in this direction without any amendment to the federal reserve act. perhaps the setting of an explicit inflation target by the federal reserve might be analogous to its earlier setting of numerical money growth ranges. in 1978, the congress instructed the fed to report an objective for money growth. the fomc then decided unilaterally on the numerical ranges. in 2000, the congress amended the federal reserve act to remove the requirement that the fed report to the congress on the ranges for monetary aggregates. in the case of an inflation objective, the congress has already imposed a price - stability objective. all the fomc would be doing is communicating back to the congress and the public its interpretation of that objective. nevertheless, such a move would likely be interpreted as an important change in the conduct of monetary policy. consequently, if the fomc desired to move in this direction, extensive prior consultations would be appropriate, especially with the congress, but also with the administration. it might also be constructive to get feedback from a wider audience on a proposal to set an explicit inflation target before proceeding in this direction. it would, however, be problematic for the united states to follow the approach in many inflation - targeting countries of having the ministry of finance ( in our case, the treasury department ) set the inflation target. such an approach is more comfortable politically in a parliamentary system, in which the legislative and executive branches are always controlled by the same party or coalition. it seems unlikely that the congress would delegate this responsibility to the treasury department. even regular consultation with the treasury department about a specific goal under the approach i have mentioned here might raise questions unless the congress explicitly authorized it. choosing a specific price index most broad measures of inflation move roughly in concert over time. nevertheless, the differentials among the most widely used aggregate measures of inflation generally are not stable over long periods. therefore, it does make some difference which measure is selected for the target. all inflation - targeting central banks use a measure of consumer price inflation for their target. in the absence of a complete model of the cost of inflation to guide the choice, the use of consumer price measures seems appropriate because these measures are the most relevant to the calculation of real income for households, because the welfare of households is ultimately the goal for monetary policy, and because measures of consumer price inflation are often the most visible of inflation measures. in the united states, this would mean a choice between the consumer price index ( cpi ) and the price index for personal consumption expenditures.

the " long and variable lags " between policy actions and the economic effects. economists agree that monetary policy cannot " fine tune " the economy to ensure that the full employment objective is continuously maintained. however, a considerable amount of research supports the contention that monetary policy can reduce the variability of output around its full - employment level. for a discussion of the case for price stability, see fischer ( 1996 ). much of this research involves simulations of empirical macroeconomic models with alternative policy rules. the simple policy rules used in these exercises mimic the systematic aspects of the response of discretionary policy to changes in the macroeconomy. for example, taylor has shown that federal reserve policy actions in recent years have been broadly similar to what a simple policy rule would have prescribed. these exercises therefore demonstrate the ability of simple rules – and by extension, discretionary monetary policy more broadly – to both reduce the variability of output and achieve a long - run inflation target. see taylor ( 1999 ) for a series of papers involving simulations of models with various policy rules. preferences households and businesses are presumed to prefer low and stable inflation to high and variable inflation. but they also prefer high and rising real income per capita and output that is consistently close to the economy's maximum sustainable level of output. this is often expressed in terms of a loss function where the loss to society is expressed as a weighted average of squared deviations of inflation from its target and of output from its potential level. the squaring of the deviations ensures that deviations on either side of the target are treated equivalently as losses. the weights, a and 1 - a, indicate the relative intensity of the public's distaste for deviating from their preferred rates of inflation and output. the loss to society, l, can be expressed as ( 1 ) l = a ( f - f * ) + ( 1 - a ) ( y - y * ) where f is the rate of inflation, f * is the target rate of inflation, y is the level of output and y * is the target level of output or potential output. tradeoff between inflation and output variability although it is possible in principle to achieve price stability and full employment simultaneously, an inevitable tradeoff between the variability of output and the variability of inflation exists. this tradeoff is most obvious in the case of a supply shock, for example an abrupt increase in the price of oil. an adverse supply shock typically raises inflation and lowers aggregate demand ( by reducing the