In the near term, headline inflation is likely to continue to be boosted by the direct effects of the recent increases in the prices of energy and food. If, as futures markets suggest, those prices level off later this year, prospects seem reasonably good for headline inflation to move back in line over time with core inflation. And I expect core inflation to ease off slowly as commodity prices level out and as economic slack creates competitive conditions that inhibit increases in labor costs and prices

My expectations for moderating inflation and limited spillover effects from commodity price increases depend critically on the continued stability of inflation expectations. In that regard, year-ahead inflation expectations of households have increased this year in response to the jump in headline inflation. Of greater concern, some measures of longer-term inflation expectations appear to have edged up. If longer-term inflation expectations were to become unmoored--whether because of a protracted period of elevated headline inflation or because the public misinterpreted the recent substantial policy easing as suggesting that monetary policy makers had a greater tolerance for inflation than previously thought--then I believe that we would be facing a more serious situation.

The Federal Open Market Committee will be monitoring inflation developments closely for any sign that our longer-run objective of promoting price stability is threatened.

Although the current financial and economic situation remains quite difficult, I believe that the most likely scenario over the next year or so is one in which economic activity firms during the second half of this year and then gathers some strength in 2009. In the near term, consumer spending is likely to receive a boost from the rebates that are now flowing to taxpayers. Although the timing and the magnitude of the spending response are uncertain, economic studies of the previous experience suggest that a noticeable proportion of households respond reasonably quickly to temporary cash flows. Of course, the stimulus to domestic production will depend on the extent to which the additional demand is met by a temporary drawdown of inventories or an increase in imports rather than by an expansion in domestic output. But to date, businesses appear to be keeping tight control on inventories, and a reasonable assumption is that we will see a temporary lift to the economy in coming months.

The demand for housing is not likely to rebound substantially for a while after this episode, but the drag on growth from declining activity and prices in the housing market will ebb as excess inventories are worked off and affordability improves.

As with any forecast, mine is subject to a number of uncertainties. One is the extent of the housing correction ahead of us. If the retrenchment in house prices becomes deeper than anticipated, its effect on lenders and financial markets could further damp overall economic activity. We are in uncharted waters when the financial system becomes so disrupted, though we should consider ourselves fortunate that we have very few similar historical episodes on which to base our judgments. In such circumstances, uncertainty about how credit conditions will evolve and how businesses and households will react to changing terms and conditions means that we can have even less confidence than usual in our economic forecasts.

Still, the persistence of relatively wide spreads in many markets suggests that investors continue to be worried about credit quality; the issuance of speculative-grade bonds has been scant this year; and securitization markets for many types of mortgages continue to be impaired. In addition, term bank funding markets remain under pressure as banks and other lenders in these markets conserve capital and liquidity and limit risk-taking. Banks have further tightened lending standards across a wide range of business and consumer loans.

These findings generally suggest that market participants remain wary, and in that environment, improvements in financial markets are vulnerable to negative news on the economy or the extent of credit losses. I expect further, but gradual, improvement in financial markets.

The U.S. economy is in the midst of a pronounced slowdown, with very little growth recorded for two consecutive quarters. The weakness was initially centered in the housing sector but has become more widespread.

My view is the following: Global economic integration has progressed in recent years to the point that a slowdown in the United States will unquestionably be felt, but not as severely as imagined by some. Domestic growth momentum in many emerging economies will attenuate the influence of U.S. weakness. And the accumulation of foreign currency reserves by these countries—the result of trade surpluses—provides an accessible resource to stimulate their own domestic growth to offset weaker exports, should that weakness materialize.

We expect inflation to abate somewhat in the second half and going into 2009 based upon our forecast of weak economic growth. ... There is some early indication that the strength of inflation has softened.

From Q&A as reported by Bloomberg News.

I don't want to hazard a guess that it's, oh, around the corner ...  If you look at the charts, the lines are headed south. Most measures of inventories look like they're going up.

As reported by Market News International, on whether an end to the housing downturn is near.

While much of the turmoil in financial markets occurred during relatively benign macroeconomic conditions, the economic situation has changed.  We have seen job losses, persistent increases in food and energy prices, and falling asset prices – all increasing the risk that less benign economic circumstances will add to the already intense challenges faced by financial institutions this year. 

Slower income growth, falling consumer sentiment, higher food and energy prices, lower housing and equity wealth, and tighter credit conditions are all restraining household spending, and are likely to do so in the near term.

Looking ahead, our outlook at the Chicago Fed is for continued weakness in real GDP over the near term. Activity is likely to remain weak for a number of reasons. Strains on intermediation and financial balance sheets mean that credit conditions will likely continue to restrict spending for some time. Businesses and consumers could limit their discretionary expenditures because of caution over the economic environment. And housing continues to be a downside factor. The unsold inventory of homes will continue to restrain residential investment, and it will take time for this overhang to unwind.

However, eventually the cumulative adjustments in house prices will bring more buyers into the market and activity will stabilize. While we don't expect any significant contributions to growth from residential construction for some time, the drag from the sector ought to at least diminish as we move through the rest of this year and next. Similarly, as financial market participants revalue portfolios and repair their balance sheets, the drag from credit conditions ought to diminish over time. Furthermore, even given the financial turmoil, the stance of monetary policy is accommodative and supportive of growth. Productivity growth, although below the lofty rates enjoyed in the late 1990s and earlier this decade, is still solid. Finally, the effects of the fiscal stimulus bill are likely to boost spending in 2008.

We have had this financial crisis; I think on balance as we at the Federal Reserve have provided liquidity to the marketplace, it's my thought that we have stabilized things.

This allows the other policy choices, the tax cut ... monetary policy that's in place, to strengthen the economy as it goes through the course of the year. And in that context then, our big challenge will be to make sure that we bring inflation in check and make sure that we do not repeat some of the experiences we had in the late 70s and early 80s when inflation became far too high.

As reported by Reuters.

[Inflation is increasing] to what I call unacceptable levels.

As reported by Bloomberg News