For the past few years, inflation has been persistently too low, but we’re starting to see some upward movement. Over the past year, the Fed’s preferred inflation measure, the personal consumption expenditures price index, stands at 1 percentage point. Measures of underlying inflation like core inflation—which strips out volatile components like food and energy—or the trimmed mean, are running about 1¾ percent over the past year. Fed officials do understand that gas and groceries are important parts of household budgets. It’s just that for making policy, we need to look at the underlying trends that give us a better picture of where inflation is likely headed.

All in all, the recent data reinforce my expectation that inflation is on track to move back to 2 percent over the next two years.

Fed Chair Janet Yellen urged caution last week in interpreting the latest data. She acknowledged the pickup in core inflation, which excludes energy and food prices, but also said “it remains to be seen if this firming will be sustained.”

Evans echoed her concern, saying “it’s not completely clear” that recent improvements in core inflation “are going to be sustainable increases.” He also pointed to seasonal effects in recent years that make it more difficult to judge the outlook.

“It has been a notable feature of the inflation data for the last several years that we start the year off with a bit of a higher burst of inflation relative to what we had in the second half of the previous years, and then when the second half of the year comes, it kind of comes down again,” he said. “So there’s some residual seasonality.”

Inflation has been held down recently by two factors, the falling price of oil and the rising value of the dollar. But neither factor is likely to depress inflation indefinitely. After the price of oil bottoms out, I would expect to see headline inflation move significantly higher. And after the value of the dollar ultimately tops out, core inflation should move back toward 2 percent. Although recent declines in inflation compensation do give me some pause, I think the evidence indicates that inflation expectations (as opposed to inflation compensation) remain well-anchored. Therefore, I am reasonably confident that, barring subsequent shocks, inflation will move back to the FOMC’s 2 percent objective over the medium term.

An important concern about persistently low inflation is that it can lead to a fall in longer-term inflation expectations, making it much more difficult to achieve our inflation target. For the most part, longer-term inflation expectations appear to have remained reasonably stable, though there are some concerning signs. Longer-term inflation expectations of professional forecasters and primary dealers have held quite steady in recent years at levels consistent with the FOMC's target. However, households' inflation expectations appear to have moved down somewhat recently.

We should put a high premium on clear evidence that inflation is moving toward our 2 percent target. Inflation has persistently underperformed relative to our target. Moreover, measures of inflation compensation and some survey-based measures of inflation expectations suggest that inflation expectations may have edged lower. Given the currently weak relationship between economic slack and inflation and the persistent, depressing effects of energy price declines and exchange rate increases, we should be cautious in assessing that a tightening labor market will soon move inflation back to 2 percent. We should verify that this is, in fact, taking place.

Since the U.S. economy is now below our 2 percent inflation target, and since unemployment is in the vicinity of full employment, it is sometimes argued that the link between unemployment and inflation must have been broken. I don't believe that. Rather the link has never been very strong, but it exists, and we may well at present be seeing the first stirrings of an increase in the inflation rate--something that we would like to happen.

I still anticipate that the combination of decreasing resource slack and anchored longer-term inflation expectations will contribute to inflation rising to our 2 percent objective over the medium term. Even so, because of the more persistent effects of energy and commodity price declines and U.S. dollar appreciation, the return of inflation to that goal may be slower than I earlier anticipated. This does not deny the possibility of some upside surprise―such as a sharp upswing in wage growth triggered by low unemployment. But, on balance, I am somewhat less confident than I was before.

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I judge that the balance of risks to my growth and inflation outlooks may be starting to tilt slightly to the downside.

Turning to the FOMC’s normalization strategy being predicated on an environment of stable inflation expectations, Bullard said this renewed downward pressure on market-based measures of inflation expectations during 2016 has called this assumption into question. “I regard it as unwise to continue a normalization strategy in an environment of declining market-based inflation expectations,” he said. “A decline in inflation expectations represents an erosion of central bank credibility with respect to the inflation target.”

“My preferred interpretation is that risk and liquidity premia associated with inflation compensation are relatively small with low volatility,” he explained. “Hence, I interpret declines in TIPS spreads as reflecting mostly declines in inflation expectations.”

While most observers expect that the appreciation of the dollar and the fall in oil prices will eventually stabilize, recent global events may make it less likely that the 2 percent inflation target will be achieved as quickly as had been projected in recent forecasts by private economists or by Federal Reserve policymakers. In my own view, if inflation is slower to return to target, monetary policy normalization should be unhurried. A more gradual approach is an appropriate response to headwinds from abroad that slow exports, and financial volatility that raises the cost of funds to many firms.

There is one way that these temporary downward pressures on reported inflation could pose more permanent impediments to reaching the 2 percent inflation goal – if inflation expectations were to change as households and firms viewed the prospects for future inflation differently. [The Federal Reserve Bank of New York’s survey of consumers’ expected inflation rate one and three years ahead] does show a gradual but clear downward trend in inflation expectations over the past several years. This suggests we cannot take for granted that regular, persistent, but seemingly temporary shocks to inflation will not have a larger and more lasting impact.

It is also fair to say that the risks to my outlook are tilted to the downside. The nervousness in the financial markets and the increased caution that it may cause for economic decision-makers, both households and firms, could imply somewhat slower growth, at least in the first half of the year.

Also, inflation is not likely to pick up substantially until the second half of the year, although, for the reasons I have discussed, I remain confident that inflation will move toward the Committee’s long-run objective of 2 percent.

These considerations make me a bit more conservative in my approach to policy, at least in the very near term. Although I cannot give you a definitive path for how policy will evolve, it might prove prudent to wait until the inflation data are stronger before we undertake a second rate hike. Thus, I am approaching near-term policy a bit more cautiously than I did a few months ago. That is part of being data dependent. And attentiveness to the data will be a key factor in all of my future policy recommendations as well. If financial headwinds dissipate quickly and inflation picks up a bit more aggressively, it will require a slightly more aggressive approach to policy.

I believe as we move into the second half of the year with economic activity growing at trend or slightly above trend, the unemployment rate below its natural rate, and price pressures starting to assert themselves, policy can truly normalize. I mean this in the sense that we can move away meaningfully from the zero lower bound and that our reaction to incoming data can return to a more historical pattern.

Inflation is probably going to take a little bit longer to get back to our 2 percent objective, everything equal, than maybe what you thought a few months ago.

[The Phillips Curve] is essentially a theory that fits reasonably, but certainly not perfect, explaining the inflation process. And it's a theory that says first that inflation expectations play a key role in determining inflation. Second, that various supply shocks, such as movements in the price of oil or commodities or import prices, also play an important role. And third, that the degree of slack in the labor market or the degree of more generally of pressure on resources in the economy as a whole exert an influence on inflation as well.

And that theory underlines the kind of statement that I've made, that if inflation remains -- inflation expectations remain well anchored and the transitory influence of energy prices and the dollar fade over time, that in a tightening labor market with higher resource utilization, I expect inflation to move back up to 2 percent. It is consistent with that Philips curve theory.

I think we have been and markets have been and we have been quite surprised by movements in oil prices. I think in part they reflect supply influences, but demand may also play a role.

The stronger dollar is partly something that we anticipated because the U.S. economy has been performing more strongly than many foreign economies, and we have a divergence in the stance of monetary policy that influences capital flows in the dollar. Nevertheless, the strength of the dollar and the extent to which it has moved up since mid-2014 is not something that we anticipated.

So yes, we've been surprised in part by those developments and they have played a significant role in holding down inflation.