##mediaries – through which the effects of monetary policy flow to the real economy – find themselves at a crossroads. starting in august, my fellow fed policymakers and i persistently subjected ourselves to the age - old dialectic in determining the breadth and depth of our policy response : what do we know? what do we think we know – that is, what do we suspect? what can't we know? and, perhaps most important, in light of various forms of uncertainty : what should we do about it? the more we asked ourselves these questions during this period of extraordinary tumult, the more we recognized the need to broaden our policy response beyond monetary policy's blunt traditional tool. changes in the policy rate affect many sectors, not just those that seem out the opinions i am expressing are my own and do not necessarily correspond with those of my colleagues on the board of governors or the federal open market committee. nellie liang and dave reifschneider, of the federal reserve board's staff, provided valuable contributions to these remarks. milton friedman ( 1968 ), " the role of monetary policy ", american economic review, vol. 58 ( march ), pp. 117 ; edmund s. phelps ( 2008 ), " our uncertain economy ", wall street journal, march 14. of balance. charlie munger, the under - heralded partner of the " oracle of omaha, " warren buffett ( perhaps comprising the finest investment team of the last half - century ), believes that economics remains a rather insular field of practice. he seems to delight in accusing the economics profession of suffering from " man with a hammer syndrome. " he recounts, " [ t ] o the man with only a hammer, every problem looks pretty much like a nail. " 3 i suspect munger feels similarly about the orthodoxy of monetary policy. consistent with munger's admonition, the fed saw it necessary to expand our toolkit beyond the proverbial hammer of the policy rate in the last nine months. and as i discussed in remarks last month, the fed's nontraditional policy response included the use of innovative liquidity tools to counter the market turmoil and improve the functioning of financial and credit markets. 4 in my remarks today, i would like to discuss the use of the hammer – the setting of the federal funds rate – particularly in extraordinary times. of course, determining the proper level of the federal funds rate is rarely simple, given typical imprecision on

reserve : the plot thickens ", speech delivered at the new york university school of law global economic policy forum, new york, april 14. for analytical purposes only, let's assume that we are in a world where inflation is running well within acceptable levels and that the central bank and stakeholders have ultimate conviction it will remain as such. this, of course, smacks of the old joke about economists and can - openers. 5 i'll revisit this heroic assumption later in my remarks. but with the assumption in mind, monetary policy can focus on the real side of the economy. the taylor rule provides a convenient rule - of - thumb for setting monetary policy. 6 the rule posits that the appropriate setting of the real federal funds rate incorporates three components. the first component is the economy's natural rate of interest. this is the real federal funds rate consistent with output equal to potential, on average, over the medium - to long - run. if policymakers set the real federal funds rate at this level, the fed would be neither artificially boosting nor restricting the real economy over long periods. holding the federal funds rate at the natural rate, however, may yield an undesirably slow return of real activity to normal, particularly if shocks have a persistent effect on aggregate demand and supply. to expedite the process, the taylor rule adds a second component to the real federal funds rate, one that purports to be proportional to the size of the current output gap. by setting the real federal funds rate below the natural rate when resource utilization is loose – and, correspondingly, above the natural rate when resource utilization is tight – policy purports to help move the real economy back to normal at a speedier pace. the third component responds to the gap between actual inflation and its desired rate, pushing real rates up when inflation is too high and pushing rates down when inflation is too low. the taylor rule provides a reasonable description of actual monetary policy behavior on average over the past 20 years. the reasonably good macroeconomic performance of this period suggests that central banks should pay some heed to its prescriptions. by design, however, the taylor rule focuses largely on what can be observed in real - time, without accounting for some factors that influence monetary policy. for example, policymakers may try to peer, however imperfectly, into the future when setting the federal funds rate rather than responding solely to the current state of the economy.