[H]istorically, I believe it has been more difficult to remove policy accommodation in a timely fashion, which may have consequences for a central bank's long-term inflation objective.

Headline and core inflation have come in higher than anticipated, and inflation expectations have also moved up. If the risk of significant damage to growth from these financial market pressures is attenuated and if global growth remains strong and drives a continuing rise in energy and commodity prices, then inflation may not moderate as much as we anticipate. If the medium term outlook for inflation deteriorates significantly, the FOMC will move with appropriate speed and force to address this risk.

The point is that, at present, we simply do not have the ability to adequately account for the impact globalization has on the gearing of our domestic economy. Absent that capacity, we cannot, in my opinion, confidently assume that slower U.S. economic growth will quell U.S. inflation and, more important, keep inflationary expectations anchored. Containing inflation is the purpose of the ship I crew for, and if a temporary economic slowdown is what we must endure while we achieve that purpose, then it is, in my opinion, a burden we must bear, however politically inconvenient.

To some, this may appear a Hobson’s choice. I don’t see it that way. Our obligation is to prevent inflation in order to sustain long-term employment growth. I believe that the best way to cut through the treacherous economic waves that are upon us and keep our ship steaming forward is to stick to our purpose. 

[T]he FOMC must be careful to not undermine that recuperative process. Here, of course, I refer to the potential harm to the consumer and the business and financial sectors alike by unwittingly allowing the perception to take hold that, as the New York Times editorialized in its lead front page article last Thursday, “the Federal Reserve, signaled [its] readiness … to bolster the economy with cheaper money even though inflation is picking up speed.”[2]

Talk of “cheap money” makes my skin crawl. The words imply a debased currency and inflation and the harsh medicine that inevitably must be administered to purge it. So you should not be surprised that I consider the perception that the Fed is pursuing a cheap-money strategy, should it take root, to be a paramount risk to the long-term welfare of the U.S. economy.

I believe the Times overstates its case. Chairman Bernanke made clear in his congressional testimony last week that we are monitoring inflationary pressures and expectations closely. And yet, I understand the source of the Times’ sentiment.

It's no question that in a globalized economy, whereas before we were the beneficiary of tailwinds that helped us with new labor supply feeding into our productivity here in the United States, now we're facing headwinds based on demand-pull inflationary forces with these 3 billion plus new consumers around the world. So I'm more concerned about inflation than I have been of late. It's a growing concern.

We see it in particularly in commodities, and energy products. Those are usually taken out in core inflation measurements. However in Dallas, at the Dallas Fed, we don't use a core measurement. We use a trimmed mean measurement and even on that basis we see inflationary levels rising.

I believe there're longer term tectonic, structural forces at play. If they were temporary I'd be less concerned about them. I'm more concerned because I think they have to do with demand-pull as I mentioned earlier coming from the world at large as it grows and the ability of supply to respond. I'm concerned also by the way that the futures markets for oils have not proven to be very good indicators of future oil prices. So if we have these sustained high price levels... if gasoline at the tank goes as it has up 8 cents two weeks ago, 9 cents this past week and keeps rising, no doubt it will feed into inflationary expectations of consumers, and then business women and men who run businesses, and that's what we have to guard against.

Even as we respond to forces currently weighing on real activity, we must also set policy to resist any tendency for inflation to increase on a sustained basis. Allowing elevated rates of inflation to become entrenched in inflation expectations would be costly to reverse, constrain our ability to cushion further downward shocks to spending, and result over time in lower and less stable economic expansion. Inflation expectations generally have appeared reasonably well anchored, giving the FOMC room to focus on supporting economic growth

The basic point from these simulations is that monetary policy that responds to headline inflation rather than to core inflation in response to an oil price shock pushes unemployment markedly higher than monetary policy that responds to core inflation. In addition, because this policy has larger swings in the federal funds rate that must be reversed, it leads to more pronounced swings in unemployment. On the other hand, monetary policy that responds to core inflation does not lead to appreciably worse performance on stabilizing inflation than does monetary policy that responds to headline inflation. Stabilizing core inflation, therefore, leads to better economic outcomes than stabilizing headline inflation.

What you're seeing is more and more reports and discussion about inflation ... Women and men that run businesses are reading those and they are beginning to think in their own brains, in terms of positioning their companies, how they deal with what is suddenly becoming more and more of a noticeable issue.

From press Q&A, as reported by Market News International

Being a dissenter -- it's not like in politics where it's some awful negative thing. All of us are responsible and take very seriously the duties of inflation management.

From press Q&A as reported by Market News International.

Could it be that there are now trends in place in the relative prices of food and energy? I am not prepared to dismiss this possibility. Rapid economic development in China and India has placed increased demand on the world capacity to produce both food and energy and therefore has surely contributed to the persistent gap between core and headline inflation numbers observed over the past five years. It is not unreasonable to forecast that increased demand for food and energy by emerging economies with large populations will continue for a considerable period. This possibility suggests the FOMC must exercise caution lest monetary policy inadvertently accommodate an increased inflation trend by focusing on the behavior of price indexes excluding food and energy.

Although the danger is real, it is also true that oil futures prices for contracts several years ahead do not suggest continuing increases in oil prices of the magnitude observed over the past five years. That was also true five years ago—the futures market turned out to be wrong. However, my view is that policymakers should rely on the judgment of the markets unless we have solid evidence that the markets are wrong. My personal experience is that, although the markets obviously can be wrong, I have no confidence that my own judgment on something like oil prices will be systematically more accurate.

Recent research at the Federal Reserve Bank of St. Louis suggests that such movements along a short-run Phillips curve or transitory shifts up and down in that curve only account for a relatively minor portion of the observed inflation in the United States since the mid 1950s. The dominant factor in U.S. inflation history over the past 50 years has been changes in inflation expectations, or semi-permanent shifts up and down in the short-run Phillips curve. When it comes to the forces behind U.S. inflation, expectations trump the gap.(6) While some observers might be startled by this conclusion, reflection on the broad outline of our economic history should allay any apprehensions. In the 1960s and 1970s, successive business cycle peaks had both higher inflation and higher unemployment rates, explained by increases in inflation expectations. After the recession of 1990-91, both inflation and unemployment trended down for the remainder of the decade. In the textbook paradigm, such patterns can only be produced by shifts in the short-run Phillips curve generated by changes in inflation expectations. Indeed, direct evidence on inflation expectations suggests that expectations did trend gradually down over the 1990s.

The conclusion that expectations trump the gap in generating inflation is extremely important for monetary policy. It implies that low and stable inflation will only be observed when the private sector’s expectations of inflation are solidly entrenched at a low level.

The potential for headwinds is integral to thinking about economic prospects over the next year or two. To the extent that these headwinds gain momentum, they suggest relatively modest growth for a time and the likelihood of increases in the unemployment rate. Their implications for inflation are not so clear, although I would note that the pace of inflation diminished in the early 1990s relative to its performance over the preceding several years.