I’m sympathetic to the view that policy has to be anticipatory.  If you wait too long you may not be able to address what could at that time be increased inflation expectations and inflation impulses in the economy.

As reported by Market News International.

We face, as always, the same difficult decision about what is the right moment to begin to remove accommodation. You don't want to remove accommodation so soon as to -- you know, as to prevent the recovery from taking hold. On the other hand, you don't want to wait so long as to lead to an inflation in the medium term. But that decision is the same difficult decision we always face when we come to a point to move a monetary accommodation.

Starting from where we are today, it is clear that interest rates must rise.  As the economy recovers, even at a modest pace, resource demands will begin to increase.  At this point, the current level of monetary accommodation will need to be withdrawn to avoid introducing inflationary impulses. Also, with the almost certain adjustments that need to occur in consumption, savings and the rebalancing of imports and exports, I expect there would be additional pressure for interest rates to rise steadily over time.

Right now, because of the weakness in economic conditions here and around the world, inflation has been running less than that, and our best forecast is that inflation will remain quite low for some time. Thus, the Fed's proactive policy approach is not at all inconsistent with the goal of price stability in the medium term.

I can assure you that monetary policy makers are fully committed to acting as needed to withdraw on a timely basis the extraordinary support now being provided to the economy, and we are confident in our ability to do so. To be sure, decisions about when and how quickly to proceed will require a careful balancing of the risk of withdrawing support before the recovery is firmly established versus the risk of allowing inflation to rise above its preferred level in the medium term. However, this delicate balancing of risks is a challenge that central banks face in the early stages of every economic recovery. I believe that we are well equipped to make those judgments appropriately. In addition, when the time comes, our ability to clearly communicate our policy goals and our assessment of the outlook will be crucial to minimizing public uncertainty about our policy decisions.

"What are the dangers now? What keeps you up at night?" Pelley asked.

"I think the biggest risk is that, you know, we don't have the political will. We don't have the commitment to solve this problem, and that we let it just continue. In which case, you know, we can't count on recovery," Bernanke said.

To break the adverse feedback loop, it is essential that we continue to complement fiscal stimulus with strong government action to stabilize financial institutions and financial markets.  If actions taken by the Administration, the Congress, and the Federal Reserve are successful in restoring some measure of financial stability--and only if that is the case, in my view--there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery. 

In the United States, the Federal Reserve has done, and will continue to do, everything possible within the limits of its authority to assist in restoring our nation to financial stability and economic prosperity as quickly as possible.

[F]iscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system.  History demonstrates conclusively that a modern economy cannot grow if its financial system is not operating effectively...

...Consequently, more capital injections and guarantees may become necessary to ensure stability and the normalization of credit markets.  A continuing barrier to private investment in financial institutions is the large quantity of troubled, hard-to-value assets that remain on institutions' balance sheets.  The presence of these assets significantly increases uncertainty about the underlying value of these institutions and may inhibit both new private investment and new lending.  Should the Treasury decide to supplement injections of capital by removing troubled assets from institutions' balance sheets, as was initially proposed for the U.S. financial rescue plan, several approaches might be considered.  Public purchases of troubled assets are one possibility.  Another is to provide asset guarantees, under which the government would agree to absorb, presumably in exchange for warrants or some other form of compensation, part of the prospective losses on specified portfolios of troubled assets held by banks.  Yet another approach would be to set up and capitalize so-called bad banks, which would purchase assets from financial institutions in exchange for cash and equity in the bad bank.  These methods are similar from an economic perspective, though they would have somewhat different operational and accounting implications. 

(W)hile inflation is receding for the moment, I must remind you that monetary policy is extremely accommodative, and if it remains so too long, as history suggests it may, inflation pressures could re-emerge as the economy recovers.
...
Inflation will remain moderate over 2009 and much of 2010.  Lower energy and commodity prices along with moderate improvement in demand for goods and services will keep price pressures temporarily contained.  How prices behave beyond the immediate horizon depends most critically on how the Federal Reserve conducts policy and manages its expanding balance sheet in a strengthening economy.  This is no doubt the central bank's most difficult long-run challenge.

 In December, the Committee took the historic final step of lowering the federal funds rate essentially to its "zero bound," establishing a target range of 0 to ¼ percent and communicating its expectation that weak economic conditions would likely warrant exceptionally low levels of the federal funds rate for some time. This move exhausts the Fed's ability to provide stimulus through "conventional" monetary policy actions. But it by no means exhausts the Fed's options to stimulate the economy through other measures. The Committee's focus going forward will be on "non-conventional" programs that use its balance sheet to improve the functioning of financial markets, an arena where considerable scope for action remains.

The potential for real interest rates to rise as inflation declines creates a significant downside risk because, with an extended period of abnormally high unemployment in the forecast, it is increasingly likely that inflation will fall to undesirably low levels. This is an additional consideration that, to my mind, militates in favor of strong policy responses.

The Federal Reserve has undertaken policy actions of historic proportion. We have aggressively cut the federal funds rate, our traditional policy lever. We have also created multiple new lending facilities and transformed the asset side of our balance sheet. And, going forward, we will be expanding nontraditional policies now that the fed funds rate is approximately zero. Accordingly, we are faced with the challenge of calibrating these unfamiliar policies and, in the future, determining the appropriate time and methods for winding them down.

While the downturn in real economic activity is going to pose challenges for monetary policy in the period ahead, it’s essential that we not let inflation drift from view. Since 2004, overall inflation has trended upward, and has been higher than I would like, over the last few years. Much of the acceleration we saw earlier this year reflected energy prices, however, and with oil prices down we have seen overall inflation subside in recent months.

Many economists are forecasting relatively low inflation in the months ahead, on the grounds that widening economic slack is generally associated with declining price pressures. While this correlation is detectable in many datasets, I would be cautious about relying on it as a causal relationship.⁵ And while it may seem premature to be worrying about how inflation behaves after the recession is over, we need to be sure our policy remains consistent with a strategy that does not allow inflation to ratchet up over the business cycle.

In response to a question about an ultra-low rate policy:

"I have not been a fan of going to really low levels," Bullard said today in a Bloomberg Television interview.  "Why is it zero this time?  I don't quite get that, though I know some people want to go in that direction."

In response to a question about the implications of the slowdown in money supply growth:

 “If you want to go to quantitative measures, then all of the issues about money come back to haunt you.  You have to talk about velocity and shocks to velocity, and you have to think about all the other things that are going on.  That is a debate that existed in the Eighties and probably sort of petered out in the Nineties, but it might be re-merging now.  But I don’t know exactly how the Fed is going to play that going forward.”

 In response to a question about quantitative easing and unconventional methods.

 “I think these issues are being discussed right now, and I don’t know how it’s all going to come out. I will point out that you have the 1979-82 period and there the famous monetarist experiment, for those of your viewers that were around at that time.  And in that case, gave up interest rate targeting, went to quantity targeting, lots of controversy about exactly how that worked and so and so forth, so it’s been done before.  And you could do it again.”

 “I think the Fed has plenty of tools that we can use.  One of the main things that I’m concerned about is somehow we can communicate what we’re going to do to a private sector that is used to thinking in terms of interest rates, because for the time being it looks like that is going to be off the table for a while.”