If we’re on target with our present forecast for growth to moderate to a sustainable pace and for inflation to fall back within acceptable bounds, I would say that monetary policy is now close to where it should be.

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 FOMC will react to changes in economic prospects. Future policy is not predetermined, nor will it be a mechanical reaction to the next number on inflation or employment.

It is also hard to assess the degree to which the current constellation of global monetary conditions has influenced the behavior of long-term interest rates. This makes it harder to assess the appropriateness of the current stance of monetary policy. And it may also mask some of the pressures on risk premiums we might expect to see given the deterioration of the U.S. long-term fiscal situation and the magnitude of the U.S. current account imbalance.

With respect to monetary policy, I find nothing either in theory or the existing empirical evidence to overturn the conclusion that a country like the United States, operating under a flexible exchange rate regime, can ultimately achieve the inflation target of its choice.

If—and I emphasize if—my most likely forecast of sustainable output growth and modest inflation is right, then I am of the view that we are very close to having Fed policy properly calibrated for now.

[The FOMC] generally feels we're in the ballpark of where we want [the targeted fed funds rate] to be.

Even if in the Committee's judgment the risks to its objectives are not entirely balanced, at some point in the future the Committee may decide to take no action at one or more meetings in the interest of allowing more time to receive information relevant to the outlook. Of course, a decision to take no action at a particular meeting does not preclude actions at subsequent meetings, and the Committee will not hesitate to act when it determines that doing so is needed to foster the achievement of the Federal Reserve's mandated objectives.

The Federal Reserve has a three-part mandate: price stability, low/moderate long-term interest rates and maximum employment.  Clearly, keeping inflation low and stable addresses directly the first two of those, in particular, since long-term interest rates can only be low if investors expect inflation to remain low.  I would argue that there's very strong evidence that low and stable inflation and well-anchored inflation expectations also contributes mightily to the third objective which is strong and stable employment growth.

In the presence of a productivity surge, the Fed should not tighten but should instead let the economy enjoy the ride without fearing a rise in inflationary pressures.

The Fed's gradual removal of monetary policy accommodation should tend to damp the pace of activity. This effect is likely to be reinforced by a related development—a significant moderation in the rate of appreciation of house prices. This could well restrict not only the pace of residential construction but also the pace of consumer spending.

This desirable trajectory appears to be within reach at a time when the Fed's key policy interest rate—the federal funds rate—is close to a neutral stance, one that neither stimulates the economy nor restrains it.

This phrase—"policy will be data-dependent"—is all the rage right now in policy circles, but I think it's worth a moment to clarify what I mean when I use it. To me, it means that we should interpret the implications of incoming data for our forecast and evaluate whether resulting changes in the forecast call for a change in the policy path.

We at the Chicago Fed think that after a strong rebound in the first quarter of 2006, real GDP growth will average somewhat above three percent over the next couple of years. We expect that the unemployment rate will change little from its current level and that inflation will remain contained. However, inflation currently is near the upper end of the range that I feel is consistent with price stability. As such, I believe monetary policy must be vigilant. We need to make sure that increases in resource utilization or prices of energy and other commodities do not add to inflationary pressures or increase inflation expectations.

The most likely scenario is for a slow decline in the net saving rate by the rest of the world that would induce a gradual contraction in the U.S. current account deficit. This probably would not have a major impact on U.S. price pressures or growth, so there is little reason to think that monetary policy would need to react significantly.