In particular, the entry of China, India, and others into the global trading system probably has exerted a modest disinflationary force on prices in the United States in recent years. Moreover, we should recognize that these disinflationary effects could dissipate or even be reversed in coming years. They reflect, at least in part, the global imbalances that are the subject of this conference, rather than just the integration of emerging-market economies into the global trading system

But we are also subject to inflationary forces from abroad, including those that might accompany a shift to a more sustainable pattern of global spending and production, or those that might emanate from rising cost and price pressures.

Statistical studies to detect pass-through from recent energy price increases have failed to show significant effects in U.S. price data but stories about widespread pass-through are becoming increasingly common. We may—and I emphasize “may” because my purpose is to make a general point and not to conduct a full analysis of the current situation—face more inflation pressure than currently shows up in formal data.

Overall, the combination of lower and less volatile inflation around the world has led to a reduction in inflation expectations and lower perceived inflation risk, hence a lower inflation uncertainty premium in long rates. I believe that these factors have been important contributors to the lower long-term yields and the flattening of yield curves, particularly in emerging markets.

Of late, the Trimmed-Mean PCE Deflator has been running at a rate of 2.4 percent, about 30 basis points higher than the PCE ex-energy and food. A compounding of 2.4 percent over a decade cuts the purchasing power of a dollar to 79 cents. Of course, it is reckless to extrapolate historical numbers. But this 2.4 percent rate is disarmingly close to one of the market’s key indicators of inflationary expectations—the spread between rates paid on Treasury Inflation-Protected Securities, or TIPS, and ordinary Treasury bonds of 10-year maturity

Over a decade, 3.2 percent yearly would reduce the value of a dollar to 73 cents. To me, this is more than discomforting. It is unacceptable.

To date, demands from these [emerging market] economies appear to have contributed to the rise in energy and other commodity prices, which is boosting overall inflation here, while their supply of low-cost exports seems to have been placing some limited downward pressure on our underlying inflation rate.  But that latter result may not persist; it stems in part from the imbalance of production over spending in some of those economies and the constraints some have placed on the appreciation of their currencies, neither of which is likely to be sustained indefinitely.

The core CPI has increased at an annualized rate of more than 3 percent during the past three months. This inflation picture, if sustained, exceeds my comfort level.
Fortunately, the public is, for the most part, looking at this disappointing inflation news as a transitory development. Measures of long-term inflation expectations have been mixed lately, but, on the whole, I regard them as remaining contained. The FOMC's challenge is to make sure that they stay contained.

Headline measures of inflation of late have been bothersome, with higher oil prices contributing to much of the run-up in those broad readings. Core inflation, which excludes volatile food and energy costs, has moved into the upper end of—or beyond—the range I consider acceptable over time.

I view current inflation risks to be elevated for three reasons. First, we have been expecting and have not yet seen secondary pass-through of energy prices to core inflation. Secondly, some key components of core inflation such as services have been moving at rates that warrant continued concern. Finally, some measures of inflation expectations recently have edged upward.

While monthly inflation data are volatile, core inflation measured over the past three to six months has reached a level that, if sustained, would be at or above the upper end of the range that many economists, including myself, would consider consistent with price stability and the promotion of maximum long-run growth.

With the economy now evidently in a period of transition, monetary policy must be conducted with great care and with close attention to the evolution of the economic outlook as implied by incoming information. Given recent developments, the medium-term outlook for inflation will receive particular scrutiny.  There is a strong consensus among the members of the Federal Open Market Committee that maintaining low and stable inflation is essential for achieving both parts of the dual mandate assigned to the Federal Reserve by Congress...Therefore the Committee will be vigilant to ensure that the recent pattern of elevated monthly core inflation readings is not sustained. Toward this end, and taking full account of the lags with which monetary policy affects the economy, the Committee will seek a trajectory for the economy that aligns economic activity with underlying productive capacity.  Achieving this balance will foster sustainable growth and help to forestall one potential source of inflation pressure.  In addition, the Committee must continue to resist any tendency for increases in energy and commodity prices to become permanently embedded in core inflation.

The best way to prevent increases in energy and commodity prices from leading to persistently higher rates of inflation is by anchoring the public's long-term inflation expectations.  Achieving this requires, first, a strong commitment of policymakers to maintaining price stability, which my colleagues and I share, and second, a consistent pattern of policy responses to emerging development needed to accomplish that objective.

For most of the past year core PCE inflation has been running close to 2 percent, which is at the upper end of the range that I feel is consistent with price stability.

Higher energy prices do not necessarily imply a persistent rise in inflation. Suppose energy costs stabilize, as the oil futures market predicts. Once businesses adjust their own prices to cover the higher costs, prices would not have to rise faster than increases in the cost of other inputs, and overall inflation would return to its earlier rate. Thus, the energy price increases we have seen to date should result in a one-time increase in prices and a temporary rise in the core inflation rate, not a sustained higher rate of core inflation. Indeed, this pattern can be seen in the slightly lower range for most core inflation forecasts in 2007 compared to 2006.