Thus far, market participants appear to believe that core inflation will remain contained. Survey measures of expected inflation rose sharply in September when retail gasoline prices reached their peak, but have come back down since. Measures of expected inflation derived from market prices of inflation-protected U.S. Treasury securities drifted up a bit this fall, but they too have returned to mid-summer levels. To maintain credibility for price stability, it is essential that monetary policy should respond vigorously to any visible erosion in inflation expectations.

It is the duty of the Fed to refrain from the slightest temptation to monetize deficits or embrace any other inflationary policy,  In the Volcker and Greenspan eras, the Fed has done quite well in this regard, and it can be expected to continue countering inflationary pressures should they arise.

Coddling inflation by monetizing deficits is not an option in a globalized world.  It would erode our currency's value and undermine our economy's potential to grow and create jobs.  The solution to the problems laid out by the participants in today's conference rests squarely in the hands of our politicians, not with the central bank.

Inflation expecations have become "well anchored" to price stability--most likely because people are confident that the Fed will act to limit any potential rise in inflation.  This may account for research results suggesting that, during this period, energy price increases have generally not been passed through to core inflation.

But there is another very important point to emphasize. Even if the funds rate were at neutral, further changes in policy may be appropriate. My view is that inflation will likely remain contained. Energy prices have come off their highs, and solid underlying trends in productivity should keep overall production costs in check. But there are risks to this scenario. With inflation at the upper end of my comfort zone, an unexpected increase in inflation would be a serious concern, while a decline in inflation would be beneficial.

Of course, this is ultimately Congress's decision. But from a purely technical perspective, I believe there are better measures of inflation than the CPIU. In that respect, one might want to consider alternatives.

There's no perfect forecaster, no perfect indicator of inflation...Exchange rates reflect inflation pressures. They may also reflect the balance of trade and other factors. So there's no single optimal indicator of inflation. My personal strategy, therefore, is to be very eclectic and to look at a wide range of indicators. And among those is commodities, gold, exchange rates, the whole list. I think interest rates, real- side indicators, surveys, expectations, there's a whole list of variables which can be useful in forecasting inflation. And I think one has to be very open minded about using whatever information one has.

In sum, I see risks on both sides of my expectations that the growth of economic activity will slow modestly on balance over the next year or so, leaving the economy producing at about its sustainable potential. But unless activity slows unexpectedly, and after the rise in retail energy prices, the risks may be skewed a little toward the upside on inflation. Because the economy is producing at a reasonably high level and activity is most likely on a solid upward track, my focus at this time is naturally on keeping inflation contained.

To be sure, the integration of newly industrializing economies into the global trading system is exerting downward pressure on costs and prices. But the effect on inflation--the rate of change in prices--has probably not been large to date, and the extent and duration of its damping influence on inflation in the future are open questions.

In the case of the hurricanes, the largest impact is likely to be of a regional nature: the need to rebuild businesses, homes, and infrastructures along the affected Gulf Coast regions.  If monetary policy was redirected to provide more accommodation to the rebuilding efforts, such policy could lead to excessive stimulus in the rest of the country.  The overall result would likely be an economic boom and rising inflation.

A negative supply shock leads to higher prices and decreased demand for goods and services.  As we have learned from the experience of the 1970s, a more accommodative monetary policy that attempts to offset decreased demaing during a negative supply shock leads to higher inflation that can be very costly to remove in the future.

In the case of hurricanes, the negative effects are most likely to be felt over the next six months.  If monetary policy were to increase the level of accommodation, the benefits would not likely be felt until next year.  By that time, the rebuilding effort would be well underway, and there might be a danger that monetary policy stimulus could combine with the sizeable fiscal stimulus to overheat the economy and lead to higher inflation.

Given the positive momentum of the economy, it is much less likely that a regional shock will have an overall negative impact.  And should additional policy accommodation be added, there is a much greater chance that the economy will overheat and result in strong inflationary pressures.

Now, the inflation rate is near the upper end of the Fed’s tolerance zone, and it shows little inclination to go in the other direction. We now face higher energy prices and businesses’ desire to pass the increased costs on to their customers. Combine the energy spikes with spending increases by governments at every level in the aftermath of the two hurricanes...and you have new demand pressures added to the old ones.

We must keep in mind that with expansions inevitably come increasing inflationary pressures.  In the near term, overall inflation will be affected by the substantial increase in energy prices.  To keep cyclical price pressures and any transitory spike in energy prices from permanently disrupting the price environment, the Fed will have to continue shifting monetary policy from its current somewhat accommodative stance to a more neutral one.