Personally, I want to see these inflation expectations mitigated, and I need to think through, in terms of my input into the process, whether and when it makes sense to argue for increases as opposed to just stopping the cutting.

That's a personal thing, and I'm just one of 17 people, and that depends on how -- to me -- whether or not we see some mitigation of inflation pressures and expectations without seeing an intensification of the economic anemia I spoke of earlier,

Looking at our record over the last 4 years of inflation that has fluctuated between just below 2 percent and (above) 3-1/2 percent, the danger in that pattern persisting is that people might become accustomed to it, and come to expect inflation to continue at rates greater than we would like to see. ...

A deterioration of inflation psychology is a major concern because it is very difficult to unwind.

From comments to press, as reported by Reuters

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.

Comfort zones, shmumfort zones.

...

An explicit point objective anchors inflation expectations more effectively than a comfort zone.  

I agree that the Fed certainly cannot afford to take for granted that inflation expectations will remain well-anchored.

At the same time, there are downside inflationary pressures relating to the slowdown in the U.S. economy. ... [T]he U.S. economy is particularly exposed to downside risks from the unwinding of the housing bubble and disruptions in financial markets. There is some slack now in the U.S. labor market and, if these downside economic risks materialize, quite a bit more slack could emerge. Even with a flatter Phillips curve, such a development would place some downward pressure on inflation. It is this unpleasant combination of risks to both inflation and employment that the FOMC must balance as it assesses the appropriate path for monetary policy going forward.

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.

The most prominent financial-asset-based measures are derived from Treasury Inflation Indexed Securities, commonly known as TIPS. These securities give the investor a fixed real return because their principal and interest payments are tied to the CPI. Regular Treasury securities are not tied to the CPI so breakeven inflation, the difference between nominal Treasury securities and TIPS, is used to infer expected inflation over length of the contract. However, it is difficult to extract a clean measure of inflation expectations from breakeven inflation. Two prominent problems are inflation uncertainty and liquidity risk.

A rise in inflation uncertainty is distinct from a rise in inflation expectations, although both impose costs on the economy. Rising inflation uncertainty - or, in other words, a widening in the range of plausible inflation outcomes - introduces a risk in making long-term contracts, particularly financial contracts. Investors look to be compensated for this risk, as they would for any other risk, making the terms of financial contracts more costly than they would be otherwise.

The second problem - liquidity risk - arises because the liquidity characteristics of the regular Treasury markets and the TIPS markets are not the same. The regular Treasury market is broader and deeper. So in periods of financial stress, such as those we have witnessed lately, large flights to quality might create a downward bias in breakeven inflation as a measure of inflation expectations.

Perhaps a more straightforward way to gauge inflation expectations is to simply ask people their views on inflation. In fact, the University of Michigan's monthly survey does just that. Unfortunately, we have problems with interpreting this data. For one thing, households' beliefs about future inflation are typically much higher than the actual inflation rate. Also, people are likely to report their inflation predictions in terms of whole numbers, and particular whole numbers at that. On average, women also tend to have higher inflation expectations than men, the poor higher than the rich, and the young and elderly higher than the middle-aged.[2]

These patterns in survey responses lead many to question the accuracy of using them to measure inflation expectations. When you get right down to it, they underscore the fact that we really know very little about how people form their inflation expectations. Economists at the Federal Reserve Bank of Cleveland, like many others, are pursuing research that seeks to better measure the inflationary expectations of households and businesses and to shed some much-needed light on the process by which inflation expectations are formed.

Until that time, I am left with the data I have in hand. Both the TIPS-based and survey-based measures of inflation expectations seem to have been fluctuating in a stable range during the past couple of years. In other words, inflation expectations appear to be anchored.

As for inflation compensation derived from spreads between yields on nominal and inflation-indexed Treasury securities (known as Treasury Inflation-Protected Securities, or TIPS), the implied rate of inflation compensation from five years ahead to ten years ahead (the so-called five-to-ten-year-forward rate) has risen somewhat since the beginning of the year.  Does this rise in forward inflation compensation indicate that long-run inflation expectations have risen by a similar amount?  My best guess is that much of the rise in inflation compensation reflects other factors.

To begin, recall that inflation compensation measured by using TIPS yields is not the same thing as inflation expectations.  Rather, movements in inflation compensation reflect not only changes in inflation expectations, but also changes in an inflation risk premium and in the relative liquidity of TIPS and similar maturity nominal Treasuries.  To see that these components are distinct, recall that during the period of heightened concerns about deflation in 2003 and 2004, forward inflation compensation rose substantially to an unusually high level amid concerns about an unwelcome fall in inflation; that earlier episode, in particular, underscores the fact that we must be careful in using the forward rates of inflation compensation as a gauge of long-run inflation expectations. 

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.

Once the genie is out of the bottle, it's hard to get it back in. We can't wait too long for inflation expectations to materialize; otherwise we'll get behind the curve.

From press Q&A  as reported by Market News International

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

One critical precondition for effective central-bank easing in response to adverse demand shocks is anchored long-run inflation expectations. Otherwise, lowering short-term interest rates could raise inflation expectations, which might lead to higher, rather than lower, long-term interest rates, thereby depriving monetary policy of one of its key transmission channels for stimulating the economy.

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