I believe that the optimal rate of inflation is zero, properly measured. However, biases in price indexes imply that, in practice, price stability will likely be consistent with a small positive measured rate of inflation. These biases arise from the difficulty of capturing improvements in the quality of goods and services, as well as substitutions among products that comprise consumers’ total purchases. Differences in how price indexes are put together imply that the specific rate of inflation that is consistent with price stability will likely vary across countries and over time. For the United States, I’ll hazard a guess that zero true inflation translates to an annual rate of increase in the CPI of about 1 percent and in the broader price index for personal consumption expenditures of about 0.5 percent.

...

A number of FOMC members have spoken about a “comfort zone” of 1 to 2 percent inflation, measured by the PCE price index excluding food and energy—the so-called “core” inflation rate.  That statement is fully acceptable to me.  My way of stating my comfort zone is core inflation of 1.5 percent per year, plus or minus a range of 0.5 percent to allow for unavoidable short-run fluctuations.  My statement is meant to indicate that I would like monetary policy to aim at 1.5 percent core inflation and not just accept inflation barely inside one end or the other of a 1 to 2 percent range.  

"There's still some overstatement'' {in the CPI} by about half to a full percentage point, Bernanke said."

"Clearly, when the Fed looks at inflation measures, we do have to look at more than one measure to get a sense of what inflation is doing."

From the audience Q and A, as reported by Bloomberg News

For example, a significant portion of the personal consumption expenditures (PCE) price index is based on imputations of prices for important categories of household purchases, such as banking services, rather than on direct observations of market prices.  This "nonmarket" component of the index is hard to replicate, tends to move in an erratic manner from month to month, and is subject to considerable revision--factors that reduce the usefulness of the overall index as a short-run indicator of price pressures.

Market-based PCE

  "I'd prefer an inflation target of zero, assuming it was possible to exactly measure the rate of purchasing power erosion," Poole said in the interview.
  Since that isn't possible, the Fed should establish a core inflation target of 1%-2%, Poole said, according to the article.
  "A lot would be gained in terms of discussions at the Federal Reserve Open Market Committee," Poole said. "The discussion would be clearer because everybody would mean the same thing when they speak of price stability."
  The discussion on the Fed's communication policy, which could result in the adoption of an inflation target, will probably take some time, Poole added.

From a DJ summary of a FAZ interview.

A good central banker knows how costly imperfect data can be for the economy. This is especially true of inflation data. In late 2002 and early 2003, for example, core PCE measurements were indicating inflation rates that were crossing below the 1 percent "lower boundary." At the time, the economy was expanding in fits and starts. Given the incidence of negative shocks during the prior two years, the Fed was worried about the economy's ability to withstand another one. Determined to get growth going in this potentially deflationary environment, the FOMC adopted an easy policy and promised to keep rates low. A couple of years later, however, after the inflation numbers had undergone a few revisions, we learned that inflation had actually been a half point higher than first thought.

In retrospect, the real fed funds rate turned out to be lower than what was deemed appropriate at the time and was held lower longer that it should have been. In this case, poor data led to a policy action that amplified speculative activity in the housing and other markets. Today, as anybody not from the former planet of Pluto knows, the housing market is undergoing a substantial correction and inflicting real costs to millions of homeowners across the country. It is complicating the task of achieving our monetary objective of creating the conditions for sustainable non-inflationary growth.

Some of my earlier concerns about the core CPI have diminished, in part because my concerns about the core PCE have increased.

As reported by the Wall Street Journal

In the past, I have stated my own personal inflation objective as “zero inflation, properly measured” but have also said that FOMC agreement on an inflation objective, which some might express as a “comfort zone of 1-2 percent inflation,” is more important than which precise specification is selected. There are practical difficulties that can and should be addressed, such as what price index to use, over what period to measure price changes and what degree of tolerance to adopt if inflation runs outside the range. I do not believe that uncertainty about the Fed’s inflation objective is a large issue at present but do believe that there is an opportunity to improve clarity.

The increase in inflation we have seen is a much broader phenomenon than that single component [owner-occupied equivalent rent in the CPI].  If that single component was the only issue, I would think twice. But I do see movements in inflation in a broad range of goods and services.

With respect to choosing a inflation objective in the medium term, there are many considerations one would want to take into account, familiarity by the public, for example. So that I think would be something that would need to be discussed by the Federal Open Market Committee and in our general consultations. To the extent that, say the CPI overstates inflation by an approximately known amount, one could simply adjust the range of inflation rates that define price stability to allow for that bias.

I find myself still pretty comfortable with the numerical objective I had recommended almost a decade ago. More specifically, I would now favor a 1.5 percent numerical objective for inflation as measured using the core personal consumption expenditures (PCE) price index, which, given the recent average differences in measurement bias, corresponds to a 2 percent objective for the core CPI.

It is generally agreed that the biases are about 1 percentage point per year for the CPI and about 1/2 percentage point per year for the PCE deflator (Lebow and Rudd, 2003).

Because of differences in the construction of this index and the CPI, an upward adjustment of 0.2 to 0.4 percentage point is probably necessary to make PCE inflation comparable to CPI inflation.

Part of the reason that core PCE inflation fell less than CPI inflation is that the PCE index includes so-called nonmarket prices--prices that are imputed by the Bureau of Economic Analysis because reliable market data are not available--and nonmarket prices have been trending upward lately. Indeed, the market-based portion of core PCE inflation for the year ending in May was only 0.7 percent.

When industrial product was the centerpiece of the economy during the first two-thirds of the twentieth century, our overall price indexes served us well. Pricing a pound of electrolytic copper presented few definitional problems. The price of a ton of cold rolled steel sheet, or a linear yard of cotton broad-woven fabrics, could be reasonably compared over a period of years. But in our new century, the simple notion of price has turned decidedly ambiguous. What is the price of a unit of software or a legal opinion? How does one evaluate change in the price of a cataract operation over a ten-year period when the nature of the procedure and its impact on the patient has changed so radically? Indeed, how will we measure inflation, and the associated financial and real implications, in the twenty-first century when our data—using current techniques—could become increasingly less adequate for tracing price trends over time?

In evaluating risks with respect to our price stability objective, I believe that it is preferable to consider all the various measures and not be unduly influenced by a numerical target for any specific index. Obviously, under these circumstances, changing policy just because a single, specific price index is out of line might not always be sensible, especially if doing so might have detrimental consequences for our other objectives. For this reason, it seems to me that defining our price stability objective in terms of a numerical target for the rate of inflation of some specific price index could well be problematic.