Inflation has been running about 1.5 percent recently, and from my point of view, that's ideal. Earlier this year some economists were highlighting the risk that the low level of economic activity could push the rate of inflation down, perhaps even below zero. I think the risk of a substantial further reduction in inflation has diminished substantially since then. The historical record suggests that the early years of a recovery are when the risk is greatest that confidence in the stability of inflation erodes and we see an upward drift in inflation and inflation expectations. This risk could be particularly pertinent to the current recovery, given the massive and unprecedented expansion in bank reserves that has occurred, and the widespread market commentary expressing uncertainty over whether the Federal Reserve is willing and able to promptly reverse that expansion.

As a technical matter, I do not see any problem – we do have the tools to remove as much monetary stimulus as necessary to keep inflation low and stable. The harder problem is the same one that we face after every recession, which is choosing when and how rapidly to remove monetary stimulus. There is no doubt that we must be aware of the danger of aborting a weak, uneven recovery if we tighten too soon. But if we hope to keep inflation in check, we cannot be paralyzed by patches of lingering weakness, which could persist well into the recovery. In assessing when we will need to begin taking monetary stimulus out, I will be looking for the time at which economic growth is strong enough and well-enough established, even if it is not yet especially vigorous.

My outlook is for roughly 3 percent (GDP growth) over the next 18 months. That’s positive but modest after this downturn. Unemployment will be high. The combination of very large slack with stable inflation expectations leads me to an inflation outlook which is on the order of 1.5 percent core for the next few years, for the next two years at least.

With that environment, I’m underlying what my own guideline is for price stability. I’d say that’s 2 percent.  With that, policy is likely to continue to be appropriate for 2010 and most likely beyond.

Unless there are unusual developments, I think the policy is going to be highly accommodative, as it is now, for quite some period of time.

From comments to the press, as reported by Bloomberg News

For the record, the core price index for personal consumption expenditures increased 1.5 percent in the last 12 months. That’s right on target, as far as I’m concerned, and so a large further decline would be unwelcome.

Over the longer-run, with appropriate monetary policy, I see both overall and core inflation averaging somewhere into the neighborhood of 2 percent, which is a rate I see as being consistent with price stability. That said, there is notable risk that inflation will remain a good deal below this range in the medium term.

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[A]t a time when near-term inflation is likely to be lower than usual, endorsing an explicit numerical objective for inflation could help keep inflation expectations from falling very far. Such an anchor on inflation expectations would help preserve low real inflation-adjusted interest rates.

I interpret the available economic theory and empirical evidence as indicating that a long-run average inflation rate of about 2 percent, or perhaps a bit lower, is low enough to facilitate the everyday decisions of households and businesses while also alleviating the risk of debt deflation and other pitfalls of excessively low inflation.

While the growth outlook has improved since the beginning of the year, the inflation outlook has deteriorated. The latest figures confirm that inflation is unacceptably high. The price index for personal consumption expenditure increased 3.1 percent over the 12 months that ended in May, and is up at a 3.9 percent annual rate for the last 3 months. To put that in perspective, for several years, I have suggested an inflation target of 1.5 percent.

Price stability has multiple interpretations. In the late 19th and early 20th centuries, price stability meant that variations in the general level of prices would be transitory: the price index would revert to a mean. In recent policy discussions, price stability generally is interpreted as a small positive rate of inflation. Under these conditions, the level of prices does not revert to a constant, but trends upward. I accept this latter definition of price stability. There may be theoretical and practical reasons to believe that the best price indexes we have available are subject to upward biases. While I am not a big fan of the upward-bias argument—after all, the best-available adjustments are already made to the indexes—I admit that I do not have better measures myself. My preferred definition of price stability is that trend inflation, correctly measured, is zero. In practice, this likely converts into a trend in measured inflation on the order of ½ to 1½ percent, depending on the particular price index referenced.

What do we mean by price stability?  A widely cited definition is that the inflation rate is sufficiently low so that households and businesses do not need to take inflation into account in making everyday decisions.³  Broadly speaking, I believe this definition of price stability is a reasonable one, and in practice, central banks around the world have chosen average levels of inflation between 0 and 3 percent as consistent with this criterion. However, this range can be narrowed a bit further by considering the implications of economic theory and empirical evidence about the average inflation rate that produces the best economic outcomes...

In contrast, given shocks like those seen over the past several decades, an average inflation rate higher than about 1 percent substantially reduces the frequency with which the economy hits the zero lower bound. An inflation objective of about 2 percent implies that monetary policy is rarely constrained by the zero lower bound and thereby minimizes the adverse consequences for macroeconomic stability.

While inflation is currently at the upper bounds of my comfort zone, the Fed has made progress against it. That's why I believe the recent moderation of inflation readings allowed a tactical move to reduce risks to the general economy with a fed funds rate cut.

Since 2005, the three- to five-year moving average of U.S. inflation has hovered around 3 percent. This is above where I would like to see the trend settle in the longer run.  [Note:  These figures are measured by the Consumer Price Index.]

"We can't take our eye off the ball" on inflation. "I'm uncomfortable with inflation running about 2 percent," referring to the core price index for personal consumption expenditures.

As reported by Reuters

Over the last 12 months, the core PCE price index, the Fed's preferred measure of inflation, rose 2.4 percent, up from the 2.0 percent rate of the prior 12-month period. By contrast, I prefer inflation to be between 1 and 2 percent—that's the range that I consider to be most compatible with the Fed's goal of price stability.

I regard “price stability” as zero inflation, properly measured. What does “properly measured” mean? Price indexes have biases of various sorts and experts generally believe that U.S. indexes overstate inflation by a modest amount. If statisticians understood these biases with precision, the indexes could be corrected. I myself make a rough guess that, for example, the Consumer Price Index overstates inflation by about one percentage point a year.

...In recent years several FOMC members have referred to a “comfort zone” of 1-2 percent inflation measured by the price index for personal consumption expenditures, excluding the volatile food and energy components. Because agreement on some reasonably low rate of inflation is more important than exactly what that rate is, I am perfectly happy to state my personal inflation objective as an inflation rate measured by the core PCE price index of 1.5 percent, plus or minus 0.5 percent.

I prefer inflation to be between 1 and 2 percent—that's the range that I consider to be most compatible with the Fed's goal of price stability. The monthly inflation numbers did come in lower toward the end of the year, and I was pleased to see the improvement. But the most recent couple of readings on inflation have been higher. So clearly, it is much too early to say that inflation is no longer a concern.

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.

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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.