{On the question of a second stimulus package}

Well, again, if we go into next year and the economy continues weak and monetary policy is not being effective, and financial markets, for whatever reason, are not improving, then that would be a time to look at alternative options.

I think, for the near term -- and again, I'm not addressing issues like homeownership and many other things that Congress may want to deal with.

But simply, in terms of the fiscal stimulus package that was put in place, it's a fairly significant package which should add something like a percentage point, or even a little more, to growth in the second half of the year.  And I think we ought to -- on that particular issue, I think we ought to give that some time to work before we take additional steps.

We are thinking of the forecasts for the real economy not where it is today.

From Q&A as reported by Market News International

The principal challenge for policy is to provide an adequate degree of insurance against the downside risks that still confront the economy as a whole, without adding to concerns about inflation over the medium term. We cannot know with confidence today what level of the short-term real funds rate will be consistent with our objectives of sustainable growth and low inflation, but if turbulent financial conditions and the associated downside risks to growth persist, monetary policy may have to remain accommodative for some time.

Of course, even Taylor's research points out that periods of financial stress may require policy responses that differ from the usual prescriptions... The baseline outlook may be only modestly affected by the conditions, but there may be risks of substantial spillovers that could lead to persistent declines in credit intermediation capacity or large declines in wealth. These in turn would reduce business and household spending. In such cases, policy may take out insurance against these adverse risks and move the policy rate more than the usual prescriptions of the Taylor Rule.

Now if we took out such insurance too liberally or too often, then private sector markets would change their views regarding policy and alter their base level of risk-taking. But in doing so, we likely would observe inflationary imbalances emerging or unusual volatility in output. So part of our job as a central bank is to properly price these insurance premiums against the achievement of maximum employment and price stability over the medium term. Importantly, when insurance proves to be no longer necessary, removing it promptly and recalibrating policy to appropriate levels will reiterate and reinforce our commitment to these fundamental policy goals. And if we are transparent so that markets understand that we will adhere to this strategy, such insurance-based monetary policy will not encourage excessive risk-taking.

     SEN. DODD:  Am I hearing you correctly that we're in actually -- we're in a worse position today to respond to this than we were eight years ago? Is that my -- is that how I hear what you're saying?

      BERNANKE: I think that's fair, in that both fiscal and monetary policy face some additional constraints, and that the broad effects on the consumer -- I mean, many people own stocks, too, of course, and so that affected their wealth and their willingness to spend.

      But, in fact, the effects of the stock market declines in 2001 were primarily on investment and on firms more than on consumers. In this case, the consumers are taking the brunt of the effects.

We'll be looking over the next few quarters -- obviously the general performance of the economy, but as I mentioned in my testimony, there are a few areas of particular sensitivity that we could watch.

First is the housing market.  We need to begin to see some stabilization in starts and sales, it would be very productive in terms of both the economy and the credit markets.

Secondly is the labor market.  We don't expect a riproaring labor market by any means, but it would be nice if the labor market would begin to stabilize close to current levels.

Third, credit markets.  Senator Schumer was correct that there is a lot of concern among participants of the financial markets about the state of the credit markets. Much of that is connected with uncertainty about the broader economy. A significant worsening in financial conditions or credit availability would certainly be a warning bell that we need to take further action.

From Q&A, when asked how the Fed would decide if January's policy actions were sufficient. As reported by Market News International.

VICE CHAIRMAN GEITHNER. I really couldn’t tell, President Lacker, what inference you were going to draw from that. But I would just reinforce the point that, if you are more worried and uncertain now about the magnitude of the headwinds and the duration, I think it has to mean that you err on the side of going lower sooner. But the main point is that we just don’t know much about it, and I think it is worth a lot of humility. I mean, think how surprised we have been by so much over this period, even with all our thinking through three years ago about alternative paths for housing. So I would just vote for humility. But the basic point is that we have to err on the side of being worried about reducing the risk that you end up with 75 mile an hour headwinds rather than 25 for a long period of time.

….

PRESIDENT LACKER. Our Vice Chairman urges humility. I strongly support that. I agree with President Evans that it’s not obvious that the greater one’s humility, the greater one should favor ease. I think we should be humble about the path of inflation going forward, whether it’s likely to fall on its own. I think we should be humble about our understanding of the output gap. I think we should be humble about whether that’s even a sensible way to think about how real and monetary phenomena interact. The Phillips curve itself embodies a relationship. It is uncertain, but it embodies expectations of our future behavior. I think we should be humble about what those expectations are in the present circumstance. Times in the past when we’ve gotten in trouble on inflation have often been when we were over-solicitous about weak economic growth, and I think we should be humble about whether we’ve completely gotten past those inflation dynamics or not. I think we should be humble about the willingness of our future selves to reverse course, and a lot has been said about that. For some it seems to counsel greater ease now, but I think the opposite argument can be made that the extent to which we think we may be hindered or feel impeded in raising rates, even if we think it’s warranted in the future, should cause us to be more cautious about lowering rates now. It always seems in recoveries that there’s always something that looks fragile, that looks likely to threaten economic growth. You know, one month it will be the commercial paper market and CDO writedowns, and this month it’s monolines. There will be headwinds. I predict we’ll be talking about headwinds a fair amount in the next couple of years. But if those are genuinely going to impede us, we need to be realistic about that, and I think we need to take it on board now. I agree with President Poole. We need to be humble about our ability to prevent a recession. I think we should also be humble about the extent to which what we see in terms of both growth and financial markets is presumptively inefficient and needs remedial action on our part. You spoke several meetings ago, I think a year or two ago, Mr. Chairman, about our need to retain a concern about inflation but not be seen as inflation nutters. I think we need to care about financial fragility but not be fragility nutters.

I always stand ready to cut rates when it is appropriate.  The incoming data over the last several weeks has certainly made me willing to contemplate rate cuts. It has certainly altered the outlook.

From press Q&A, as reported by Bloomberg News and Market News International

Recently, negative information has been exceeding expectations. I think these circumstances call for policymakers to be prepared to respond pragmatically. In my view, pragmatism in the face of growing weakness in the general economy may very well require additional moves to lower the federal funds rate.

The Committee will, of course, be carefully evaluating incoming information bearing on the economic outlook. Based on that evaluation, and consistent with our dual mandate, we stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks.

Financial and economic conditions can change quickly. Consequently, the Committee must remain exceptionally alert and flexible, prepared to act in a decisive and timely manner and, in particular, to counter any adverse dynamics that might threaten economic or financial stability.

November 27, as reported by Bloomberg News

``I will not be surprised to see weaker statistics making headlines,'' Plosser said today. ``Too often people seem to think that when a weak economic number is released, the Fed will respond to it immediately with a policy action.''

November 30, after more market-friendly guidance from Vice Chairman Kohn and Chairman Bernanke, as reported by Dow Jones:

In a press conference ahead of a Fed policy forum here, Plosser said the Fed will closely monitor economic data due out over the next two weeks to assess whether the economic outlook should be revised downward...

Plosser said the Fed will evaluate the new data and assess "whether the outlook should be revised downward again," and if so, what change in monetary policy might be appropriate.    "I'm just sort of cautiously waiting to see what kind of data is available at the time," he said.

In sum, as I have indicated, we will be receiving a good deal of relevant information in the coming days. In making its policy decision, the Committee will have to judge whether the outlook for the economy or the balance of risks has shifted materially. In doing so, we will take full account of the implications for the outlook of both the incoming economic data and the ongoing developments in the financial markets.

Economic forecasting is always difficult, but the current stresses in financial markets make the uncertainty surrounding the outlook even greater than usual. We at the Federal Reserve will have to remain exceptionally alert and flexible as we continue to assess how best to promote sustainable economic growth and price stability in the United States.

[T]he increased turbulence of recent weeks partly reversed some of the improvement in market functioning over the late part of September and in October.  Should the elevated turbulence persist, it would increase the possibility of further tightening in financial conditions for households and businesses.  Heightened concerns about larger losses at financial institutions now reflected in various markets have depressed equity prices and could induce more intermediaries to adopt a more defensive posture in granting credit, not only for house purchases, but for other uses as well.

We clearly must be vigilant about these risks to economic growth. However, overly accommodative liquidity provision could endanger price stability, which is the second component of the dual mandate. After all, inflation is a monetary phenomenon. Indeed, one of the many reasons for the Fed's commitment to low and stable inflation is that inflation itself can destabilize financial markets.

...

That is, the Fed must adjust the stance of policy to guard against the risk of events that may have low probability but, if they did occur, would present an especially notable threat to sustainable growth or price stability...  But while the risk is still present of notably weaker-than-expected overall economic activity, given the policy insurance we have put in place I don't see this as likely.

Turning from the abstract to the concrete, the FOMC's decisions to ease policy at its September and October meetings were, in my view, governed in part by an attempt to manage the macroeconomic "tail risks" facing the U.S. economy.  To no small extent, stresses in financial markets contributed significantly to those macroeconomic risks.