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The U.S. Federal Reserve might adjust the pace of purchases up or down as the labor market and inflation outlook changes in a material way, William Dudley, president of the Federal Reserve Bank of New York said Tuesday.
However, "because the outlook is uncertain, I cannot be sure which way - up or down - the next change will be," Dudley said in a speech delivered at the Japan Society.
The speech came a day before Fed Chief Ben Bernanke speaks on Wednesday ahead of the release of the minutes of the Federal Open Market Committee's latest policy meeting.
The Fed said in a statement after its May 1 meeting that it will keep the short-term interest rate near zero and continue its assets purchase program to bolster economic growth and job creation.
"The committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes," the statement said.
Dudley said he expected to see sufficient evidence about the prospect for substantial improvement in the labor market outlook.
"At that time, it will be appropriate to reduce the pace at which we are adding accommodation through asset purchases," Dudley added.
"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," he said.
Last December, the Fed announced for the first time explicit targets for both inflation and unemployment in setting monetary policy. The Fed decided to keep the short-term interest rates at near zero range as long as the unemployment rate remains above 6.5 percent, and inflation is projected to be no more than 2.5 percent.
"The thresholds are thresholds, not triggers. Thus it is hard to link the timing of the end of reinvestment to short-term rates," Dudley said.
"In recent months, we have communicated that ... we will not be overly hasty in tightening monetary policy once the recovery gets well established," the New York Fed president said.
The market has been watching closely and reacted sensitively to any hint of the Fed's possible exit or tapering of its 85-billion-U.S.-dollar monthly asset purchases.
Dudley warned that there is a risk that "market participants could overreact to any move in the process of normalization (of monetary policy). 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."
"Not only could such responses threaten financial stability, but also they might make it harder to calibrate monetary policy appropriately to the economic situation," Dudley added.
The New York Fed president said: "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."
The Fed's exit principles stated that it will first stop reinvesting, then raise short-term interest rates, and finally sell agency mortgage backed securities over a three-to-five year period, Dudley noted.
