[L]et me say a few words about the Federal Reserve's strategy for normalizing policy in the long run. In the minutes of its June 2011 meeting, the committee set forth principles that it intended to follow when the time came to normalize policy and the size and the structure of the Federal Reserve's balance sheet. As part of prudent planning, we've been reviewing these principles in recent meetings. We expect those discussions to continue and intend to provide further information at an appropriate time.

     For today, I will note that, in the view of most participants, the broad principles set out in June 2011 remain applicable. One difference is worth mentioning. While participants continue to think that in the long run the Federal Reserve's portfolio should consist predominantly of Treasury securities, a strong majority now expects that the committee will not sell agency mortgage-backed securities during the process of normalizing monetary policy, although in the longer run limited sales could be used to reduce or eliminate residual MBS holdings. I emphasize that given the outlook in the committee's policy guidance, these matters are unlikely to be relevant to actual policy for quite a while.

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.”

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.

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.”

Before I am in favor of tapering I would like to see some assurance that inflation is going to move back towards target.

Even if we do taper, it would still be a very aggressive pace of purchases because we would only be moderating the rate by a small amount ... I don't think we are actually that close at this point to talking about an exit.

Recognizing the drawbacks of persistently low rates, the FOMC actively seeks economic conditions consistent with sustainably higher interest rates. Unfortunately, withdrawing policy accommodation at this juncture would be highly unlikely to produce such conditions. A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further. Such outcomes tend to be associated with extended periods of lower, not higher, interest rates, as well as poor returns on other assets. Moreover, renewed economic weakness would pose its own risks to financial stability.

Because only a healthy economy can deliver sustainably high real rates of return to savers and investors, the best way to achieve higher returns in the medium term and beyond is for the Federal Reserve--consistent with its congressional mandate--to provide policy accommodation as needed to foster maximum employment and price stability. Of course, we will do so with due regard for the efficacy and costs of our policy actions and in a way that is responsive to the evolution of the economic outlook

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. 

I'm uncertain about what's going to happen to the economic outlook over the near term because I don't really understand really well how the tug-of-war between the fiscal drag and the improving economy are going to sort of work their way out over the next couple months. I think three or four months from now I think you're going to have a much better sense of is the economy healthy enough to overcome the fiscal drag or not.

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It's something that I certainly have my eye on, but I'm not very nervous about the fact that inflation's come in a little low relative to our 2 percent target because inflation expectations are still well-anchored. If inflation expectations were coming down, then I'd be a lot more concerned. If inflation expectations are well-anchored, what that means is inflation expectations are higher than the current rate of inflation, and so that'll tend to pull inflation back upwards a little bit.

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.

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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.

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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.

Given its statutory mandate, the FOMC's policy actions and communications have naturally sought to lower interest rates as a means of strengthening aggregate demand, promoting the pace of recovery in the labor market, and keeping inflation from falling further below the rate preferred by the Committee over the longer run. We will continue to calibrate monetary policy--including both the ongoing pace of asset purchases and communications about the likely path of the federal funds rate--in light of our interpretations of the latest data and the implications of those interpretations for the outlook for economic activity, labor market conditions, and inflation.

...[M]ost members of the FOMC project a modest improvement in the pace of the recovery this year and next, and, accordingly, a modest decline in the unemployment rate. The Federal Reserve will continue to conduct monetary policy so as to promote a stronger economic recovery in the context of price stability.

Based on the stated views of the Committee regarding the flexibility in pace of purchases, I believe that labor market conditions warrant scaling back the pace of purchases as soon as our next (June 18-19) meeting. Moreover, unless we see a significant reversal in current trends that jeopardizes my forecast of near 7 percent unemployment rate by the end of this year, then I anticipate that we could end the program before year-end.

“I would like to see us begin to scale this thing back beginning even as early as the next meeting” of the Federal Open Market Committee, Plosser said to reporters after a speech today in New York. The committee is scheduled to meet June 18-19.