limit the temptation to use the fed ’ s balance sheet as an instrument of fiscal policy. a road map to the future once we know where we want to go, we can begin to map out a path that will take us there. by articulating a systematic plan that gets us to our objective, we improve communication with the public, reduce uncertainty in the marketplace, and lend credibility to the commitment that policymakers will follow through. bis central bankers ’ speeches any exit plan that is to lead us to a corridor - like operating system has to describe how the fed funds rate or interest rate on reserves will be increased and how the balance sheet will be reduced. there are many ways to do so, but in every case, we must remember that monetary policy decisions should be contingent on the evolution of the economy. in late march 2011, i outlined a proposal for a systematic, rule - based approach that would involve the fed ’ s selling assets from its portfolio as it increased its policy rate, with the pace of sales dependent on the state of the economy. the plan would get us back to a normal operating environment in a timely manner, with the fed ’ s balance sheet reduced to a size that would again allow the federal funds rate to be the primary policy instrument. i also suggested that the first step of the normalization process would be to increase the interest rate paid on reserves and the targeted federal funds rate away from the zero bound, perhaps to 50 basis points. the federal open market committee would also announce its intention to stop re - investing the proceeds from maturing agency and treasury securities. these decisions would initiate the normalization process and begin to raise the funds rate and shrink the balance sheet from the start. how the process evolves from that point will depend on the plan and the state of the economy. the committee would also announce that at subsequent meetings it would regularly evaluate the policy rate based on economic conditions, as it always does. sales of assets between meetings beyond those maturing would also be tied to economic conditions, just as policy rate decisions are. the fed would announce a pace of sales, which would increase when the committee chose to increase the policy rate. since the amount of securities to be sold between meetings would be determined in advance, the public and markets would see the fed shrinking its balance sheet in a predictable manner. for example, the committee might set a sales pace of $ 20 billion of assets between fomc meetings and announce that for each 25 basis points the funds rate target

very establishment of a systematic plan itself – one that can be clearly communicated to the markets and the public in a way that reduces uncertainty. a systematic plan will help define for the public and the markets not only where we are headed but also how we will get there. of course, monetary policy will always be dependent on the evolution of the economy, but the more we can articulate how we will conduct policy during the transition to normalization, the more we will reduce uncertainty and contribute to stability. announcing an explicit plan in advance would also enhance the credibility of our commitment to normalization. if, for some reason, the committee chose to deviate from the plan, it would be forced to explain its reasons to the public. this brings me to one final but important consideration for the fed ’ s normalization strategy. unlike most of the major central banks around the world, including the ecb, the bank of england, and the riksbank, the federal reserve has not clearly announced and committed itself to an inflation target. some form of inflation targeting is widely accepted as a best practice by the majority of central bankers and monetary economists around the globe. given the extraordinary amount of liquidity present in the u. s. banking system, it is reasonable for the public to be concerned about the prospects for inflation down the road. if the public ’ s expectation of inflation continues to drift upward, whether it is caused by higher commodity prices, concerns over fiscal deficits, or the fed ’ s large balance sheet, we could find our credibility under pressure. it is noteworthy that just within the last year or so the public discussion has swung from concerns that the u. s. might face a period of sustained deflation to concerns that monetary policy and rising commodity prices could produce higher - than - desired inflation. it is troubling that the public ’ s inflation concerns can be so volatile. it suggests that there may be less confidence in the credibility of the fed ’ s commitment to price stability than we might desire. yet, if we are to exit from this period of extreme monetary accommodation in a way that neither leads to higher inflation nor risks undermining the recovery, the public ’ s confidence in the fed ’ s commitment to price stability will be crucial. for this reason, it would be highly desirable for the federal reserve to publicly commit to a clear and explicit inflation objective. conclusion the actions taken in response to the economic and financial crisis have left the federal reserve and a number of other central banks far