Under Chairman Bernanke, who is expected to step down when his current term expires in January 2014, the U.S. central bank has embraced the goal of making the historically shrouded business of setting monetary policy far more transparent.
It has adopted a string of new rules and guidelines to clarify its policy intentions, including an inflation target and a conditional vow to hold interest rates near zero until at least mid-2015.
The next step is being hotly debated now.
Fed policymakers are striving to agree on a set of economic variables, or thresholds -- probably particular levels of unemployment and inflation -- that would signal when the time to raise interest rates was finally drawing near.
The trick is making a credible commitment that convinces investors to keep longer-term borrowing costs low, thus stimulating the economy, while at the same time ensuring the Fed can react swiftly to changing economic realities.
The concern is that these rules and guidelines will crimp the central bank's flexibility in years to come as it deals with the fits and starts of a protracted U.S. economic recovery.
"The more they do it over the next year, the more the next chair will be constrained," said Vincent Reinhart, chief U.S. economist at Morgan Stanley and a former Fed economist. The "constructive ambiguity" the central bank has famously used over the years to safeguard its policy-setting discretion is slowly disappearing, he said.
PRESERVING POLICY CREDIBILITY
In battling the worst recession in decades, central banks around the world have deployed untested tools, such as large-scale bond purchases. They have also often made commitments about how, and for how long, they plan to use the tools.
Their decisions will matter for years to come.
After eight grueling years battling a severe financial crisis, the deepest recession since the Great Depression and a disappointing recovery, Fed watchers say Bernanke will likely want to step down when his second term as Fed chief expires, even if Obama wants him to stay.
But the economy is unlikely to have fully recovered by then, leaving any rate-hike cycle to his successor. Fed Vice Chair Janet Yellen and Lawrence Summers, a former White House economic adviser, are both considered possible top candidates for the job.
Whomever Obama nominates will be handed a rule book from the Bernanke era that will be difficult, and maybe unwise, to erase.
Though the guidelines adopted under Bernanke are not iron-clad law, "the credibility of policy actions would be at stake if they were easily overturned," said Peter Hooper, chief U.S. economist at Deutsche Bank Securities.
AGE OF IMPROV
If Fed officials can reach agreement, economic thresholds would replace their stated expectation that interest rates would remain near zero through at least mid-2015.
It would be the latest refinement to the Fed's communications toolkit. In the last 16 months alone, it moved to tie low interest rates to calendar dates, adopted a formal inflation target of 2 percent, and published the policy expectations of each of its 19 policymakers. It built on that list in September when it said it expected to buy bonds until the labor market outlook improved "substantially."
Within the Fed's policy-making committee, however, consensus on which unemployment or inflation levels to use has proven elusive. Four top Fed officials have gone public with their own proposals, whether simply to provide a window into their tough internal debate or to sway their colleagues.
"It would be nice if we could communicate more clearly what those parameters are," William Dudley, the influential president of the Federal Reserve Bank of New York, said last month.
"The problem of course is that it's very hard to summarize the economy, and how you're going to feel about the economy, through just one or two parameters," said Dudley, who has not pitched a plan.
Yellen -- who as chair would likely smooth the transition from Bernanke -- could shed more light on the issue on Tuesday when she gives a speech on central bank communications.
To be sure, Bernanke's Fed has been careful to leave itself some breathing space. The current round of bond purchases is "open-ended," meaning there is no dollar value or timeline constraining it.
Still, the drum beat of rule changes continues.
The Fed is also considering adopting a "consensus forecast" to give investors a better sense of how policy is likely to evolve. That would build on a January decision to publish for the first time individual policymakers' rates forecasts.
As Bernanke's term draws to a close, the jury is still out on the effectiveness of the new transparency steps.
"It is the improvisation stage," Reinhart said, "and it does feel unsatisfying."
(Reporting by Jonathan Spicer; Editing by Tim Ahmann and Leslie Adler)