we’re in a global economy so what happens in Brazil or China has a huge impact on the U.S. in terms of our inflation and employment goals."

"We've been missing our 2 percent inflation goal for three and a half years or so, global disinflationary factors are still holding inflation down...The data to me isn't so much about the labor market continuing to improve, I'm very positive on that, it's more about inflation moving back to 2 percent in the context of very strong headwinds," he explained, citing the strong dollar and low commodity prices.

For the past few years, inflation has been persistently too low, but we’re starting to see some upward movement. Over the past year, the Fed’s preferred inflation measure, the personal consumption expenditures price index, stands at 1 percentage point. Measures of underlying inflation like core inflation—which strips out volatile components like food and energy—or the trimmed mean, are running about 1¾ percent over the past year. Fed officials do understand that gas and groceries are important parts of household budgets. It’s just that for making policy, we need to look at the underlying trends that give us a better picture of where inflation is likely headed.

All in all, the recent data reinforce my expectation that inflation is on track to move back to 2 percent over the next two years.

There are factors slowing global growth, and they’re very real. But to some extent, the attention has distorted their size and scope, and it’s important to separate the facts from the chatter. The data don’t show that the song is over. Europe may be under something of a gray cloud, but the death of European growth, to paraphrase Mark Twain, is greatly exaggerated. I don’t want to evince a stereotypical American overoptimism—and as a native Californian, I will admit to being an optimist in general—but I don’t see a looming global crisis. Growth expectations may be slightly tempered, but that’s a far cry from the triage bay we were in eight years ago. My view is essentially, let’s just stay on track. Let’s not get sidelined by the noise and distraction commentary can sometimes cause.

As for the balance sheet, there’s a ways to go before we start to unwind it, and it won’t happen until normalization of the funds rate is well under way. After that, our plan is to shrink the balance sheet “organically,” through the maturation of the assets. It’s going to take at least six years to get the balance sheet back to normal, which is in keeping with the overall approach to removing accommodation gradually.

"I definitely see two to three rate hikes ... as reasonable" San Francisco Fed President John Williams told reporters after a speech [in San Francisco].

Speaking at a panel on systemic risk at the Milken Institute Global Conference, Williams said the biggest systemic financial risk currently is the possibility that "broad sets of assets are going to see big movements downward" as interest rates rise. "That's an area that I think is a potential risk.”

The “new normal” for interest rates might be lower than the Fed’s median estimate, San Francisco Federal Reserve President John Williams said at a conference on Monday.

San Francisco Federal Reserve President John Williams said that he would support an interest-rate hike in June as long as he sees continued progress on the economy, inflation and jobs.

If inflation keeps rising toward the Fed's 2-percent target, economic growth rebounds toward his 2-percent forecast for the year, and job gains continue to be strong, "it would be appropriate" to raise rates in June, Williams said in an interview on Bloomberg Radio.

"It's not about tightening policy so much as pulling back a little bit" on monetary accommodation, Williams said.

If the economy were to suffer a bad shock, we could keep interest rates low, institute a new quantitative easing program, or use forward guidance. These tools proved to be very effective during the recent episode and I see them as providing a better option rather than going to negative interest rates.

One other issue that has been getting some attention is what we’re planning on doing with our sizable balance sheet, which swelled to some $4 trillion after three rounds of quantitative easing. We have a ways to go before we start to unwind it, and it won’t happen until normalization of the funds rate is well under way. After that, our plan is to shrink the balance sheet “organically,” if you will, through the maturation of the assets. It’s going to take at least six years to get the balance sheet back to normal, which is in keeping with the overall approach of removing accommodation gradually.

“I think that the data to my mind are lining up to make a good case for rate increases in the next few meetings, not just June, which means it’s very live in terms of that,” Mr. Williams said Tuesday in an interview with reporters and editors of The Wall Street Journal.

“If we stay on the good path which we’re on, then if we were to raise two or three times this year it wouldn’t be that much of a surprise,” Mr. Williams said.

"[Brexit] is a factor in the decision for June obviously because you have an event right after, and we can obviously hold off until July if we wanted," Williams, speaking to reporters here, said of raising rates at the next two policy meetings.

"But of course we could also make a decision to raise rates at a meeting and if later on economic conditions for the U.S. change, we can always move interest rates back down," said Williams, an influential centrist who does not have a vote on policy this year.