Gold is down, and I consider that to be a sign -- just one of a jillion, and I wouldn't overweight it -- that the marketplace considers the Fed serious about inflation -- not just me or somebody else -- but the Committee.

To start with, central bank credibility and low and stable inflation expectations are of critical importance. Earning that confidence is the most important thing the Fed can do in dealing with shocks as they occur. If the Fed doesn’t have that underlying confidence, then all sorts of things can go wrong and, indeed, the Fed may find itself willy-nilly taking policy actions intended to maintain or restore credibility rather than dealing with the current problem, whatever it might be. So, most of the work in dealing with the crises comes before they even happen. Where the Fed is now is a consequence of earning that credibility starting with Paul Volcker and then dealing successfully with a whole series of issues during the Volcker, Greenspan and now Bernanke eras.

Over the past year, inflation has been elevated by rising food, energy and other commodity prices and declines in the value of the dollar that have boosted import prices. However, several developments suggest that inflation is likely to moderate over the next couple of years. For example, broad measures of compensation have expanded quite modestly over the past year, and productivity growth has been fairly robust. In addition, futures markets point to a leveling out of energy and other commodity prices. Furthermore, the weakening in economic activity should put somewhat greater downward pressure on inflation going forward.

The Federal Reserve cannot, however, be complacent about inflation. Most survey measures of longer-run inflation expectations have remained reasonably well behaved. But measures of inflation compensation derived from the differential between nominal and real Treasury yields have moved up for the period of five-to-ten years ahead. Such measures are an imperfect indicator of inflation expectations, because they are affected by inflation risk and illiquidity. Nevertheless, these movements highlight the risk that our attempts to deal with problems in the real economy could lead to higher inflation expectations and an erosion of our credibility.

One important characteristic of simple rules is that they can be more easily explained to the public. That makes it easier for the public and for financial market participants to form expectations about policy. Simple rules could enhance the credibility of monetary policy, help anchor expectations, and better align the public’s expectations with the central bank’s intentions, which would minimize policy surprises and the detrimental effects often caused by such surprises.

Inflation is a very real phenomenon out there. It is there. We have to protect our credibility.

From audience Q&A as reported by Reuters.

Credibility accounts for why inflation appears generally to have become less persistent. Households and firms believe that such shocks will not be allowed to feed into further increases in inflation, so inflation expectations have become better anchored. Indeed, much research documents that movements in energy prices have had far smaller effects on core inflation since the mid- 1980s, and the most compelling reason for this shift is the credibility of monetary policy.

To the extent that people think consumer attitudes have soured, I think just going out there and trying to reassure people, I don't think that in and of itself is effective ...

I think actions speak louder than words and I think people will experience things on the ground that will either confirm their concerns or diminish them. We have a limited number of policy tools. I think we've used them, we could continue to use them, that remains to be seen.

From press Q&A as reported by Market News International

To date, inflation expectations appear to have remained reasonably well anchored, but any tendency of inflation expectations to become unmoored or for the Fed's inflation-fighting credibility to be eroded could greatly complicate the task of sustaining price stability and reduce the central bank's policy flexibility to counter shortfalls in growth in the future. Accordingly, in the months ahead we will be closely monitoring inflation expectations and the inflation situation more generally.

Fortunately, so far inflation expectations have not changed very much. But they bear watching because there are some signs that they, too, are edging higher. These may be early warning signs of a weakening of our credibility, and we must be very careful to avoid that.

Good communication is essential to successful central banking.  It is critical to preserving the democratic accountability and public legitimacy of central banks that, for good reasons, have been granted a high degree of insulation from short-run political pressures.  And good communication strengthens the effectiveness of good policy, largely because expectations are so important to the choices that households and businesses make about spending and saving and about prices and wages, as well as to the asset prices that help shape those choices.  Private decisions are more likely to reinforce the achievement of central bank objectives if decisionmakers understand the goals of the central bank, its evaluation of the forces bearing on the economy, and its possible responses to economic shocks. 

Excessive attention to the price behavior of a particular asset or asset class sends confusing and potentially misleading messages to the public. Will the public come to expect the central bank to implicitly place a ceiling on rates of return on certain assets, to the exclusion of its other stated goals? Undermining the credibility of the central bank’s commitment to price stability would complicate and raise the costs of achieving that goal. Hence, I view it as unwise to single out the price of houses, or any other item, for special consideration in conducting monetary policy.

I believe that the factors of globalization, deregulation, and financial innovation, arising partly in response to episodes of high inflation, have effectively eroded the central bank monopoly on the provision of monetary services and have enhanced global competition among currencies. These changes have, in turn, altered the incentives for central banks to behave badly and for finance ministries to use central banks as "piggy banks" to finance their fiscal policies. The resulting constraint on monetary policy, combined with increased public understanding of the costs of inflation, have led to institutional changes in central bank governance that bolster their credibility for maintaining price stability in the future. Thus, improved central bank performance and credibility are the consequences of this combination of factors.

One notable change is that movements in inflation now appear to tell us much less about future inflation than was the case, say, thirty years ago. Here I am talking about predictions of inflation using only information on past inflation, without taking into account any other information. The evidence suggests that, at the peak of U.S. inflation in the late 1970s and early 1980s, the best such “univariate” forecast of inflation--into the indefinite future--was a simple average of inflation over the past few quarters (Stock and Watson, 2007; Cecchetti and others, 2007). In that period, sharp increases in inflation were reversed only slowly. By contrast, shocks to inflation since roughly the mid-1980s have tended to be short-lived, so that the best forecast of future inflation would be a very long average of past inflation. Thus, when inflation moves above its recent long-run average, most of the upswing will likely be quickly reversed, although this result is not guaranteed.

Maintaining price stability does not require that the central bank come down hard on every upward twitch in the inflation rate, but disciplined response is required when the inflation rate threatens to rise in a sustained fashion or fall into deflation. Central bankers need to apply their best judgment, and they will not always be correct in those judgments. But if they have a good record and the market retains confidence that the central bank will correct its mistakes, errors in judgment will not do lasting damage. I myself rely heavily on market measures of inflation expectations in forming my judgments and in deciding what policy risks to run—in an uncertain world, it is always the case that policy judgments depend on probabilistic calculations.

If, however, core inflation seems to be settling at a rate above 2 percent, then such an outcome would be unacceptable to me. I put a very high weight on the Fed’s responsibility to maintain low and stable inflation...

My commitment, certainly, is to do what I can to promote policy adjustments that will yield an inflation outcome, on average over a period of several years, centered on 1½ percent on the core PCE price index. Such an outcome will ensure that the FOMC maintains its current high level of credibility. Maintaining price stability is central to maximizing sustainable economic growth and the highest possible level of employment.