I think the case for checking off the criterion of "reasonable confidence" that inflation will converge to the 2 percent target is harder to make than employment. Even so, I have gotten comfortable enough on the inflation question to take a first step in one of the coming FOMC meetings in what will likely be an extended process of normalization of the interest-rate environment.

At 5.1%, the unemployment rate is near that long-run level. But some Fed officials have expressed concern about the inflation rate, which has run well below the central bank’s target for more than three years. But Mr. Bullard said that wasn't in itself enough to justify such loose monetary policy.

Much of the weakness in inflation, he said, is due to lower oil prices, which he described as a “temporary” phenomenon.

“Oil prices will stabilize so that when you look at year over year inflation it’s going to start coming back to 2% over the forecast horizon,” he said.

First, the statement indicated the committee needed to see “some further improvement in the labor market.” In my own view, this condition has largely been met by the continued growth in payroll employment – averaging in excess of 200,000 jobs per month, year-to-date through July, and a U-3 unemployment rate – the typical, widely reported measure of unemployment – that is currently at 5.3 percent.

The second condition noted in the statement was that policymakers must be “reasonably confident that [PCE] inflation will move back to its 2 percent objective over the medium term.” For this condition, the data have not been as clear-cut. Core PCE inflation for the past year has only been 1.2 percent, and recently there have been substantial declines in oil prices and other commodity prices. These will likely feed into core (and headline) measures of inflation for some months to come, temporarily lowering inflation readings. Adding to this, recent reports on wages and salaries still show few signs that the tightening labor markets are translating to increases in wages and salaries consistent with reaching 2 percent inflation.

As a result, current data have yet to indicate that this second condition will be met in the coming months; instead, policymakers will need to rely on forecasts of inflation...

Such a forecast needs to be mindful of recent developments, including data that suggest the slowing of foreign economies, coupled with volatile stock prices and falling commodity prices – both of which are consistent with a weaker global economy. In my view, these developments might suggest a downward revision in the forecast that is large enough to raise concerns about whether further tightening of labor markets is likely. And without an expectation of growth above potential and further tightening of labor markets, I would lose my primary rationale for a forecast of rising inflation, diminishing my confidence that inflation will reach the 2 percent target within a reasonable time frame.

I would say the inflation picture will be hard to read in the coming weeks, perhaps months. Therefore the conclusion that I will have to draw—and any individual participant on the [Federal Open Market Committee] will have to draw—in terms of being reasonably confident that inflation will converge in the medium term back to target, is going to be more of a composite of indirect evidence or indirect indicators than being satisfied with the direct evidence on inflation.

Having said that, one of the ways I go about evaluating inflation—I obviously like everyone else look at the 12-month number. Then I look at the near-term, shorter-horizon numbers. The three-month number gives me more of a sense of a run rate, the six month number has some of those benefits as well. Some of the shorter-horizon inflation numbers in the [personal consumption expenditures[ price index seem to be firming relative to the longer horizon. I take some courage from that.

...

My own approach to that is to say is I think we have to put significant weight on the accumulated progress we have seen quite literally over a number of years, but certainly since the first of the year, and not be overly influenced by the gyrations that so often occur in month-to-month data. That is not to say that you ignore the evidence that is most proximate to the date of having to make a decision, but I won’t be overly influenced by just the latest thing I’ve heard on the economy. I do think this is a time to try to take a pretty broad perspective, a pretty long horizon perspective to where the economy is relative to where it was and whether a policy rate at zero continues to be appropriate for the circumstances.

...

I want to sort of hold off on {the specific question of whether liftoff will come in September}. I have said publicly before that I lean toward September and I am still very open to a September move.

...

One framework that I will be using will be looking for any indication in the economic data that undermines my basic belief about the track of the economy... I will be looking closely at all evidence that we see in the data for indications that my basic assumptions are wrong or should be doubted... That is going to be one of the principal ways I will go about judging the question of whether liftoff in September is appropriate or not. To interpret that, that means I think there is a high bar right now to not acting, speaking for myself. It will take a significant deterioration in the economic picture for me to be disinclined to move ahead.

The burden is still on the data, and if oil prices stabilize, tepid inflation data will likely abate and help open the door to central bank action, he said. Oil prices are the main reason for inflation weakness and it is likely the strong declines seen in recent months wont continue, which means the strong drag they have imposed on headline inflation, which is well below the Feds 2% target, will almost certainly abate over time, [Bullard] said.

Really what I see is a labor market that is getting stronger and stronger. And historically, when the U.S. economy strengthens, unemployment comes down, we see wage growth pickup. We see pricing power, if you will, among businesses rise. And, you know, that's the historical pattern. It's what we've seen in other expansions and that's what I expect happen over the next couple of years.

My forecast is for inflation to reach about 2 percent on our preferred measure by the end of next year.

I do worry about TIPS-based inflation compensation and it has been down a lot recently and it does concern me. What I want to do with that is wait and see what happens in global oil markets, wait and see what equilibrium turns out to be and then see what happens with breakeven inflation at that point.
...
But right now, weve got such a big dislocation in oil markets it might be mixing up the signal coming from TIPS-based breakevens.

Our objective is to keep inflation under control, so keep it averaging 2 percent, Lacker said today in an interview with Kathleen Hays on Bloomberg Radio. So to my mind, that doesnt mean it has to cross two before the Fed raises rates

It wouldnt surprise me to see softer inflation for a couple of months, but I think if you look a year out, I think well be at 1.5 or higher, Lacker said

Inflation is, I think, a key swing variable in the outlook for when the Fed will raise its benchmark policy rate from zero, where it has been since 2008, Lacker said.

The unemployment rate has continued to decline, and so I think thats dramatically reduced the extent to which we ought to be sort of unhappy about labor market conditions and our employment mandate, he said. On the other hand, inflation has run below two for quite some time now, and the longer that goes on, the more you ought to focus on inflation.

The trimmed main which we calculated in Dallas which is a trim main on the PCE has been very steady at 1.6-1.7% for several months, so that tells me that there is no slide to the down side nor pressure on the upside. Whether were exactly at 2% in terms of the way I look at policy it doesnt make much difference the point is we have price stability and thats the important factor.

And while I think the Bureau of Labor Statistics and Bureau of Economic Analysis do fantastic jobs of collecting and distilling inflation data, I also look atand point critics tomore straightforward assessments like the Billion Prices Project from the Massachusetts Institute of Technology.8 This tool scrapes the Internet for prices, giving a daily reading of, well, billions of prices of myriad products. It lacks the complicated adjustments and methods that characterize the government agencies models. Nonetheless, it does track pretty closely with the official numbers. Whats more, it gives an independent assessment of consumer prices that is helpful for those who may distrust official federal data. While the BPPs numbers run a tad higher on average than the official indices, it shows that price inflation remains low and shows no sign of taking off.

The signal from all these indicators, both government and independent, point to the same conclusion: Inflation trends are quite modest. As I said, I expect that we will be moving back toward our 2 percent longer-run goal over the next few years.

Yet the labor market’s journey is not yet complete – more progress needs to be made. My outlook is that as the expansion continues, firms will continue to add to their payrolls and the unemployment rate will continue to decline. I expect that by the end of next year, the unemployment rate will fall to around 5½ percent, which is what I view as the “natural rate,” or longer-run rate, of unemployment.

...

Putting all of this together, I expect growth over the next six quarters to be somewhat above my estimate of trend growth, which I put at around 2.5 percent. Of course, there is always a good deal of uncertainty around estimates of trend growth, perhaps even more so today in the aftermath of such a deep recession. I am a bit more optimistic than some about longer-run growth because while productivity growth has been running low, I think it is good to remember the experience of the 1990s. Back then, over a period of several years, many forecasters revised down trend growth estimates only to subsequently revise them up significantly in response to strong productivity growth.

...

One might ask whether that’s a reasonable inflation forecast given that we haven’t seen much acceleration in wages yet. I believe it is. Cleveland Fed analysis, based on several measures of wages and broader compensation, indicates that it is difficult to find a lead-lag relationship between wages and prices – the strongest correlations are contemporaneous ones, especially since the mid-1980s. We should expect wages to rise with prices, not necessarily lead prices. In my view, it would not be prudent for policymakers to simply wait for wages to accelerate before assessing the implications of the stance of monetary policy for future price inflation. Indeed, policymakers must always be forward looking.

Of course, my forecast is only a forecast. I am extremely confident that the actual path of inflation over the next four years will turn out to be higher or lower than what I currently expect it to be! What you should take away, though, is that I currently see the probability of inflations averaging more than 2 percent over the next four years as being considerably lower than the probability of inflations averaging less than 2 percent over the next four years. And thats why I conclude my discussion of inflation by saying that the FOMC is undershooting its price stability goal.

The Federal Open Market Committee is on record as stating that its goal is for the price index for personal consumption expenditures to rise at an annual rate of 2 percent. Many observers expressed concern last year that inflation, at about 1 percent, was running well below the FOMC's target. Inflation has averaged 2 percent over the last three months, however. While the inflation numbers will often run hot or cold for several months at a time, the latest numbers suggest that inflation has bottomed out and is moving toward the Committee's target. I expect that firming trend to continue this year.

[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.

So, whether we look over the past six years or over the past two years, inflation has been running too low to be consistent with price stability. The good news is that the FOMC does expect inflation to turn back toward 2 percent. However, I expect that return to 2 percent to take a long timepossibly on the order of four years. And Im not the only one forecasting a slow return to 2 percent inflation. Earlier this year, the Congressional Budget Office (CBO) predicted that inflation will not reach 2 percent until 2018.