I don't mean to imply that monetary policymakers ignore short-term economic fluctuations. We don't. Indeed, we calibrate our policy actions to have the best possible overall effect on short-term and long-term economic conditions. But supply and demand factors in the economy must ultimately adjust on their own. Our role is to provide a stable environment that enables these short-term imbalances to work themselves out in the least disruptive manner.

I expect real GDP to grow by about 3 percent, which I estimate to be its underlying trend rate. That kind of growth should hold the unemployment rate to just below 5 percent. The outlook for inflation is more uncertain. Inflation stopped accelerating in the last few months, but whether it will continue to recede in the coming year is not yet clear. Additional monetary policy action may be needed to keep us moving along the path to price stability. 

It is a truism in economics that the primary source of persistent inflation is monetary policy, and clearly monetary policy was accommodative for the period from 2001 through 2005. It is an open question whether our current monetary policy is sufficiently restrictive to return the economy to price stability over a reasonable horizon.

Even if policy is now well positioned, as I think is likely to be the case, it will still take some additional time for inflation to unwind due to lags between policy actions and their impacts on economic activity and inflation. These lags can be anywhere from several months to a couple of years. This means that we have yet to see the full effects of the series of 17 funds rate increases—some are probably still in the pipeline.

I am a central banker to my core, so I know that somewhere, somehow, something will go wrong...

On the inflation front, the good news is inflationary pressures appear to have reached a stasis, despite the labor shortages in certain sectors -- particularly in chemicals and petroleum industries and in functions requiring skilled and semiskilled workers. The bad news is that the stasis is at too high a level for party poopers like me who will have no choice but to advocate tightening monetary policy further if inflation does not ratchet downward.

Given all of this, I would have to say that the risk of unacceptably high inflation still outweighs the risk of substandard economic growth

I’m leaving the FOMC confident in the Fed’s commitment to keep inflation at bay. I’m sure future policymakers will remember the lessons we learned in the past 40 years about what happens when you start down the slippery slope of trading inflation for growth.

It appears to me that the federal funds rate currently lies in a vicinity that is roughly appropriate for the Fed to attain its key objectives over the medium run...

In the present circumstances, I would consider it appropriate for the actual rate to be a bit above the neutral rate—in other words, I'd like it to be modestly restrictive—to promote price stability, especially given that the economy may be operating with labor and product markets that are a bit on the tight side.

The lags between policy actions and their effects imply that we must be forward-looking, basing our policy choices on the longer-term outlook for both inflation and economic growth.  In formulating that outlook, we must take account of the possible future effects of previous policy actions--that is, of policy effects still "in the pipeline."

I would agree that we have essentially removed that extraordinary degree of monetary policy accommodation, and we're much more in the more normal range of interest rates at this point.

Well, I think that the risk that we are considering -- and again, it's just a risk, that inflation might move up and might force us to be more aggressive, which we don't want to do, because we hope that inflation will stay under control and come down as we expect it to -- I think that is a risk.

Amid signs of slower growth, recent inflation news has been somewhat distrubing.  While higher energy costs have caused broad inflation measures to rise over the past few years, most core measures of inflation, which exclude volatile energy and food prices, have remained low.  In the past few months, however, we have seen sizeable increases even in core measures of inflation...If these recent elevated inflation readings persist, they could make it difficult for the Federal Reserve to maintain price stability over a medium-term time horizon.

Central banks in a number of other industiralized countries are currently tightening policy, and slower growth abroad could limit some of the anticipated improvements in US exports over the next year.

Faced with an uncertain view of the future, the natural tendency of policymakers is to wait for further information on the state of the economy. In the absence of decisive policy actions, central bankers may be able to stabilize long-term inflation expectations by clarifying their vision of price stability.

In the end, however, policymakers here and abroad cannot lose sight of a fundamental truth:  In a world of separate currencies that can fluctuate against each other over time, each country’s central bank determines its inflation rate.