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In a New York Times op-ed, Paul Volcker expresses some concern that members of the Federal Reserv's Open Market Committee are starting to find the prospects of "a little inflation" tempting. The thinking that concerns Volcker is that 4 or 5% inflation might have a stimulating effect for the economy. Not so, says Volcker: My point is not that we are on the edge today of serious inflation, which is unlikely if the Fed remains vigilant. Rather, the danger is that if, in desperation, we turn to deliberately seeking inflation to solve real problems — our economic imbalances, sluggish productivity, and excessive leverage — we would soon find that a little inflation doesn’t work. Then the instinct will be to do a little more — a seemingly temporary and “reasonable” 4 percent becomes 5, and then 6 and so on. What we know, or should know, from the past is that once inflation becomes anticipated and ingrained — as it eventually would — then the stimulating effects are lost. Once an independent central bank does not simply tolerate a low level of inflation as consistent with “stability,” but invokes inflation as a policy, it becomes very difficult to eliminate. It is precisely the common experience with this inflation dynamic that has led central banks around the world to place prime importance on price stability. They do so not at the expense of a strong productive economy. They do it because experience confirms that price stability — and the expectation of that stability — is a key element in keeping interest rates low and sustaining a strong, expanding, fully employed economy. Read A Little Inflation Can Be a Dangerous Thing here .

James Bullard , president of the Federal Bank of St. Louis , believes the Fed has done its job in working to right the economy. And though the recovery is not exactly humming along, Bullard views the recent "mixed " reports on housing and jobs as relatively positive, and he sees signals that we are in a "soft patch in the recovery." He spoke with Dow Jones Newswires' Michael Derb y about the state of the economy:

The Federal Open Market Committee is set to meet tomorrow to discuss the state of the US economy and ways to push recovery. The Financial Times is now reporting that the Fed will "downgrade its assessment" of the economy . So that opens up questions of what tools the Fed may use to stimulate the sluggish recovery. Will the Fed be able to inject additional fiscal stimulus measures? Is additional quantitative easing a possibility? The University of Oregon's Tim Duy is expecting a "small change." Bottom Line: The incoming data appears largely consistent with the Fed's priors - especially expectations of glacially slow improvement in the labor market. Yet the probability of any upside risk to the forecast have diminished markedly. The V-shaped recovery has not emerged. The elimination of that upside risk argues for additional easing, but the Fed appears hesitant to do more. Uncertainty about the effectiveness of additional easing argues against more action, especially given relatively quiescent financial markets and positive, albeit lackluster, growth. Moreover, any additional action now is essentially a promise to do more later, even if growth remains along its current trajectory. All of these points argue against additional easing tomorrow, and that remains my baseline scenario. The case becomes muddied by internal, staff level pressure to do more now, combined with rising expectations of imminent easing given the steady flow of leaks to the press. This opens the possibility of a small policy adjustment that eliminates that passive reduction of the balance sheet. Any more is off the table. Read Tim Duy's Fed Watch here .

The Federal Reserve announced yesterday that Fed Vice-Chair Donald Kohn is retiring. Kohn had served the Fed for four decades, had been a member of the Board since 2002, and Vice-Chair since 2006. We thought it would be useful to look back at a couple of Kohn's speeches over the last few years. We've found two that bear watching. One is from last spring, when Kohn addressed the Financial Markets Research Center Conference at Vanderbilt University. In his speech, Kohn firmly defended the Fed's actions over the previous 20 months, and outlined how the Fed is the key player in guiding economic recovery: In the fall of 2007 Kohn spoke at the Council on Foreign Relations . His speech came just a few months after we started seeing housing markets tremble, so the central focus was market turbulence. And he directly addressed the Fed's during times of "moral hazard," stating: Central banks seek to promote financial stability while avoiding the creation of moral hazard. People should bear the consequences of their decisions about lending, borrowing, managing their portfolios, both when those decisions turn out to be wise and when they turn out to be ill-advised. At the same time, however, in my view, when the decisions go poorly, innocent bystanders should not have to bear the cost. In general, I think those dual objectives -- promoting financial stability and avoiding the creation of moral hazard -- are best reconciled by central banks focusing on the macroeconomic objectives of price stability and maximum employment. Here is the full speech:

San Francisco Fed President Janet Yellen spoke in Phoenix yesterday, and she presented a relatively reserved view of the economy. it was her first speech since the economy entered its current recovery phase, and she defended and commended government action in fighting off economic meltdown. But she also warned that this recovery is going to be very slow. And she focused on two key factors--household spending and the woeful labor market: Consumers have surprised us in the past with their free-spending ways and it’s not out of the question that they will do so again. But I wouldn’t count on them leading a strong recovery. They face high and rising unemployment, stagnant wages, and heavy debt burdens. Their nest eggs have shrunk dramatically as house and stock prices have fallen, and their access to credit has been squeezed. It may be that we are witnessing the start of a new era for consumers following the harsh financial blows they have endured. 2 We often hear the word “deleveraging” used to describe the push by financial institutions to scale back debt and build equity. Households too have now begun to pay down debt and rebuild their savings. This phenomenon can be seen not only in the United States, but in most countries that experienced similar housing booms. The United States was hardly the only country where households borrowed heavily just before a severe housing bust set in. And those countries with greater increases in debt relative to income before the crisis experienced greater declines in consumption spending once the crisis began. In the United States, the personal saving rate, which had fallen to an incredibly low 1 percent in early 2008, has averaged 4 percent so far this year and may well rise higher. In the current environment, such belt-tightening makes great sense from the standpoint of individual households. In fact, some households may have no other option because their access to credit has been crimped. Over the long run, higher saving is surely a good thing for our economy because it provides capital that can be devoted to modern infrastructure, technology, and other productive investments that enhance our standard of living. All the same, the transition to a higher saving plane could be painful if it reduces the growth rate of consumer spending for an extended period. Weakness in the labor market is another factor that may keep the recovery sluggish for quite some time. Payroll employment has been plummeting for more than a year and a half, and, even though the pace of the decline has slowed, unemployment now stands at its highest level since 1983. In addition, many workers have seen their hours cut or are experiencing involuntary furloughs. To bolster earnings in the face of weak revenue growth, employers have been aggressive in cutting labor costs and jobs, and my business contacts say they will be reluctant to hire again until they see clear evidence of a sustained recovery. Weak demand for workers is also putting a lid on paychecks. Wages are barely rising. A well-known measure of overall employment costs rose by only 1¼ percent over the past year, the smallest increase in the history of the series. High unemployment, weak job growth, and paltry wage increases are a recipe for sluggish consumer spending growth and a tepid recovery. The U.S. experienced so-called jobless recoveries following the previous two recessions in 1991 and 2001, when job creation remained weak for several years following the business cycle trough. In both cases, output growth was less robust than in the typical recovery and, unfortunately, things seem to be shaping up similarly this time around. Since she gave the speech in Phoenix, Yellen's comments about the real estate market were both interesting and relevant to the local crowd. And she also addresses the Fed's monetary policy, past and present. Read the full speech here .

Add Fed Chair Ben Bernanke's voice to the growing chorus that the recession appears to be over and a long slow recovery is beginning. Bernanke spoke at the Brookings Insititution yesterday about the events of the last year, and during his speech he noted that he was well aware that forecasters were announcing the end of the recession. Here is a key excerpt from the speech. But the general view of most forecasters is that that pace of growth in 2010 will be moderate, less than you might expect given the depth of the recession, because of ongoing headwinds, including still ongoing financial and credit problems, you know, deleveraging by households, the needs for adjustments in the economy, sectoral adjustments in the economy, the need for a fiscal exit at some point, many, many factors that will likely, at least based on current information, make the 2010 recovery moderate, and in particular, not much faster than sort of the underlying potential growth rate of the economy. And the arithmetic is that unless the economy grows, you know, significantly faster than its longer term growth rate, it’ll be relatively slow in creating jobs over and above those needed to employ people coming into the labor force, and therefore, the unemployment rate would tend to come down quite slowly. So that’s a risk, that’s a possibility. Of course, there is on both sides of that forecast; we could have a stronger recovery, we could have a weaker recovery, but if we do, in fact, see moderate growth, but not growth much more than the underlying potential growth rate, then, unfortunately, unemployment will be slow to come down. It will come down, but it may take some time. Obviously, that’s a very serious concern, and that’s one reason why, even though from a technical perspective the recession is very likely over at this point, it’s still going to feel like a very weak economy for some time as many people will still find that their job security and their employment status is not what they wish it was, and so that’s a challenge for us and all policy-makers going forward. You can read a full transcript of the speech, and watch the full session by clicking here .