One way that monetary policy influences financial and economic activity is through the clarity of our intentions and communications. Expectations of likely future outcomes, including those for monetary policy, obviously matter for decisions made by households and businesses today. In this vein, at a time when near-term inflation is likely to be lower than usual, endorsing an explicit numerical objective for inflation could help keep inflation expectations from falling very far. Such an anchor on inflation expectations would help preserve low real inflation-adjusted interest rates.

Later today, with the release of the minutes of the most recent FOMC meeting, we will be making an additional significant enhancement in Federal Reserve communications: To supplement the current economic projections by governors and Reserve Bank presidents for the next three years, we will also publish their projections of the longer-term values (at a horizon of, for example, five to six years) of output growth, unemployment, and inflation, under the assumptions of appropriate monetary policy and the absence of new shocks to the economy. These longer-term projections will inform the public of the Committee participants' estimates of the rate of growth of output and the unemployment rate that appear to be sustainable in the long run in the United States, taking into account important influences such as the trend growth rates of productivity and the labor force, improvements in worker education and skills, the efficiency of the labor market at matching workers and jobs, government policies affecting technological development or the labor market, and other factors. The longer-term projections of inflation may be interpreted, in turn, as the rate of inflation that FOMC participants see as most consistent with the dual mandate given to it by the Congress--that is, the rate of inflation that promotes maximum sustainable employment while also delivering reasonable price stability. This further extension of the quarterly projections should provide the public a clearer picture of FOMC participants' policy strategy for promoting maximum employment and price stability over time. Also, increased clarity about the FOMC's views regarding longer-term inflation should help to better stabilize the public's inflation expectations, thus contributing to keeping actual inflation from rising too high or falling too low.

Bullard told reporters after the speech he supports the adoption of an inflation target to prevent expectations for prices from falling too far. A target for inflation “would be helpful at this time,” he said.

“You have to consult with all players, including Congress,” he said. “If they don’t want to do it, then we don’t do it.”

As reported by Bloomberg News

Over the past few years, the FOMC has taken important incremental steps toward making its longer-term inflation goals more explicit.  For example, we are now publishing FOMC members’ inflation forecasts for the next three years under the assumption of “appropriate monetary policy,” and the publication of such forecasts has helped shape public understanding concerning the range of inflation outcomes that FOMC members regard as desirable in the longer term.  Looking forward, there could be scope for the Committee to improve the clarity of these communications.  I am optimistic that, by clearly communicating the Fed’s commitment to low and stable inflation and by backing that commitment up with determined policy actions should the need arise, any deflationary pressures caused by the weak economy can be contained.

(A)t a time when near-term inflation is likely to be lower than usual, having an explicit numerical objective for inflation could help keep inflation expectations from falling very far. Such an anchor on inflation expectations would help preserve low real inflation-adjusted interest rates.

I am not particularly concerned about the possibility of persistent deflation. When oil and commodity prices stabilize, the negative rates of inflation we have seen in the CPI are likely to disappear. Moreover, I am confident that the FOMC is committed to maintaining price stability. Nonetheless, we must act to ensure that expectations of deflation do not take root, just as we must act to ensure that expectations of higher inflation do not emerge. The failure to maintain well-anchored inflation expectations can wreak havoc with the real economy, foster unnecessary volatility, and make it more difficult for the Fed to deliver on its dual mandate to keep the economy growing with maximum employment and price stability.

I and others have long proposed establishing an explicit inflation target as one way to signal the FOMC's commitment to price stability and help anchor expectations. Such a commitment not only helps prevent inflation expectations from rising to undesirable levels, but it can also help prevent expectations from falling to undesirable levels.

Communication also can be important in the Fed's efforts to anchor long-term inflation expectations. As I mentioned at the outset, the odds are high that over the next few years, inflation will decline below desirable levels. It is especially important in such circumstances for the Fed to emphasize its commitment to returning inflation over time to the higher levels that are most appropriate to the attainment of its longer-term objectives. A decline in inflationary expectations when economic conditions are weak is pernicious, especially so when the federal funds rate has reached the zero bound, because any downdrift in inflation expectations leads to an updrift in real interest rates and a tightening of financial conditions.

Work by Refet Gürkaynak, Eric Swanson, and coauthors (2005, 2006) suggests that committing a central bank to a long-run inflation objective helps anchor longer-run inflation expectations in that country. Over the past few years, the FOMC has in fact taken important incremental steps toward making its longer-term inflation goals more explicit. For example, we are now publishing FOMC members' inflation forecasts for the next three years under the assumption of "appropriate monetary policy," and the publication of such forecasts has helped shape public understanding concerning the range of inflation outcomes that FOMC members regard as desirable in the longer term. Looking forward, there could be scope for the Committee to improve the clarity of these communications. I am optimistic that, by clearly communicating the Fed's commitment to low and stable inflation and by backing that commitment up with determined policy actions should the need arise, any deflationary pressures caused by the weak economy can be contained.

Federal Reserve Bank of St Louis President James Bullard said on Saturday that an explicit inflation target would help policy-makers prevent either deflation or inflation from taking hold in the United States.

"An inflation target would help focus expectations," he told a panel discussion during the annual meeting of the American Economic Association.

...

"Maybe now would be a particularly good time to do that because you have this possibility of expectations drifting off to deflation or a lot of inflation. ... I think it would help," said Bullard

       "The FOMC does not have an official inflation target; the former Chairman Greenspan was opposed to it,'' he said.

``We're working in that direction,'' Bullard said. ``FOMC members and the Fed generally are talking about longer-term inflation outcomes and you can interpret that as something close to a perceived target over a period of, say, five years -- a medium-run kind of episode.'' 

     ``I do think the output gap or some measures of resource utilization have some role to play in some sort of optimal policy to get you toward the inflation target at any point in time,'' he said. ``So I wouldn't be a strict inflation targeter.''

As reported by Bloomberg News

A strong nominal anchor can be especially valuable in periods of financial market stress, as we have been experiencing recently, when prompt and decisive policy action may be required to minimize the risk of a severe contraction in economic activity that could exacerbate uncertainty and financial market stress.¹²  Thus, the establishment of an explicit numerical inflation objective can play an important role in promoting financial stability as well as the stability of employment and inflation.
...
I would like to suggest several specific modifications to the Federal Reserve's current communication strategy.

• First, the horizon for the projections on output growth, unemployment, and inflation should be lengthened.  This change might involve simply an announcement of FOMC participants' assessment of where inflation, output growth, and unemployment would converge under appropriate monetary policy in the long run.  Alternatively, the horizon for the projections could be extended out further, say to five or more years.
• Second, FOMC participants should work toward reaching a consensus on the specific numerical value of the mandate-consistent inflation rate, and this consensus value should be reflected in their longer-run projections for inflation.²⁵
• Third, the FOMC should emphasize its intention that this consensus value of the mandate-consistent inflation rate would only be modified for sound economic reasons, such as substantial improvements in the measurement of inflation or marked changes in the structure of the economy.

The FOMC has chosen not to announce such a quantitative guideline, although many past and current participants on the Committee have expressed individual preferences or “comfort zones” about ranges of inflation that they personally feel are appropriate objectives for policy. Within the past year, the FOMC has started publishing the ranges and central tendency of the inflation forecasts of the participants on a three-year horizon. These forecasts generally have been consistent with the revealed “comfort zones.” In the media, midpoints of these forecasts are often associated with an implicit FOMC objective for trend inflation. This represents important progress concerning the transparency of the FOMC inflation objective. Still, there is some risk that if the evolving inflation situation appears inconsistent with the inflation objective that is inferred from the revealed preferences of the individual FOMC participants, the anchor for inflation expectations may start to drag or come completely loose.

One of the biggest innovations came in 1994 when the FOMC began to disclose what its policy decision was after each meeting. The communication since then, however, has sometimes been a bit muddled. I don’t think there is a settled view in the FOMC about the value of essentially forecasting policy, or trying to give hints about where you’re going to go. I’ve become skeptical of that approach because I think the correlation between where you go and where you can see yourself going in advance is very low. … I also think that there is unfinished business with regard to clarity of objectives. I’ve been an advocate since the first day I came here of a formal inflation target, and that issue is still unresolved. There is a huge amount of unfinished business in trying to define and communicate the Fed’s reaction function.

Comfort zones, shmumfort zones.

...

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

Even if policymakers are relatively indifferent about the level of inflation within a comfort zone, research on the optimal design of monetary policy indicates that they shouldn't be: The central bank should actively seek to bring inflation back to the midpoint of its comfort zone, thereby minimizing the probability that inflation wanders outside the boundaries of that zone. In effect, the optimal policy strategy takes into account the benefits of insurance, and hence the midpoint of the zone becomes the point objective for inflation

What is very important is that the central bank not control inflation in the very short run, or try to hit very narrow ranges. And the reason for this is that a lot of movements in underlying inflation have to do with things that are out of the monetary policy control. What is particularly important in this regard is supply shocks, for example, sharp rises in energy prices.

From audience Q&A, as reported by Market News International and Reuters