I expect the economy to continue to operate at a high level relative to its potential, which could eventually lead to the emergence of increased inflationary pressures. In addition, if actual inflation does not show clear enough signs of returning to the center of the range I associate with price stability, there is a danger that expectations of inflation could run too high, which would likely be a self-fulfilling prophesy. Taking all of these factors into account, my assessment is that the risk of inflation remaining too high during the forecast period is greater than the risk of growth falling too low. Thus, some additional firming of policy may yet be necessary to address this inflation risk.

I have never believed that slack is the main engine of inflation control.  I have talked about this a lot. If you take a standard Phillips Curve model, the inflation rate depends on a gap term, slack if you will, or resource utilization. {It also} depends on inflation expectations and a shock, or random term.  And I have often said that inflation expectations trump the gap.  So I put a high weight on inflation expectations. 

If you condition monetary policy strictly on expectations you're going to get a hall of mirrors problem, and it's not a good idea, to put it mildly...

We do look at expectations.  We think it's informative in a number of ways.  But we certainly don't substitute expectations data for more fundamental analysis of inflation. 

From the Q&A session.

[Lacker] said the reason inflation “seems to be so persistent ... is that we have not communicated very strongly that we want inflation to be lower and would be willing to take action to bring that about”.

He added the Fed sometimes talked about pass-through “as if it is a force of nature rather than a product of policy expectations”.

His remarks are likely to be seen by some Fed watchers as critical of Ben Bernanke, the Fed chairman, even though Mr Lacker was careful not to mention him by name.

Mr Lacker said he had been “surprised over the last several months by the extent to which the markets seem to discount the possibility of us firming policy further to bring inflation down”.

When you get right down to it, we really know very little about how people form their inflation expectations.  To what extent are expectations based on past inflation experience versus looking into the future? Do people scour all of the available data to predict inflation, or do they just consider the information most readily available to them? And, perhaps most important, how do people act on the inflation expectations that we measure through the household surveys?

There is much at stake in the answers to these questions. We might discover important differences between household survey information and financial market data. We may also find an answer to one of the great questions - and obstacles - in the monetary policy process. Namely, are inflation expectations responsible for the long time it takes for monetary policy actions to show up in the inflation data?

Understanding what lies behind our measures of inflation expectations could greatly enhance the design and conduct of monetary policy. For example, it could help us understand what types of institutional arrangements and communication policies help the central bank retain credibility for meeting its price stability objective, even when large and persistent relative price changes ripple through the inflation data.

To that end, unlocking some of the mysteries about inflation expectations may help central banks decide whether, and how, to incorporate a numerical inflation objective into the monetary policy process.  Some central banks have used these numerical objectives as a tool to help anchor inflation expectations. Economists refer to a numerical inflation objective as a "commitment device," that is, a means for holding a central bank's feet to the fire. That may be so. But whether or not there is an explicit numerical objective, anchoring inflation expectations requires a central bank to keep inflation low and stable, to reinforce its commitment to price stability, and to clearly communicate its policies in pursuit of that commitment

I put the greatest weight by far on the TIPS spread because you observe it daily, hourly if you want. And I don't just trust the surveys. I think the surveys can be influenced heavily by what people are seeing on television, by the latest readings on gasoline prices.

In fact, I wouldn't be surprised with the substantial decline we've had in gasoline prices in recent weeks that you'll see the next surveys coming out down from where they were. But I don't put a whole lot of weight on the surveys.

Most of the market commentary, I think, is picking up half the story. The commentary is that the economy is perhaps soft and that the next Fed moves will be down on the Fed funds rate rather than up. So the market is anticipating some easing of monetary policy in the future. That's part of the story.

There's another part of the story, though, which is that the bond market works as a built-in stabilizer for the economy.  So the fact that rates are down is going to tend to support housing, for example, which is very, very sensitive, and other consumer durables, interest-sensitive spending.

So the bond market is serving as a built-in stabilizer and will help to keep the economy from weakening dramatically going forward. That's my expectation.

I think there's a danger of inflation becoming entrenched at the level it is now with core inflation well over two and I think that most people and I myself personally would like to see it down around one-and-a-half percent..

Right now it's difficult at all times to get a hand on where people in the economy generally expect inflation to be. But right now I think there's, you know, a sense that inflation expectations are contained but having said that, there's a dispersion. There's, you know, a range of view about how rapidly inflation will come back down.
    The longer we let inflation remain, core inflation, remain where it is I think the more likely it is that expectations collapse on core inflation remaining about where it is now rather than declining as I would like to see it decline.
     So that's what I mean by becoming entrenched, becoming firmly lodged in the public's mind as an expectation that that's the inflation rate we're going to tolerate and I think that would be a mistake.

As to inflation risks, the main concern is that inflation could stay elevated for a considerable period of time and could feed into higher inflation expectations in financial markets and labor markets.  If so, the Federal Reserve might have to tighten policy further to insure that inflation expectations are contained and price stability is maintained over the long term.  Thus far, inflation expectations have remained fairly subdued, but they will require continued scrutiny in coming months.

Overall, the combination of lower and less volatile inflation around the world has led to a reduction in inflation expectations and lower perceived inflation risk, hence a lower inflation uncertainty premium in long rates. I believe that these factors have been important contributors to the lower long-term yields and the flattening of yield curves, particularly in emerging markets.

The core CPI has increased at an annualized rate of more than 3 percent during the past three months. This inflation picture, if sustained, exceeds my comfort level.
Fortunately, the public is, for the most part, looking at this disappointing inflation news as a transitory development. Measures of long-term inflation expectations have been mixed lately, but, on the whole, I regard them as remaining contained. The FOMC's challenge is to make sure that they stay contained.

"If inflation turns out to exceed . . . our target range, I do not believe we can count on a slowing economy to bring inflation down, by itself, quickly," William Poole, president of the Federal Reserve Bank of St. Louis, said in an interview. If inflation expectations rose in "a persistent way . . . we could expect to see that show up in measured inflation in fairly short order." 

In a Wall Street Journal interview

The best way to prevent increases in energy and commodity prices from leading to persistently higher rates of inflation is by anchoring the public's long-term inflation expectations.  Achieving this requires, first, a strong commitment of policymakers to maintaining price stability, which my colleagues and I share, and second, a consistent pattern of policy responses to emerging development needed to accomplish that objective.

As for inflation, the rise in energy costs has had a significant impact on overall or "headline" inflation and has likely also affected core inflation (which excludes the direct effect of energy price increases), although thus far the impact on core inflation appears to have been relatively modest. In the longer run, these inflation effects should fade even if energy prices remain elevated, so long as monetary policy keeps inflation expectations well-anchored by responding appropriately to future price and output developments.

Both survey data and the market prices of inflation-protected Treasury securities tell us that the public expects inflation to continue to be contained. I am confident that we at the Fed have the knowledge and the will to validate those expectations.