In a speech delivered at the University of Richmond yesterday, Federal Reserve Bank of Richmond president Jeff Lacker lays out his argument for a Fed statement about its long-term inflation objective.  He starts with a recap of what happened the last time we exited from a protracted period of very low real interest rates.

...1994 was a year of heightened risk of rising inflation. There was an inflation scare in the bond market that took the 30-year bond rate from below 6 percent in October 1993 to a peak of over 8 percent in November 1994. That nearly 2.5 percentage point increase in the bond rate indicated the Fed’s credibility for low inflation was far from secure.

The Fed fought the challenge to its credibility by raising the federal funds rate — our monetary policy instrument — in seven steps from 3 percent to 6 percent between February 1994 and February 1995... The bond rate returned to around 6 percent by January 1996, and one began to hear talk of the “death of inflation.”

From this experience I draw three conclusions for monetary policy. First, a well-timed preemptive increase in the federal funds rate is nothing to be feared. In 1994, it was necessary to take the real federal funds rate — the nominal rate adjusted for expected inflation — from around zero up to around 3 percent in order to avert the potential build-up of inflationary pressures. And yet real growth picked up and the unemployment rate trended down.

  Second, to keep inflation well-anchored, the Fed must be prepared to move the federal funds rate around over the business cycle even though inflation remains stable...

Third, the anchoring of inflation expectations achieved by preemptive policy in 1994 has produced enormous benefits for monetary policy. The bond market arguably has not exhibited a major inflation scare since 1994 — not during the boom in the late 1990s and not during the period of very low federal funds rates in the last few years. The successful stabilization of inflation expectations has been the cornerstone for effective monetary policy ever since.

President Lacker goes on to indicate that the third lesson has convinced him that announcing an explicit numerical inflation objective would be a good move for the Fed.

The minutes [or the February FOMC meeting] cite three benefits of an explicit price-stability objective: (1) its usefulness as an anchor for long-term inflation expectations, (2) its power to enhance the clarity of Committee deliberations, and (3) its usefulness as a communication tool. I agree wholeheartedly with the first point in light of the critical importance of tying down inflation expectations as I discussed earlier. As much as one can debate the usefulness of allowing short-run fluctuations in realized inflation, I see no utility in tolerating unnecessary fluctuations in long-run expectations of inflation.

I also agree completely with the second point about enhancing the clarity of deliberations, because when it comes to internal policy analysis and discussion, coherence demands that FOMC participants implicitly agree on a long-run numerical objective for inflation. Accountability in a democratic society then argues for making available to the public the numerical objective upon which our internal discussions of monetary policy are based.

Finally, I believe that the Fed’s experience in May and June 2003 indicates that references to inflationary or deflationary risks in the policy statements we now release after every meeting cannot reliably substitute for an explicit inflation target.

Here is the take-away from the 2003 episode...

The statement issued following the May 2003 FOMC meeting asserted that a fall in inflation — then about 1 percent — would be “unwelcome.” This came as a something of a surprise to markets and caused a sharp reaction in long-term rates. If an inflation target range had been in place in 2003 with a lower bound of 1 percent, the public could have inferred the Fed’s growing concern about disinflation as the inflation rate drifted down toward that bound. Expected future federal funds rates and longer-term interest rates would have moved lower continuously, with less chance of overshooting or undershooting the Fed’s likely policy path.

... followed by a pretty good question:

If the May 2003 statement is interpreted as the revelation of the lower bound of an inflation target range, then half of an inflation target range has been announced. And if revealing a dislike of inflation below 1 percent was useful in May 2003, is it not likely that revealing an upper bound will prove useful in some future circumstance?

In case you didn't get the message the first time:

Ambiguity about the Fed’s long-run inflation intentions has outlived its usefulness.

UPDATE: William Polley notes this speech, and Philadelphia Fed president Anthony Santomero's comments on the subject as well.