In light of this cumulative progress, the FOMC concluded at our June meeting that the criterion of substantial improvement in the outlook for the labor market might well be met over the subsequent year or so. Accordingly, the committee sought to provide more guidance on how the pace of purchases might be adjusted over time.

The committee anticipated in June that subject to certain conditions it might be appropriate to begin to moderate the pace of purchases later this year, continuing to reduce the pace of purchases in measured steps through the first half of next year and ending purchases around mid-year 2014. However, we also made clear at that time that adjustments to the pace of purchases would depend importantly on the evolution of the economic outlook; in particular, on the receipt of evidence supporting the committee's expectation that gains in the labor market would be sustained and that inflation is moving back toward its 2 percent objective over time.

At the meeting concluded earlier today, the sense of the committee was that the broad contours of the medium term economic outlook, including economic growth sufficient to support ongoing gains in the labor market and inflation moving toward its objective, were close to the views it held in June. But in evaluating whether a modest reduction in the pace of asset purchases would be appropriate at this meeting, however, the committee concluded that the economic data do not yet provide sufficient confirmation of its baseline outlook to warrant such a reduction.

Well, some days I wish that questions like these {about tapering} could be answered with a firm date, a single number and a confident “yes,” accompanied by a fist pump. Unfortunately, the answer to the first question is not as simple as giving a calendar date. Instead, uncertainty over the pace of the recovery means all of this depends on the progress that the economy makes toward our goals of maximum employment and price stability. In my view, this means continuing our current QE3 asset purchase program until three conditions are met. First, the unemployment rate must be in the vicinity of 7 percent with expectations for it to continue falling in a self-sustaining fashion. Second, other important labor market indicators must show a commensurate improvement. And third, we must have considerable confidence that inflation is moving back toward our target of 2 percent. Currently, my best assessment is that by the time these conditions have been met, our QE3 asset purchases since January of this year will total at least $1.25 trillion. By comparison, that would be twice the size of our QE2 purchases made in 2010 and 2011. This would mean that our System Open Market Account (SOMA) balance sheet will reach approximately $4 trillion.

Mr. Bullard noted that inflation is “low” and “near the lower edge of acceptable outcomes.” He added “on balance, inflation expectations have declined since March,” and said the Fed “would not normally remove policy accommodation in an environment where inflation is below target and is projected to remain there.”

The central banker said it is also challenging to determine the health of the labor market. Based on the unemployment rate alone, declines in joblessness suggest improvement, while other measures indicate the labor market might not be as healthy as the unemployment rate indicates. But he also said “payroll employment growth has generally been strong.”

On the growth front, recent data have been “weak,” but there are reasons to be hopeful for the future. “Real estate markets are improving, equity markets have rallied, the European sovereign debt crisis remains subdued for now, U.S. fiscal brinkmanship has been less of a problem, and household deleveraging is further along,” he explained.

That said, Mr. Bullard said “I have generally been too optimistic” about the economy’s outlook, and because of this, “I think caution is warranted in taking policy action based on forecasts alone.”

In other comments, the central banker noted the Fed’s balance sheet, while very large in absolute terms, “is not particularly large when scaled by GDP and compared to other major central banks, or when compared to historical data on the Fed’s balance sheet.”

As reported by WSJ.

In response to a question about the reasons for the back-up in interest rates:

There are essentially three reasons why we've seen some increase in longer-term rates, although, I would emphasize they remain relatively low.

The first is that there's been some better economic news. As investors see brighter prospects ahead, interest rates tend to rise. For example, we saw a relatively good labor-market report, which was accompanied by a pretty sharp increase in interest rates on that day.

Second reason for the increase in rates is probably the unwinding of leveraged, and perhaps successfully risky positions in the market. It's probably a good thing to have that happen, although, the tightening that's associated with that is unwelcome. But at least a benefit of it is, is that some concerns about building financial risks are mitigated in that way, and probably make some FOMC participants more comfortable with using this tool going forward.

The third reason for the increase in rates has to do with Federal Reserve communications and market interpretations of Fed policy. We've tried to be very clear from the beginning. And I've reiterated again today that we've not changed policy.  We are not talking about tightening monetary policy. Merely, we've been trying to lay out the same sequence which I just described to you about how we're going to move going forward, and how that will be tied to the economy. But I want to emphasize that none of that implies that monetary policy will be tighter at any time within the foreseeable future.

BACHUS: Chairman Bernanke, you mentioned last year in Jackson Hole that you viewed unemployment as cyclical. Do you still believe it's cyclical and not structural?

BERNANKE: Well, just like my answer a moment ago, I think that probably about 2 percentage points or so -- say the difference between 7.6 and 5.6 -- is cyclical and the rest of it is what economists would call frictional or structural.

BACHUS: So you -- OK -- so it's -- have you done -- so your study (ph) you think maybe 5 percent structural and 2 percent cyclical?

BERNANKE: Well, most importantly, I -- so far we don't see much evidence that the structural component of unemployment has increased very much during this period. It's something we've been worried about, because with people unemployed for a year or two years or three years, they lose their skills, they lose their attachment to the labor market, and the concern is they'll become unemployable.

So far it still appears to us that we can attain an unemployment rate -- we, the country can attain an unemployment rate somewhere in the 5s.

BACHUS: The most recent FOMC minutes didn't specifically address the 7 percent unemployment target, but you -- you mentioned it in your press conference after (ph). Was that 7 percent target discussed and agreed on in the meeting?

BERNANKE: Yes, it was. Seven percent is not a target. It was intended to be indicative of the amount of improvement we want to see in the labor market. So I described a series of conditions that would need to be met for us to proceed with our moderation of purchases.

We have -- we have a go-around where everybody in the committee, including those who are not voting, get to express their general views. And there was -- there was good support for both the broad plan, which I described, and for the use of 7 percent as indicative of the kind of improvement we're trying to get.

BACHUS: The FOMC participants have stated, some of them, that their assessment of the longer run normal level of the fed fund rate has been lowered. Do you agree with that?

BERNANKE: Well, a rough rule of thumb is that long-term interest rates are roughly equal to the inflation rate plus the growth rate of the economy. The inflation rate, we're looking to get to 2 percent. To the extent that in the aftermath of the crisis and from other reasons that the economy has a somewhat lower real growth rate going forward, that would imply a lower equilibrium interest rate as well.

We're going to continue to communicate our policy intentions and to make clear that notwithstanding how the mix of policy tools changes that we intend to maintain a highly accommodative monetary policy for the foreseeable future.

And I think that message is beginning to get through. And I think that will be helpful.

More generally, we will be watching to see if the movement in mortgage rates has any material affect on housing. I mean, the main thing is to see housing continue to grow, more jobs in construction and the like.

And, as we've said, if we think that mortgage rate increases are threatening that progress, then we would have to take additional action in the monetary sphere to try to address that.

Of course, there's always scope for Congress to look at the problems that remain in the housing market in terms of people underwater, in terms of refinancing of underwater mortgages, other kinds of issues that -- that Congress could -- could look at.

But we are -- we're going to be looking at it from the perspective of whether or not the housing recovery is continuing to a degree sufficient to provide the necessary support for the overall economic recovery.

While bond yields would naturally rise if macroeconomic performance was stronger than expected, Bullard said that “the evidence on current economic performance is mixed.” For instance, while some measures of labor market outcomes have improved since QE3 was launched in September, others (e.g., hours worked and the labor force participation rate) have not. Bullard also noted that real GDP growth has been slow in recent quarters. Therefore, he concluded, the rise in yields probably cannot be justified by better data on the U.S. economy.

“Pulling back on accommodation as inflation is sinking is not the right combination,” Bullard, who votes on monetary policy this year, said today in a Bloomberg Television interview with Michael McKee to air July 15. “I’d like to see us do more” to ensure inflation doesn’t continue to slow.

Bullard last month dissented against a pledge by the Federal Open Market Committee to maintain its current level of bond buying, saying the panel should “signal more strongly its willingness to defend its inflation goal in light of recent low inflation readings.”

Price gains have been “very low,” Bullard said today. “I’d at least like to see inflation tick up a little or get some kind of reassurance” that it “will come back toward our target.”

“Highly accommodative monetary policy for the foreseeable future is what’s needed in the U.S. economy,” Bernanke said today in response to a question after a speech in Cambridge, Massachusetts.

[T]he case for continued support for our economy from monetary policy remains strong...   [A]s our economy has gradually improved, it has become possible, and appropriate, for the Federal Reserve to provide clearer guidance on the path of monetary policy. In all likelihood, this path will involve continued support from accommodative monetary policy for quite some time.

As is well known, total inflation, as measured by the personal consumption expenditures (PCE) deflator, has slowed sharply over the past year and is now running below the FOMC’s expressed goal of 2 percent... A decomposition of core inflation reveals that some of the decline is due to slowing in the rate of increase in prices of non-food and non-energy goods. This probably is due in large part to the softening of global demand for goods and the modest appreciation of the dollar that has occurred since mid-2011.

In the service sector, the rate of increase in prices of medical services and “non-market” services—the latter includes some financial services—also has slowed notably recently. In contrast, the rate of increase in prices for other non-energy services has been relatively stable. Comparing this set of conditions to that in 2010, the recent slowing of inflation has been less widespread across core goods and core services, and inflation expectations so far have declined less appreciably than they did in 2010. Thus, my best guess is that core goods prices will begin to firm in the months ahead as global demand begins to strengthen and inventories get into better alignment with sales.

As Chairman Bernanke stated in his press conference following the FOMC meeting, if the economic data over the next year turn out to be broadly consistent with the outlooks that the FOMC sees as most likely, which are roughly similar to the outlook I have already laid out, the FOMC anticipates that it would be appropriate to begin to moderate the pace of purchases later this year. Under such a scenario, subsequent reductions might occur in measured steps through the first half of next year, and an end to purchases around mid-2014. Under this scenario, at the time that asset purchases came to an end, the unemployment rate likely would be near 7 percent and the economy’s momentum strengthening, supporting further robust job gains in the future.

As I noted last week in our regional press briefing, a few points deserve emphasis. First, the FOMC’s policy depends on the progress we make towards our objectives. This means that the policy—including the pace of asset purchases—depends on the outlook rather than the calendar. The scenario I outlined above is only that—one possible outcome. Economic circumstances could diverge significantly from the FOMC’s expectations. If labor market conditions and the economy’s growth momentum were to be less favorable than in the FOMC’s outlook—and this is what has happened in recent years—I would expect that the asset purchases would continue at a higher pace for longer.

...

[E]ven under this scenario, a rise in short-term rates is very likely to be a long way off.  Not only will it likely take considerable time to reach the FOMC’s 6.5 percent unemployment rate threshold, but also the FOMC could wait considerably longer before raising short-term rates.  The fact that inflation is coming in well below the FOMC’s 2 percent objective is relevant here.  Most FOMC participants currently do not expect short-term rates to begin to rise until 2015. 

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.

There appears to be widespread confidence that the Federal Reserve will keep inflation low and stable, consistent with our announced inflation goal of 2 percent. Indeed, most forecasters view the current readings on inflation to be a temporary phenomenon and expect inflation to run at or a little below 2 percent over the next few years. Household surveys and financial market measures also indicate that inflation is expected to remain near its longer-term average. My own view is that the transitory factors depressing inflation are likely to ebb, and we’ll see inflation edge back toward the Federal Open Market Committee’s target of 2 percent by next year.

... Looking ahead, the key question regarding the economic outlook is whether growth will remain relatively low. Many forecasters expect growth to pick up to over 3 percent next year. I have become increasingly persuaded, however, that low growth rates are likely to persist for several years.

...the slow growth in real GDP in this expansion is related to both lower productivity growth and lower employment growth. While economists understand the principles underlying productivity growth, it’s quite difficult to parse the causes of medium-term swings in productivity growth, particularly as they are happening. At this juncture, low productivity growth has persisted long enough that I think the best guess is that it will remain low for an extended period.