With respect to globalization, I agree with Bill that, through its effect on relative prices, globalization has created both tailwinds and headwinds for central banks in their quest for price stability. Such shocks do not, in my view, alter in the least the ability of a central bank to attain its desired inflation objective over the medium term in a flexible exchange rate regime. But they do affect inflation in the short run, and they can make the attainment of a particular inflation goal easier or more painful by impacting NAIRU, at least for a time.

There is no analogy in financial markets to macroeconomic price stability. The prices of financial products may change quite substantially when new information arrives. Indeed, one of the most important activities of financial markets is price discovery—the efficient assimilation of all available information into asset values. This promotes the appropriate allocation of capital among competing demands and supports maximum sustainable growth. And it is this efficient functioning of markets that is our concern with regard to financial stability.

I believe that accommodation is appropriate because the financial shock and the housing cycle have significantly restrained economic growth. While growth seems likely to be sluggish this year, the Fed’s policy actions should help to promote a pickup in growth over time. I consider it most probable that the U.S. economy will experience slow growth, and not outright recession, in coming quarters. At the same time, core consumer inflation seems likely to decline gradually to somewhat below 2 percent over the next couple of years, a level that is consistent with price stability.

However, economic prospects are unusually uncertain. And downside risks to economic growth remain. This implies that, going forward, the Committee must carefully monitor and assess the effects of ongoing financial and economic developments on the outlook and be prepared to act in a timely manner to address developments that alter the forecast or the risks to it.

The Federal Reserve’s goals for monetary policy, as established by Congress, are to seek price stability, maximum sustainable economic growth, and moderate long-term interest rates.

From my perspective, price stability is and should be the primary focus of monetary policy. Sustained inflation is ultimately a monetary phenomenon, and the Federal Reserve is our nation’s central bank and monetary authority. Thus achieving and maintaining a stable price level is uniquely the Fed’s responsibility. There is no other agency or policy arm of the government that can deliver on this goal. In addition, achieving price stability supports the other two goals.

I don’t think there has been a strong tendency to follow periods of high inflation with periods of abnormally low inflation, which is what a price level targeting regime would do. Rather, I would say, although there is kind of a mixture, I’m sure, I think the weight is probably greater on stabilizing inflation per se, and as you know arithmetically what that implies is that if you have an accidental inflation rate above your expectation, then you try to get inflation back down to your normal rate and that would tend to raise prices in the longer term. I’m quite aware that there’s a big debate about what the best way to go is… The advantage of price level targeting obviously is that people know what the value of money is going to be ten years from now whereas with inflation stabilization they may not know that. There are disadvantages though, including the fact that you may have to have periods of deflation or very sharp disinflation that may be destabilizing. So there are arguments on both sides of that, but I think if you looked at the data I think you’d find that most of that surprise would persist in later price levels. Not even later inflation rates, let me be clear, but in later price levels.

Some central banks hold regular press conferences. And, of course, some have established explicit numerical objectives - or inflation targets - and publish economic projections that clearly show what they are aiming at and how they expect to get there. Our different approaches are, in part, a result of our different histories and governance structures.  But also, I think, central banks are still developing "best practices" for securing inflation expectations in the face of unknown future risks.

However, differences in tactics should not be confused with differences in intent. I believe that my colleagues - and indeed, most central bankers today - are working to achieve the same end. We are all trying to create an environment in which inflation is so low and stable that it does not influence the decisions that households and businesses would otherwise make.

Rogoff (2003) provides an alternative theory of how globalization may affect the central bank’s inflation objective. He argues that deregulation and international integration have led to more flexible prices, so that any attempt by a central bank to stimulate the real economy by allowing inflation to rise unexpectedly will be less effective than it would have been in the past. Because central banks have less incentive to create unexpected inflation, their promises to keep inflation low are more credible, which in turn reduces the cost of keeping inflation low. Accordingly, in Rogoff’s analysis, globalization has led monetary authorities to maintain lower long-term inflation rates. A criticism of this story is that it implies that the Phillips curve is steeper today than in the past (that is, that inflation is more sensitive to slack in the economy), a prediction that does not accord with most empirical studies.

The FOMC outlook anticipates further declines. The central tendency forecast expects inflation of 2 to 2-1/4 percent for 2007 and 1-3/4 to 2 percent for 2008. If inflation were to come in at the middle or bottom of such ranges, that would represent good progress toward price stability.

My own take on what “moderate pace” means is that real GDP is likely to increase by roughly 3 percent over the four quarters of this year—particularly if the housing market is near an inflection point and no longer a significant drag on growth. But I want to emphasize that fluctuations in growth are normal and that no policy action is necessarily indicated if growth comes in somewhat above or below that outlook. When data come in outside the range expected, we need to understand the reasons and the likelihood that the departure will be sustained unless there is an offsetting policy response. Only then does it make sense to consider a policy response.

Regarding the outlook for inflation, I’ve said for quite some time that it might take a while for underlying price pressures to recede. Recent inflation data themselves, and other information relevant to judging the inflation outlook, suggest that the inflation rate is likely to fall into a reasonable range this year. If, however, core inflation seems to be settling at a rate above 2 percent, then such an outcome would be unacceptable to me. I put a very high weight on the Fed’s responsibility to maintain low and stable inflation.

At some point we’ll almost certainly see some surprises in the data. Long experience with economic forecasts indicates that we need to consider as a standard feature of the environment GDP forecast errors in the neighborhood of 1½ percentage points on a four-quarter ahead horizon. Thus, a forecast of 3 percent GDP growth should be expressed as 3 percent plus or minus 1½ percent. From experience, an outcome in this range has a probability of about two-thirds. The other one-third probability is divided equally above and below the range. Thus, the probability of an outcome significantly different from the baseline forecast is not small. The FOMC is prepared to respond when the outcome promises to depart from the baseline in a sustained way.

Every now and then there is a supposed 'revolution' that challenges price stability, but our experience is that policy based on ideas such as that money doesn't matter, or the Phillips curve trade-off, end badly. 

As reported by Market News International

This leads me to my first principle: price stability is and should be the primary focus of monetary policy. I think almost every economist would agree that sustained inflation is ultimately a monetary phenomenon, and, of course, the Fed is the monetary authority in the United States.

Don't sell the Fed's inflation concern short.

During the Q&A session.

Price stability plays a dual role in modern central banking: It is both an end and a means of monetary policy.

In principle, the problem of inflation could be reduced by the practice of indexing dollar payments such as interest and wages to the price level, but people seem to find indexing costly and avoid it when they can. It is interesting and instructive, for example, that the indexation of wages to prices in labor contracts has always been quite limited in the United States; some indexation was used during the high-inflation 1970s but the practice has been substantially reduced since then. Moreover, some countries that adopted indexing during high-inflation periods, such as Brazil and Israel, largely abandoned the practice when inflation receded.

Specifically, during the past twenty years or so, in the United States and other industrial countries the volatility of both inflation and output have significantly decreased--a phenomenon known to economists as the Great Moderation (Bernanke, 2004). This finding challenges some conventional economic views, according to which greater stability of inflation can be achieved only by allowing greater fluctuations in output and employment. The key to explaining why price stability promotes stability in both output and employment is the realization that, when inflation itself is well-controlled, then the public's expectations of inflation will also be low and stable. In a virtuous circle, stable inflation expectations help the central bank to keep inflation low even as it retains substantial freedom to respond to disturbances to the broader economy.