[F]rankly the ECB has not done anything to increase volatility in the markets. If you think that the ECB has done anything that is comparable to what is happening in the other central banks, we would not agree with this perception. I think that all in all we are currently taking a much more conservative stance, although our monetary policy remains accommodative and, as I said, it will stay accommodative for as long as needed. But, certainly, we have observed an increase in global volatility, coming from major monetary policy decisions or announcements of decisions that may be taken in the coming months. However, I do not think that the ECB has in any way been a source of this; I cannot really find any data to support this.

But I do believe that big money does organize itself somewhat like feral hogs. If they detect a weakness or a bad scent, they’ll go after it.

...

My personal feeling is that you don’t walk up to a lion and flinch.

He said the Fed statement and subsequent press conference were part of a process to prepare markets for the end of central bank support. It “made sense to socialise the idea that quantitative easing is not a one-way street”, he said, and emphasised any such move would be done cautiously.

Going forward, the economic outcomes that the committee sees as most likely involve continuing gains in labor markets supported by moderate growth that picks up over the next several quarters as the near-term restraint from fiscal policy and other headwinds diminishes. We also see inflation moving back toward our 2 percent objective over time.

If the incoming data are broadly consistent with this forecast, the committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year and that the subsequent data remain broadly aligned with our current expectations for the economy, we will continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around mid-year.

In this scenario, when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7 percent, with solid economic growth supporting further job gains, a substantial improvement from the 8.1 percent unemployment rate that prevailed when the committee announced this program.

Later, in response to a question about whether this was a formal committee decision:

Well, again, we don't think of this as a change in policy. What I was deputized to do, if you will, was to try to make somewhat clearer the implications of our existing policy and to try to explain better how the policy would evolve in various economic scenarios. And that's a little bit difficult to put into, you know, a very terse FOMC statement.

Now, that being said, going forward, I think that, you know, some of this -- some of these elements -- to the extent that we can make them useful will begin to appear in the FOMC statement. It's entirely possible. But it seemed like the right tactic in this case to -- to explain these fairly subtle contingencies in a context where I could answer questions and -- and respond to any misunderstandings that -- that might occur.

Labor market conditions have improved since last summer, suggesting the Committee could slow the pace of purchases, but surprisingly low inflation readings may mean the Committee can maintain its aggressive program over a longer time frame.

Plosser said a strategy he’d favor would be “rather than trying to push our balance sheet up at the rate of $85 billion a month, maybe we could only push it up at the rate of 70, or 75, or 65 that is still trying to provide some accommodation, but at a slower pace and begin to sort of wean our way out.”

“It would be prudent to dial back the rate of purchases we are making in mortgage-backed securities” now that “the housing market is in a good state, construction has started again, housing prices are appreciating significantly.”

Given these dynamics, and in light of improving economic conditions, I support slowing the pace of asset purchases as an appropriate next step for monetary policy. Moreover, such actions would not constitute an outright tightening of monetary policy, but rather, it would slow policy easing. History suggests that waiting too long to acknowledge the economy’s progress and prepare markets for more-normal policy settings carries no less risk than tightening too soon.

In other words, a slowing in the pace of purchases could be viewed as applying less pressure to the gas pedal, rather than stepping on the brake. Adjustments today can take a measured pace as the economy’s progress unfolds. It would importantly begin to lay the groundwork for a period when markets can prepare to function in a way that is far less dependent on central bank actions and allow them to resume their most essential roles of price discovery and resource allocation.

I think we are approaching a period in which {asset purchase cutbacks} can be considered... Thats not to say June meeting, but we are approaching a period in which it can be seriously considered based upon sort of the momentum of the economy which is not great but nonetheless is moving forward.

In terms of monetary policy, it would in my view be premature to stop the Fed’s large-scale asset purchase program at this time. I believe the Fed should continue the purchase program until we see more sustained improvement in labor markets and have greater confidence that the economic recovery is sufficiently self-sustaining to yield continued progress in reducing the still very high unemployment rate.

However, I would also say that it may be undesirable to abruptly stop purchases, so it may make sense to consider a modest reduction in the pace of asset purchases if we see a few months more of gradual improvement in labor markets and improvement in the overall growth rate in the economy – consistent, by the way, with my forecast, which is somewhat more optimistic than that of many private forecasters.

I would reiterate that with an open-ended asset purchase program, changing the flow of purchases does not necessarily yield, in the end, a smaller central bank balance sheet. That would depend on having a fixed point for cessation of purchases, combined with a lower flow of purchases. So, even if we were to adjust the rate of monthly purchases, the ultimate size of the Fed’s balance sheet would depend on the point of cessation. If economic growth proves sufficient and the purchase program was not extended over a longer time period, the size of the balance sheet could be smaller than otherwise.

I want to be very clear that a step to reduce the flow of purchases would not be an automatic mechanistic process of -- of ending the program. Rather, any change in the flow of purchases would depend on the incoming data and our assessment of how the labor market and inflation are evolving. 

 BRADY: Thank you, Mr. Chairman.  If the economy were to accelerate, the Fed would have to start unwinding QE3. So what is the Fed's exit strategy, the steps you'll undertake? And when do you anticipate, again, executing this?

BERNANKE: Mr. Chairman, so first -- the first thing, of course, would be to wind down eventually the quantitative easing program, the asset purchases. As I've said, the program relates the flow of asset purchases to the economic outlook. As the economic outlook and particularly the outlook for the labor market improves in a real and sustainable way, the committee will gradually reduce the -- the flow of purchases.

I want to be very clear that a step to reduce the flow of purchases would not be an automatic mechanistic process of -- of ending the program. Rather, any change in the flow of purchases would depend on the incoming data and our assessment of how the labor market and inflation are evolving.

   So at some point, of course, we will end the asset purchase program. Subsequent to that we will follow the guidance that we've provided about interest rates. Our principal tool for raising interest rates will be the interest rate on excess (ph) reserves that we pay, which will induce higher money market rates and a higher federal funds rate. And we will complement that with other tools, including tools that we have for draining reserves. 

    We may or may not sell assets. At this point it does not appear that it is necessary for us to sell any assets -- or particularly not any mortgage-backed securities -- in order to exit in a way that doesn't endanger price stability. 

    So there are a number of steps. We are currently discussing further our exit strategy, and we hope to provide more information going forward. But we certainly are confident that we can exit over time in a way that will be consistent with our policy objectives. 

    BRADY: You anticipate allowing maturing securities to roll off the balance sheet before you begin selling securities themselves? 

    BERNANKE: As I said, we -- we could normalize policy by simply letting securities roll off, and I think there's some advantages to doing that. For one it wouldn't disrupt markets so much. It would avoid as much irregularity in our fiscal payments to the Treasury. But we will see, ultimately, in the very long run, I think there's a desire to get back to a predominantly Treasury security portfolio. 

    But, again, in the exit process, allowing assets to roll off would be sufficient to bring us to a more normal balance sheet within a reasonable period. 

BERNANKE:  If we see continued improvement and we have confidence that that is going to be sustained, then we could in -- in the next few meetings, we could take a step down in our pace of purchases. Again, if we do that, it would not mean that we are automatically aiming toward -- toward a complete winddown. Rather, we would be looking to beyond that to see how the economy evolves, and we could either raise or lower our pace of purchases going forward. 

Again, that is dependent on the data. If the outlook for the labor market improves and we are convinced that that is sustainable, we will respond to that. If the recovery were to falter, if inflation were to fall further and we felt that the current level of monetary accommodation was still appropriate, then we would delay that process. 

BRADY: At the pace we're going, do you think it's likely these actions will begin before Labor Day? 

BERNANKE: I don't know. It's gonna depend on the data. 

The other important point to make here is when we're doing purchases, if we continue to do purchases, we're adding stimulus. And people act like if we dial the rate of purchases down somehow we're tightening monetary policy. What we're actually doing is adding less stimulus.

Because the outlook is uncertain, I cannot be sure which way—up or down—the next change will be. But at some point, I expect to see sufficient evidence to make me more confident about the prospect for substantial improvement in the labor market outlook. At that time, in my view, it will be appropriate to reduce the pace at which we are adding accommodation through asset purchases. Over the coming months, how well the economy fights its way through the significant fiscal drag currently in force will be an important aspect of this judgment.

....

There is a risk is that market participants could overreact to any move in the process of normalization. Indeed, there is some risk that market participants could overreact even before normalization begins, when the pace of purchases is adjusted but the level of accommodation is still increasing month by month.11 Not only could such responses threaten financial stability, but also they might make it harder to calibrate monetary policy appropriately to the economic situation. We will need to think long and hard about how best to develop policy in a way that enables us to respond flexibly to a changing economic outlook, but in a way that is not disruptive to the economy.