Prior to the global financial crisis, a rough consensus had emerged among academics and monetary policymakers that best-practice for monetary policy was flexible inflation targeting. In the U.S., flexible inflation targeting is implied by the dual mandate given to the Fed, under which monetary policy is required to take into account deviations of both output and inflation from their target levels. But even in countries where the central bank officially targets only inflation, monetary policymakers in practice also aim to stabilize the real economy around some normal level or path.

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Another important question is whether monetary policymakers should alter their basic framework of flexible inflation targeting to take financial stability into account. My answer to that question is that the "flexible" part of flexible inflation targeting should include contributing to financial stability, provided that it aids in the attainment of the main goals of monetary policy. The main goals in the United States are those of the dual mandate, maximum employment and stable prices; in other countries the main goal is stable prices or low inflation.

When I began my term I expected to build on the monetary policy framework I had inherited from Paul Volcker and Alan Greenspan I believed that a still more transparent approach would make monetary policy even more effective and further strengthen the Fed's institutional credibility. In particular, as an academic I had written favorably about the flexible inflation-targeting approach used by the Bank of England and a number of other central banks. [T]hese central banks provided a clear framework to help the public and market participants understand and anticipate policy actions I was confident that we could adapt this type of framework to the Federal Reserve's dual mandate to promote both maximum employment and price stability. Indeed, central banks using this framework were already, in practice, often pursuing economic objectives in addition to low and stable inflation--hence the term, "flexible" inflation targeting. Because the financial crisis and its aftermath naturally occupied so much of policymakers' attention, progress toward a more explicit policy framework at the Federal Reserve was slower than I had hoped. Nevertheless, progress was made. In the minutes of its October 2007 meeting, the FOMC introduced its quarterly Summary of Economic Projections (SEP), which included FOMC participants' projections of key macroeconomic variables such as inflation, gross domestic product (GDP) growth, and the unemployment rate. Over time, we added long-run projections of inflation, growth, and unemployment, as well as projections of the path of the target federal funds rate consistent with each individual's views of appropriate monetary policy We took another important step in January 2012, when the FOMC issued a statement laying out its longer-run goals and policy strategy.2 The statement established, for the first time, an explicit longer-run goal for inflation of 2 percent, and it pointed to the SEP to provide information about Committee participants' assessments of the longer-run normal unemployment rate, currently between 5.2 and 6 percent.

How does the Federal Reserve fit into this range of policy frameworks? The Federal Reserve is accountable to the Congress for two objectives--maximum employment and price stability, on an equal footing--and it does not have a formal, numerical inflation target. But, as a practical matter, the Federal Reserve's policy framework has many of the elements of flexible inflation targeting. In particular, like flexible inflation targeters, the Federal Open Market Committee (FOMC) is committed to stabilizing inflation over the medium run while retaining the flexibility to help offset cyclical fluctuations in economic activity and employment.

While the Fed has not adopted explicit inflation targeting, the policy strategy it has followed over the past 20 years generated many of the benefits inflation targeting offers...

My colleague Fed Governor Ben Bernanke has described the current policy framework as "constrained discretion." But, as I mentioned, I prefer the term "flexible commitment." Under flexible commitment, the central bank has been free to adjust monetary policy to stabilize output and employment during short-term disturbances, while maintaining a strong commitment to keeping inflation under control.

In an earlier speech, I referred to the policy framework that describes what I consider to be best-practice inflation targeting as constrained discretion.  Constrained discretion attempts to strike a balance between the inflexibility of strict policy rules and the potential lack of discipline and structure inherent in unfettered policymaker discretion. Under constrained discretion, the central bank is free to do its best to stabilize output and employment in the face of short-run disturbances, with the appropriate caution born of our imperfect knowledge of the economy and of the effects of policy (this is the "discretion" part of constrained discretion). However, a crucial proviso is that, in conducting stabilization policy, the central bank must also maintain a strong commitment to keeping inflation--and, hence, public expectations of inflation--firmly under control (the "constrained" part of constrained discretion). Because monetary policy influences inflation with a lag, keeping inflation under control may require the central bank to anticipate future movements in inflation and move preemptively. Hence constrained discretion is an inherently forward-looking policy approach.

Is there then no middle ground for policymakers between the inflexibility of ironclad rules and the instability of unfettered discretion? My thesis today is that there is such a middle ground--an approach that I will refer to as constrained discretion--and that it is fast becoming the standard approach to monetary policy around the world, including in the United States. As I will explain, constrained discretion is an approach that allows monetary policymakers considerable leeway in responding to economic shocks, financial disturbances, and other unforeseen developments. Importantly, however, this discretion of policymakers is constrained by a strong commitment to keeping inflation low and stable.