Allowing as best we can for measurement bias, which might be in the neighborhood of half a percent per year for broad measures of consumer prices, I favor literally zero inflation. Given measurement bias in price indexes, I might state my goal as inflation between 0.5 and 1.5 percent as measured by the price index for personal consumption expenditures (the PCE price index).

[T]he price index for core personal consumption expenditures, has averaged 1.8 percent over the 12 months ending in November. That is within the 1-to-2 percent range that I and others have proposed as an announced target.

Core inflation has been low and relatively steady in the last several years. The inflation measure that is widely preferred on methodological grounds, the price index for core personal consumption expenditures, has averaged 1.8 percent over the 12 months ending in October. That is within the 1-to-2 percent range that I and others have proposed as an announced target.  Although core PCE inflation on a year-over-year basis did drift above 2 percent for several months in late 2004 and early 2005 — it went as high as 2.3 percent at one point — it was only after the most recent Annual Revision to the National Income and Product Accounts that the series came in over 2 percent.

The latest reading of the core price index for personal consumer expenditures, the Fed's preferred measure of inflation, shows an increase of 2 percent over the last 12 months. This is at the upper end of the range that I feel is consistent with price stability.

The latest reading of the core price index for personal consumer expenditures, the Fed's preferred measure of inflation, shows an increase of 2 percent over the last 12 months. This is at the upper end of the range that I feel is consistent with price stability.

I find myself still pretty comfortable with the numerical objective I had recommended almost a decade ago. More specifically, I would now favor a 1.5 percent numerical objective for inflation as measured using the core personal consumption expenditures (PCE) price index, which, given the recent average differences in measurement bias, corresponds to a 2 percent objective for the core CPI.

My own guess is that core PCE inflation in 2005 will be slightly higher than its 2004 rate of 1.6 percent, though likely remaining within what I think of as the "comfort zone" of 1 to 2 percent.

[The core PCE's] behavior over the last twelve months has been generally quite reasonable—around the value I would endorse as a numerical, long-run inflation objective if the Committee ever were to adopt one. It rose at 1-1/2 percent in 2004.

A small step towards a more explicit statement of the FOMC’s inflation objective was taken in 2003 when, at the May FOMC meeting, the Committee indicated that “the probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pickup in inflation from its already low level.”  This statement gives a hint about the view of committee members of the lower end of a tolerance range of measured inflation.  At that time inflation, as measured by the Committee’s preferred “core” personal consumption price index, was approximately 1 percent.  To date, the Committee has not addressed the question as to what inflation rate would mark the limit such that a substantial rise in inflation above that rate would be unwelcome.

Finally, if the FOMC were to adopt a preferred range, I feel that efforts to quantify measurement bias in price indexes have, on the whole, been too conservative. My own personal preference is that the top of the range could go as high as 2.5 percent per year.

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.

Allowing for the upward biases in inflation measurement and a zone of safety to avoid accidental deflation in prices, an inflation target in the range of 1-2% per annum for the core PCE deflator might be a good initial choice, although some might reasonably disagree about either the number or the choice of index.

I want to wrap up by indicating what happens when we do the cost-benefit analysis by using the Akerlof, Dickens, Perry estimates of inflation-related changes in permanent unemployment along with Feldstein's estimates of the tax-related welfare benefits under his baseline and more conservative assumptions about the interest elasticity of savings. As I total things up, it appears to me that a reduction of inflation from 3 percent, which I take as roughly our current level, to 2 percent, very likely, but not surely, yields net benefits. The "grease-the-wheel" argument is of minor importance at that point, and tax effects could be significant. But with further reductions in inflation below 2 percent, nominal rigidity begins to bite so that the marginal payoff declines and then turns negative. To my mind, to go below 2 percent measured inflation as currently calculated requires highly optimistic assumptions about tax benefits and the sacrifice ratio. Of course, if inflation cum tax distortions were remedied through legislation instead of Federal Reserve policy, the net benefits would be lower.

CHAIRMAN GREENSPAN. If we are going to get anywhere, we can't have people literally talking at cross purposes. Janet, you did not even accept the premise with which Al is starting, that everyone agrees that we should seek price stability as a goal. If we are going to get anywhere, the question I have to ask first is whether you agree with Al that price stability is a goal we should seek. If you do not, this discussion then gets to the question of whether there is a consensus among the Committee members that price stability is something that should be our long-term goal, not how we get there. First, we have to agree on the goal.

MS. YELLEN. I would simply respond to that by saying that the Federal Reserve Act directs us to aim for both maximum employment and price stability. To the extent that there is no tradeoff at low inflation rates and there are benefits that outweigh the short-run costs, then price stability, literally zero inflation, is good and we should go for it. To the extent that there is a tradeoff, we have to weigh what to do, and I think I am pointing to the possibility of a tradeoff as we go to very low inflation rates.

CHAIRMAN GREENSPAN. So, you are discussing the issue of the transition, not the ultimate goal?

MS. YELLEN. No, I am discussing the issue of the ultimate objective. If we have to pay a permanent price at zero measured inflation in the form of permanently less employment and higher unemployment, I do not read the Federal Reserve Act as unambiguously telling us that we should choose price stability and forego maximum employment.

…

CHAIRMAN GREENSPAN: … Let me see if we can establish some structure for our discussion. Can you give me three sentences in conclusion on how you view the question: Is long-term price stability an appropriate goal of the Federal Reserve System?

MS. YELLEN. Mr. Chairman, will you define "price stability" for me?

CHAIRMAN GREENSPAN. Price stability is that state in which expected changes in the general price level do not effectively alter business or household decisions.

MS. YELLEN. Could you please put a number on that?

CHAIRMAN GREENSPAN. I would say the number is zero, if inflation is properly measured.

MS. YELLEN. Improperly measured, I believe that heading toward 2 percent inflation would be a good idea, and that we should do so in a slow fashion, looking at what happens along the way. My presumption based on the literature is, as Bob Parry summarized it, that given current inaccurate measurements, heading toward 2 percent is most likely to be beneficial.