With little confidence that the Fed would keep inflation low and stable, the public at that time reacted to the oil price increases by anticipating that inflation would rise still further. A destabilizing wage-price spiral ensued as firms and workers competed to "keep up" with inflation...

By contrast, the oil price increases of recent years appear to have had only a limited effect on core inflation (that is, inflation in the prices of goods other than energy and food), nor do they appear to have generated significant macroeconomic volatility. Several factors account for the better performance of the economy in the recent episode, including improvements in energy efficiency and in the overall flexibility and resiliency of the economy. But, the crucial difference from the 1970s, in my view, is that today inflation expectations are low and stable (as shown, for example, by many surveys and a variety of financial indicators). Oil price increases in the past few years, unlike in the 1970s, have not fed through to any great extent into longer-term inflation expectations and core inflation, as the public has shown confidence that any increases in inflation will be temporary and that, in the long run, inflation will remain low. As a result, the Fed has not had to raise interest rates sharply as it did in the 1970s but instead has been able to pursue a policy that is more gradual and predictable.

Like Volcker, Greenspan was ahead of academic thinking in recognizing the potential benefits of increased price stability. Indeed, in recent years, academic research on monetary policy has caught up with the policymakers, providing new support for what I have termed the modern consensus, that price stability supports both strong growth and stability in output and employment.

The mandate of the Federal Reserve System has changed since the institution opened its doors in 1914. When the System was founded, its principal legal purpose was to provide "an elastic currency," by which was meant a supply of credit that could fluctuate as needed to meet seasonal and other changes in credit demand...  The Federal Reserve today retains important responsibilities for banking and financial stability, but its formal policy objectives have become much broader. Its current mandate, set formally in law in 1977 and reaffirmed in 2000, requires the Federal Reserve to pursue three objectives through its conduct of monetary policy: maximum employment, stable prices, and moderate long-term interest rates.

Similarly, the attainment of the statutory goal of moderate long-term interest rates requires price stability, because only then are the inflation premiums that investors demand for holding long-term instruments kept to a minimum.  In sum, achieving price stability is not only important in itself; it is also central to attaining the Federal Reserve's other mandated objectives of maximum sustainable employment and moderate long-term interest rates.

Inflation expecations have become "well anchored" to price stability--most likely because people are confident that the Fed will act to limit any potential rise in inflation.  This may account for research results suggesting that, during this period, energy price increases have generally not been passed through to core inflation.

Under Chairman Greenspan, talk and action were combined to ensure the markets that over a period of time -- not necessarily within a quarter or two-quarters, but over a period of time, perhaps lasting several years, the Fed would ensure that inflation was stabilized in a region that was consistent with the objective of price stability.
So that is the approach I would take. I would certainly not try to return inflation to a target within a short period of time. I would simply try to assure the markets that over a long period of time that the Federal Reserve was committed to price stability as a central part of its monetary strategy.

The concern is that in an environment in which monetary policy has been accommodative, the joint effect of several inflationary pressures could erode price stability.  The FOMC will need to be alert and diligent as it works to maintain future price stability.

Now that we are in the neighborhood of price stability, we can be faced with looking at the possibility that inflation will fall too low as well as rise too high. Moreover, so long as inflation expectations are well anchored, we can tolerate limited changes in inflation, but we need to know that a rise or fall is not the beginning of a more extended trend. Consequently, we focus closely on the reasons for any changes in inflation and their implications for the outlook.

The constituency for price stability in the United States today seems broad and strong and reasonably bipartisan, but it's been a generation since we've had high inflation and had to face the costs of bringing it down.

By most measures, overall inflation today continues to be within the range I find consistent with the definition of price stability.

Preserving the credibility of our commitment to price stability is vital. It is important because price stability is critical to giving enterprises confidence to invest in the future. It is more important at a time when we are running very large external deficits, because countries investing their savings here must remain confident that their investments will not be eroded by future inflation. And it is important because confidence in our commitment to price stability affords us more flexibility to act aggressively in the event of future shocks.

Though economic activity hesitated in early 1995, it soon steadied, confirming the achievement of a historically elusive soft landing. The success of that period set up two powerful expectations that were to influence developments over the subsequent decade. One was the expectation that inflation could be controlled over the business cycle and that price stability was an achievable objective. The second expectation, in part a consequence of more stable inflation, was that overall economic volatility had been reduced and would likely remain lower than it had previously.

For all these conceptual uncertainties and measurement problems, a specific numerical inflation target would represent an unhelpful and false precision. Rather, price stability is best thought of as an environment in which inflation is so low and stable over time that it does not materially enter into the decisions of households and firms.

Is price stability really what we are after or are we after financial stability? Even more generally, going back over time we have tended to argue, I think correctly, that the objective of monetary policy is to create maximum sustainable economic growth, and we have argued, again I think quite correctly, that price stability is a necessary condition to reach that goal. But price stability may indeed be a proxy for something else, which I suspect is financial stability...It is by no means clear exactly how we should measure price stability, given the prospect that it will become increasingly difficult over time to define what constitutes output and prices...When we move into the 21st century, what we will try to stabilize may in effect be the purchasing power of money, however that is measured...While I am not saying that these involve issues that we need to  resolve today, I suspect that we will start to confront them in 5 years or certainly within 10 years, and they may very well affect our projections going out to, say, the year 2006. I also suspect that by around the year 2006, this very tricky question may involve what we are endeavoring to stabilize and may be the focus of our policy actions. My own guess is that we are going to be dealing with asset prices, the question of nominal long-term interest rates, and probably the outlook for nominal GDP as well.

My own observation of business practices over the years suggests that the inability to pass cost increases through to higher prices provides a powerful incentive to firms to increase profit margins through innovation and greater efficiency, which boosts productivity and ultimately standards of living over time. Holding the line on inflation, thus, does not impose a speed limit on economic growth. On the contrary, it induces the private sector to focus more on efforts that yield faster long-term economic growth.