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.  

"To the extent that there is a relationship between economic slack more broadly, and I mean not just labor market conditions, but capital and product market conditions as well, it's become a much weaker relationship. That is, the relationship between slack and slower inflation is clearly lower than it used to be. So that connection is much weaker and there are other factors that seem to play an important role.''

     ``The other problem with using this natural rate concept actively is that a lot of research, some of it at the Federal Reserve Board, has shown that in real time we have a really hard time determining what the natural rate is, if such a thing exists.

     ``And in particular, with demographic changes, changes in the labor market, all kinds of other things, you wouldn't expect a measure of slack to be constant. So what we do at the Federal Reserve is, we really have to be very eclectic.''

     ``We don't rely on any single indicator, on any single measure. We look at a wide variety of indicators.''

     ``The economy is just too complicated now to rely on any single indicator.''

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

[S]cenarios that project large deficits also project rapid growth in the outstanding government debt.  The higher levels of debt in turn imply increased expenditures on interest payments to bondholders, which exacerbate the deficit problem still further.  Thus, a vicious cycle may develop in which large deficits lead to rapid growth in debt and interest payments, which in turn adds to subsequent deficits.  According to the CBO projection that I have been discussing, interest payments on the government's debt will reach 4-1/2 percent of GDP in 2030, nearly three times their current size relative to national output.  Under this scenario, the ratio of federal debt held by the public to GDP would climb from 37 percent currently to roughly 100 percent in 2030 and would continue to grow exponentially after that.  The only time in U.S. history that the debt-to-GDP ratio has been in the neighborhood of 100 percent was during World War II.  People at that time understood the situation to be temporary and expected deficits and the debt-to-GDP ratio to fall rapidly after the war, as in fact they did.  In contrast, under the scenario I have been discussing, the debt-to-GDP ratio would rise far into the future at an accelerating rate.  Ultimately, this expansion of debt would spark a fiscal crisis, which could be addressed only by very sharp spending cuts or tax increases, or both. 

It's true that the empirical evidence suggests that the link is looser, that there's less responsiveness of inflation to employment conditions than there perhaps may have been in past decades.

My own view is that we should take a very eclectic approach in thinking about inflation.

I look at the state of the economy. I try to assess whether demand is exceeding supply in some sense; whether the financial conditions are promoting growth in demand which is greater than the productive capacity of the economy.  But I also look at a wide variety of indicators, including commodity prices, including financial indicators like bond rates and inflation compensation.

I don't think we can rely on any single indicator, particularly one like the natural rate of unemployment concept. It's very difficult to know. Even if there is such a relationship, it's very difficult to assess in real time where that number might be.

And so we really have no alternative but to look at, you know, many indicators -- including {commodity prices} -- to try to assess where inflation's going.

From the Q&A session

It's true that the empirical evidence suggests that the link is looser, that there's less responsiveness of inflation to employment conditions than there perhaps may have been in past decades.

My own view is that we should take a very eclectic approach in thinking about inflation.

From the Q&A session

Abnormally rapid rent increases, likely reflecting an increase in the demand for rental units by would-be owners who have been priced out of the housing market, have also elevated core inflation over the past year. As the housing market adjusts over time, however, this source of inflationary pressure is also apt to dissipate.

At this early juncture in 2007, I think it entirely reasonable to expect the economy to maintain an average pace of 3 percent growth for the year. And, if we at the Fed do our job well, we should be able to accommodate that growth rate while bringing inflation down below 2 percent

Monetary policy decisions are made without the direct input or the immediate approval of the other branches of government. This helps keep monetary policy independent of political pressures and influence. Nevertheless, we are independent within the government - not of the government. Ultimately, we are accountable to Congress for achieving two objectives: price stability and maximum sustainable economic growth.

I expect real GDP to grow by about 3 percent, which I estimate to be its underlying trend rate. That kind of growth should hold the unemployment rate to just below 5 percent. The outlook for inflation is more uncertain. Inflation stopped accelerating in the last few months, but whether it will continue to recede in the coming year is not yet clear. Additional monetary policy action may be needed to keep us moving along the path to price stability. 

... I see the economy growing at a more moderate pace over the next few years than we saw in the past couple of years. But there are risks to this outlook. The first risk is that the weakness in the housing sector spills over to other sectors of the economy, depressing overall growth. The second risk is that inflation remains stubbornly high...

The most recent price statistics have been encouraging, but not convincing...

...[T]here is still a risk that the underlying inflation trend will not continue to improve; in which case, the FOMC will need to respond with the appropriate policy actions.

It's always too early to give the "all-clear" on inflation risks. 

I find recent inflation readings encouraging, but I also am keenly aware that this pattern has yet to show up in the data on any sort of a sustained basis. The inflation situation remains uncertain and, in particular, there are upside risks to my outlook, especially having to do with the situation in labor markets.

So, taking all these factors on growth and inflation into account, my current assessment is that the risk of inflation remaining too high is greater than the risk of growth remaining too low. And as reflected in the minutes of the October meeting, the Federal Open Market Committee agreed that inflation risks remained the dominant concern.

Thus some additional firming of policy may yet be necessary to bring inflation back to a range consistent with price stability in a reasonable period of time. But that decision will depend on how the incoming data affect the outlook for the economy.

[T]he level of the core inflation rate remains uncomfortably high.

Taking all of the factors on growth and inflation into account, my current assessment is that the risk of inflation remaining too high is greater than the risk of growth being too low. Thus, some additional firming of policy may yet be necessary to bring inflation back to a range consistent with price stability in a reasonable period of time. But that decision will depend on how the incoming data affect the outlook.