In that regard, although a weak economy, associated slack in resource utilization, and rapid increases in productivity were undoubtedly reducing inflation last year, core inflation--especially as measured by the core CPI--seems to have fallen by more, and to a lower level, in 2003 than these fundamentals can explain. Typically, such departures from historically normal behavior do not persist, and inflation tends to return to a level more in line with its fundamental determinants. Indeed, the step-up in inflation this year from last year's pace may partly reflect such a return.

Judging from the results of statistical models incorporating the factors we have been examining, increases in commodity, energy and import prices together might have boosted core consumer inflation on the order of roughly 1/4 to 1/2 percentage point over the past four quarters.

When the primary battle against inflation started in 1979, there was a strong case for paying great attention to the rate of money growth as a measure of the thrust of monetary policy. Money growth is not irrelevant to assessing inflation risks today, but the emphasis has changed. For a variety of reasons, and especially because expectations of low inflation are so entrenched in the markets, short-run money growth is an inadequate indicator for monetary policy purposes. What we need to do instead is to extract as best we can evidence of possible inflationary pressures from a variety of other sources of information.

[T]he direct effects of commodity price inflation on consumer inflation are empirically minuscule, both because raw materials costs are a small portion of total cost and because part of any increase in the cost of materials tends to be absorbed in the margins of final goods producers and distributors. Accelerations in commodity prices comparable to or larger than the most recent one occurred following the 1981-82 and 1990-91 recessions, as well as in 1986-87 and 1999, with no noticeable impact on inflation at the consumer level. A reasonable rule of thumb is that a permanent 10 percent increase in raw materials prices will lead to perhaps a 0.7 percent increase in the price of intermediate goods and to less than a 0.1 percent increase in consumer prices. Thus the recent acceleration in commodity prices, even if it were to persist (and futures prices suggest that it will not), would likely add only a tenth or two to the core inflation rate. In short, rising commodity prices are a better signal of strengthening economic activity than of inflation at the consumer level.

Because of differences in the construction of this index and the CPI, an upward adjustment of 0.2 to 0.4 percentage point is probably necessary to make PCE inflation comparable to CPI inflation.

Today I would like to share my own thoughts on the prospect of an "unwelcome substantial fall in inflation"--in particular, why a substantial fall in inflation going forward would indeed be unwelcome; why some risk of further disinflation, though "minor," should not be ignored; and what such a fall would imply for the conduct of monetary policy...

Let's first be clear what we are talking about. Some in the media apparently interpreted the May 6 statement as saying that the Federal Reserve anticipated imminent deflation in the United States and informed the public accordingly. In my view, such an interpretation substantially overstates the concerns that the FOMC intended to communicate with its statement. First, we have no reason to think that a drastic change in the inflation rate is imminent...

This distinction between inflation that is positive yet too low and deflation is worth exploring for a moment. Although the Federal Reserve does not have an explicit numerical target range for measured inflation, FOMC behavior and rhetoric have suggested to many observers that the Committee does have an implicit preferred range for inflation. Most relevant here, the bottom of that preferred range clearly seems to be a value greater than zero measured inflation, at least 1 percent per year or so.

Where is inflation likely to go over the foreseeable future? Medium-term inflation forecasting is highly contentious--not least because the underlying theory of the determination of inflation continues to divide macroeconomic schools of thought--and I cannot begin to do justice to the topic in a short talk. The Board staff, for example, uses an eclectic approach that includes a number of components, including data analysis, statistical techniques, a suite of econometric models, and judgment.

We do know that as the rate of growth has slowed down, unit labor costs have gone up as they invariably do in such a period. But we've seen no evidence that those costs are being passed through into final prices in any material way. Similarly, we see a fairly extraordinary increase in energy costs. And here again, separating corporations into non-energy, non-financial, we've tried to trace the movement of energy costs into prices, and we've found that almost all does not going to final goods prices, but is squeezing profit margins, which is the same thing as unit labor costs.

From Q&A session, as reported by Bloomberg News

In evaluating risks with respect to our price stability objective, I believe that it is preferable to consider all the various measures and not be unduly influenced by a numerical target for any specific index. Obviously, under these circumstances, changing policy just because a single, specific price index is out of line might not always be sensible, especially if doing so might have detrimental consequences for our other objectives. For this reason, it seems to me that defining our price stability objective in terms of a numerical target for the rate of inflation of some specific price index could well be problematic.

We cannot yet be sure that the slower expansion of domestic final demand, at a pace more in line with potential supply, will persist. Even if the growth rates of demand and potential supply move into better balance, there is still uncertainty about whether the current level of labor resource utilization can be maintained without generating increased cost and price pressures. As I have already noted, to date costs have been held in check by productivity gains. But at the same time, inflation has picked up--even the core measures that do not include energy prices directly. Higher rates of core inflation may mostly reflect the indirect effects of energy prices, but the Federal Reserve will need to be alert to the risks that high levels of resource utilization may put upward pressure on inflation.

Recent experience does seem to suggest that the economy has become less inflation prone than in the past, so that the chances of an inflationary breakout arguably are, at least for now, less than they would have been under similar conditions in earlier cycles.

Many observers, including us, have been puzzled about how an economy, operating at high levels and drawing into employment increasingly less experienced workers, can still produce subdued and, by some measures even falling, inflation rates.

My interest in a monetary policy directed toward a dollar of stable value is not based on the feeling that price stability is a more important national objective than either maximum sustainable growth or a high level of employment, but rather on the reasoned conclusion that the objective of price stability is an essential prerequisite for their achievement.

Quoted in a speech by Bill Poole