we will see an increase in spending before the additional capacity comes on line. in addition, a technology shock also may give a boost to stock prices by raising expectations about future corporate profits. as a result, a wealth effect also may stimulate spending before the economy ’ s capacity to produce has expanded. to sum up, we know that the funds rate had to increase to contain inflationary pressures, regardless of whether the economy was being dominated by demand effects or supply effects. but the uncertainty arises when we have to decide how much to tighten and when to start. this uncertainty boils down to the question of where fomc actions should be along the spectrum of approaches ranging from strongly pre - emptive based mainly on forecasts of future developments - to more cautious - based mainly on emerging data. ideally, policy should tend more toward the pre - emptive end of the spectrum because of the long lags between policy actions and their effects on inflation. if a central bank reacts early and correctly to an inflationary threat, it can alter inflation expectations and cut off the rise in inflation before it gets started. it looks like that ’ s what happened in the us in 1994. at that time, we were dealing with forecasts of higher inflation that were based not only on increasingly tight labor markets but also on low short - term real interest rates. so the fed responded by raising interest rates substantially. in that case, inflation didn ’ t take off, and the economy moved smoothly into the favorable environment we ’ ve enjoyed in recent years. but when there ’ s a high degree of uncertainty about forecasts, it could be best to tend toward the more cautious end of the spectrum - because a somewhat delayed action could be preferable to running the risk of tightening when it ’ s not warranted. therefore, since most forecasts of output and inflation have been off the mark for several years, it has made sense to place less weight on the forecasts than we normally have in the past. it ’ s true that we began tightening policy before we saw any upward inflationary trend, and in that sense we were pre - emptive, in part because we knew interest rates would have to go up to some extent regardless of whether a demand shock or a supply shock was dominating. but the tightening phase started only a little more than a year ago, even though many forecasts have predicted rising inflation for several years. moreover, we ’ ve been fairly cautious in raising rates by a total of only 175 basis points

t fix all the economy ’ s problems. but monetary accommodation is indispensible. the economy would be in much worse shape if the fed weren ’ t acting so energetically. looking ahead, we may need to do more if the recovery falters or if inflation stays well below 2 percent. if the economy does need more stimulus, restarting our program of purchasing mortgage - backed securities would probably be the best course of action. the policy actions the fed takes will depend on how economic conditions develop. if circumstances change, our policies will adapt. no matter the circumstances, i assure you that we at the fed are doing everything we can to achieve the goals of maximum employment and stable prices. thank you very much. references board of governors of the federal reserve system. 2011. “ minutes of the federal open market committee ”, june 21 – 22. board of governors of the federal reserve system. 2012. “ press release ”, january 25. federal reserve bank of new york. 2010. “ quarterly report on household debt and credit ”, august. feroli, michael e., ethan s. harris, amir sufi, and kenneth d. west. 2012. “ housing, monetary policy, and the recovery ”. presentation to the 2012 u. s. monetary policy forum, new york, february 24. jorda, oscar, moritz schularick, and alan m. taylor. 2011. “ when credit bites back : leverage, business cycles, and crises ”. nber working paper 17621. mian, atif, kamalesh rao, and amir sufi. 2011. “ household balance sheets, consumption, and the economic slump ”. presentation at american economics association meetings, atlanta, ga, january 8, 2012. reinhart, carmen m., and kenneth s. rogoff. 2009. this time is different : eight centuries of financial folly. princeton, nj : princeton university press. for more information, see board of governors ( 2012 ). bis central bankers ’ speeches williams, john c. 2012. “ the federal reserve ’ s mandate and best practice monetary policy ”. presentation to the marian miner cook athenaeum, claremont mckenna college, february 13. bis central bankers ’ speeches