During the 1970s, inflation expectations were very poorly anchored. There was very little confidence that the Fed would keep inflation low and stable. When oil prices rose, those price increases fed through quickly into other prices and began to raise the general rate of inflation quite quickly.

The Fed responded somewhat in a panicked way by raising interest rates enormously, which then contributed to the deep recessions of 1975 and 1981-'82.

In a more recent episode, we've had extensive increases in energy prices, but outside of the energy sector, if you look at core inflation, core inflation remains very well controlled. And as a result, the Fed Reserve has been able to raise interest rates from its low accommodative level, but to only 4 percent at this point. And the economy is growing strongly.

So I think this is an enormously good illustration of why keeping inflation low, stable and keeping expectations well-anchored is of tremendous benefit, not just on the inflation side, but also on the employment and growth side.

From the Q&A session

Thus far at least, the growth effects of energy price increases appear relatively modest. The economy is much more energy-efficient today than it was in the 1970s, when energy shocks contributed to sharp slowdowns, and real energy prices remain below the peaks attained in the 1970s and early 1980s. Well-controlled inflation and inflation expectations have also moderated the effects of energy price increases, since those increases no longer set off an inflation spiral and the associated increases in interest rates, as they did three decades ago.

Thus far over this cycle, inflation has been well-behaved, and inflation expectations have remained well-anchored. I fully expect that this will continue to be the case.

Some, but not all, of the decade-long trend decline in that forward [bond] yield can be ascribed to expectations of lower inflation, a reduced risk premium resulting from less inflation volatility, and a smaller real term premium that seems due to a moderation of the business cycle over the past few decades.

We seem to be on a fairly solid growth path and inflation expectations seem well-contained, and in that kind of situation, following through is probably the order of the day.

In recent years, market confidence has been so great that only a string of poor policy decisions would have changed inflation expectations.

One important advantage of well-anchored inflation expectations is that it can give the central bank the freedom to react to other developments...without raising concerns about its commitment to price stability. Indeed, well anchored inflation expectations are likely to give the Fed greater freedom to accomplish the other part of its mandate: maximizing employment.

Changing [inflation] expectations are a principal avenue by which short-term perturbations in price levels are propagated into more persistent changes in inflation rates.

[Inflation expectation] readings from the financial markets are helpful, but they are also muddied by changing premiums for inflation risk and liquidity, and they are not necessarily representative of the attitudes of households or businesses.

Now that we are in the neighborhood of price stability, we can be faced with looking at the possibility that inflation will fall too low as well as rise too high. Moreover, so long as inflation expectations are well anchored, we can tolerate limited changes in inflation, but we need to know that a rise or fall is not the beginning of a more extended trend. Consequently, we focus closely on the reasons for any changes in inflation and their implications for the outlook.

Core inflation has been running somewhat faster more recently, in part because of the increases in the prices of energy, commodities, and imports that began last year. Nevertheless, barring further sizable increases in the prices of oil and natural gas, both core and headline inflation rates should moderate later this year. Buttressing this view, long-run inflation expectations have been, on balance, fairly stable in the face of these price gyrations.

A central bank cannot always offset the effects of government deficits on economic growth and stability. But the more credible the central bank's commitment to price stability, the less likely it is that an inflation premium will be built into market interest rates, and the less likely it is that rising inflation expectations will distort economic decisions.

Generally we've seen a pick-up in some inflation measures, but expectations have stayed anchored.

Over time, both inflation and inflation expectations will be determined not by adjustments of particular prices but by fundamental factors--the competitive environment in labor and product markets that in turn reflects the extent of resource utilization, and the pace of productivity growth and its effect on costs. The recent news on both fronts suggests that inflation pressures will remain contained, but substantial uncertainty surrounds that outlook.

The behavior of labor compensation, the height of profit margins, and still-strong productivity growth all suggest that workers and businesses continue to face very competitive market conditions and that cost increases will remain in check. But in the current circumstances, we need to be vigilant for signs of persistent upward pressure on costs, a marked tightening of labor and product markets, a reduction in global discipline on domestic pricing decisions, or increases in inflation expectations--especially expectations of price increases over the longer run.