I would not say that wage growth is a litmus test for changes in monetary policy, but it is something that is indicative both of likely inflationary pressure going forward. It's not a sure sign of it, but it's relevant, and it's also relevant in assessing whether or not we are at maximum employment.

In the first instance, as already noted, core inflation can to some extent be influenced by oil prices. However, a larger effect comes from changes in the exchange value of the dollar, and the rise in the dollar over the past year is an important reason inflation has remained low.
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The dynamics with which all these factors affect inflation depend crucially on the behavior of inflation expectations. One striking feature of the economic environment is that longer-term inflation expectations in the United States appear to have remained generally stable since the late 1990s. The source of that stability is open to debate, but the fact that the Fed has kept inflation relatively low and stable for three decades must be an important part of the explanation. Expectations that are not stable, but instead follow actual inflation up or down, would allow inflation to drift persistently.
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We should however be cautious in our assessment that inflation expectations are remaining stable. One reason is that measures of inflation compensation in the market for Treasury securities have moved down somewhat since last summer. But these movements can be hard to interpret, as at times they may reflect factors other than inflation expectations, such as changes in demand for the unparalleled liquidity of nominal Treasury securities.

My own assessment {in December 2013} was that the economy would gradually recover. I projected that by the fourth quarter of 2014 the unemployment rate would decline to 6.2 percent, and year-over-year PCE inflation would rise to 1.8 percent. Consistent with that view of gradual economic recovery, I believed that an appropriate monetary policy would require the funds rate to rise to 1.25 percent by year-end 2014.

With the economy having already reached my year-end 2014 forecast for inflation and unemployment, and appearing to be well on its way toward achieving my 2015 forecasts approximately a year ahead of schedule, the funds rate setting remains well behind what I consider to be appropriate given our goals.

One has to bear in mind that monetary policy has to lead economic developments. Monetary policy is a bit like duck hunting. If you want to bag a mallard, you dont aim where the bird is at present, you aim ahead of its flight pattern. To me, the flight pattern of the economy is clearly toward increasing employment and inflation that will sooner than expected pierce through the tolerance level of 2 percent.

Some economists have argued that we should accept overshooting our 2 percent inflation target if it results in a lower unemployment rate. Or a more fulsome one as measured by participation in the employment pool or the duration of unemployment. They submit that we can always tighten policy ex post to bring down inflation once this has occurred.

I would remind them that Junes unemployment rate of 6.1 percent was not a result of a fall in the participation rate and that the median duration of unemployment has been declining. I would remind them, also, that monetary policy is unable to erase structural unemployment caused by skills mismatches or educational shortfalls. More critically, I would remind them of the asymmetry of the economic risks around full employment. The notion that we can always tighten if it turns out that the economy is stronger than we thought it would be or that weve overshot full employment is dangerous. Tightening monetary policy once we have pushed past sustainable capacity limits has almost always resulted in recession, the last thing we need in the aftermath of the crisis we have just suffered.

[R]ecent readings on, for example, the CPI index have been a bit on the high side, but I think the data that we're seeing is noisy. I think it's important to remember that, broadly speaking, inflation is evolving in line with the committee's expectations.

The committee has expected a gradual return in inflation toward its 2 percent objective. And I think the recent evidence we have seen, abstracting from the noise, suggests that we are moving back gradually over time toward our 2 percent objective and I see things roughly in line with where we expected inflation to be.

We need to get much, much closer to two percent before we even contemplate liftoff, Evans told reporters after a presentation at the Istanbul School of Central Banking today. Whether that's late 2015 or early 2015 or 2016, it'll depend on the economy.

And in the area of monetary policy, the dynamics of inflation both during and following the recession have presented puzzles. For instance, why is inflation both here and abroad remaining stubbornly low today, even as the economic recoveries in the U.S. and the Euro area strengthen, in part boosted by highly accommodative monetary policy? In Boston, we have examined the extent to which a number of factors might explain recent behavior time-variation in the slope of the Phillips curve, a reduced impact of relative prices (especially oil) on inflation, survey measures as proxies for short-run and long-run inflation expectations, and downward nominal wage rigidities. While these factors appear to provide partial explanations, no effects singly or severally provide a complete accounting of recent inflation behavior. Given these uncertainties about inflation dynamics, we have reason to have less confidence than usual in the inflation forecasts from our suite of models, many of which would suggest a gradual rise toward the Fed's inflation target in coming quarters. This makes the current low level of inflation more troubling from the perspective of risk management. So, in short, we need to better understand inflation dynamics.

“I have been surprised by the stability of inflation and inflation expectations.”

“Given the expansion of our balance sheet, if you told me we were heading to a $4 trillion balance sheet, $4 trillion of outside money in the system, and that inflation expectations have remained stable, and apparently as a result inflation itself has remained remarkably stable, I wouldn’t have put 99% probability on that. I would have put much less probability on that,” Mr. Lacker said in response to audience questions.

My point is simply to highlight the longer-term consequences of what might appear to be smallish, shorter-term deviations from the norm. Business operators plan capital expenditure and payrolls not in one- or two- or even three-year increments; they plan and budget over longer-term horizons. The nominal stability that people need if they are going to negotiate multiyear contracts is a multiyear nominal stability. A policy that “lets bygones be bygones” from year to year may not achieve this kind of stability, especially when policy options can become constrained, in the short term, by the zero bound. A policy that takes a longer-term perspective and is properly communicated and executed—so as to instill confidence that monetary policy will hew to a 2 percent inflation target rather than fixate on the run-rate of the past four quarters or the outlook for the next four—may better supply the longer-term comfort that households and businesses need to plan and budget. Such a policy would reduce the uncertainty that monetary policy as it is currently conducted spawns and would be more effective in doing its part to assist in economic expansion.[9]

[For more information about tightening control of inflation expectations by putting a five-year inflation rate, in place of the usual four-quarter inflation rate, in the Taylor rule, see “All in the Family: The Close Connection Between Nominal-GDP Targeting and the Taylor Rule,” by Evan Koenig, Federal Reserve Bank of Dallas Staff Papers, No. 17, March 2012.]

An accurate measure of inflation is important for both the U.S. federal government and the Federal Reserve's Federal Open Market Committee (FOMC), but they focus on different measures. For example, the federal government uses the CPI to make inflation adjustments to certain kinds of benefits, such as Social Security.3 In contrast, the FOMC focuses on PCE inflation in its quarterly economic projections and also states its longer-run inflation goal in terms of headline PCE…

Given that the two indexes show different inflation trends in the longer run, having a single preferred measure that is used by both the federal government and the FOMC might be appropriate…

The FOMC carefully considered both indexes when evaluating which metric to target and concluded that PCE inflation is the better measure. In my view, headline PCE should become the standard and, therefore, should be consistently used to estimate and adjust for inflation. Although adopting a standard measure would likely not be a simple matter, it would provide clarity to the public about which one more accurately reflects consumer price inflation.

In the past, I have said we should hold the fed funds rate near zero at least as long as the unemployment rate is above 7 percent and as long as inflation is below 3 percent. I now think the 7 percent threshold is too conservative. Our latest actions put us on a better policy path than we had when I first proposed the 7/3 markers a year ago. At the same time, there still are few signs of substantial inflationary pressures. If we continue to have few concerns about inflation along the path to a stronger recovery there would be no reason to undo the positive effects of these policy actions prematurely just because the unemployment rate hits 6.9 percent — a level that is still notably above the rate we associate with maximum employment.

This logic is supported by a number of macro-model simulations I have seen, which indicate that we can keep the funds rate near zero until the unemployment rate hits at least 6-1/2 percent and still generate only minimal inflation risks. Even a 6 percent threshold doesn’t look threatening in many of these scenarios. But for now, I am ready to say that 6-1/2 percent looks like a better unemployment marker than the 7 percent rate I had called for earlier.

As always, monetary policy will need to evolve in response to ongoing shocks and new information. But I suspect that information about aggregate labor market quantities like unemployment will remain—at best—a noisy indicator about the appropriate stance of policy. Instead, I will be paying close attention to the behavior of core inflation. As the preceding analysis suggests, the changes in this variable appear to provide critical information about the empirical relevance of nominal rigidities, and therefore about the appropriate stance of monetary policy

I wrote that the cores were out and we should start focusing  more on headline inflation. You can check it out on my web page and what (ph) a recent speech I gave. But I've argued pretty strenuously that it's inappropriate to be throwing out food and energy prices. And especially in this environment where those are the prices that are going up the most. Those are the key shopping experiences for many households. It really hurts Fed credibility to be ignoring those prices when we're talking about inflation. So I'm very much in favor of looking at the headline number. I would smooth it out a little bit by looking at it over the last year or something, but - but I'm perfectly happy to look at the headline number.

Expectations are well-anchored until they are not. So it is somewhat troubling to me that expectations of inflation in the medium to longer term are moving up and down as much as they are. It suggests that the public and the markets may not have as much confidence in the Fed’s ability, or willingness, to deliver on its price stability mandate.

“Headline inflation is the ultimate objective of monetary policy with respect to prices,” Bullard said, noting that these are the prices that households actually pay.  “Core is not an objective in itself,” he added.  He said that while the only reason to look at core is as an intermediate target for headline, “its use as an intermediate target is questionable.”