St. Louis Fed President James Bullard said May 18 that central bankers are "determined" to avoid a repeat of the 1970s inflation. Paul Volcker, who took over as chairman in 1979, kept the federal funds rate on overnight loans among banks above 8 percent for more than five years, pushing it as high as 20 percent.

Forecasters Erred

During that decade, "forecasters consistently underpredicted the future level of inflation, seeing considerably more disinflation from a particular policy stance than in fact occurred," former Fed Vice Chairman Donald Kohn said in a 2007 speech. Fed staff economists and bond investors both made such mistakes, Kohn said.

"I lived through that whole thing, and it was awful," said Broaddus, who joined the Richmond Fed in 1970 and ran it from 1993 to 2004. Even though there hasn't been an incident of similar magnitude since then, policy makers "know that can happen," he said. It's "always out there as the lesson of what can happen if the Fed begins to lose focus on its main job of focusing on price stability."

Now Fed officials often speak of the credibility they regained from Volcker's inflation victory and how careful they must be not to let it slip away.

Business Cycle

"This is the point in the business cycle when the risk of losing a bit of credibility and risk of losing ground on inflation is highest," Jeffrey Lacker, the current president of the Richmond Fed, told reporters May 10.

The market-based measure of inflation five to 10 years out "is a proxy on their credibility completely," Davig said. "Any kind of financial market movement that would indicate the market's lack of belief in the Fed's ability to execute a smooth exit strategy -- the Fed's completely fearful of that."

The five-year breakeven measure has dropped 0.37 percentage points since the end of April, even as the total Consumer Price Index rose 3.2 percent last month from a year earlier. A measure of inflation five to 10 years out has fluctuated this year in a range of 2.77 percent to 3.14 percent.

Five-year breakevens traded in a range of 2.08 percent to 2.91 percent from 2004 through July 2007, just before concerns over the value of housing debt sent banks' borrowing costs surging. The five-to-10-year index traded from 2.34 percent to 3.31 percent.