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Whereas inflation is "subdued" in the near term, Plosser said he sees a "greater risk of higher inflation in the intermediate to long term for several reasons," including the fact that "monetary policy is extremely accommodative."
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He will be watching for signs of inflation in the second half of 2010, he said to reporters after his prepared remarks.
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The Philadelphia Fed president, who was speaking at Lafayette College in Easton, Pa., said some economists who predict a lengthened period of easy Fed monetary policy place too much weight on the idea that there is an excessive amount of slack in the U.S. economy.
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"Several empirical studies have shown that economic slack is difficult to measure with any accuracy," Plosser said. "It is particularly hard to measure slack near the turning points in business cycles, so making policy decisions based on measures of such slack becomes problematic."
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Suggesting that it's risky to make such assumptions, Plosser said the Fed's reputation will depend on its ability to tighten policy quickly, quite likely well before it is politically palatable to do so.
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"Just as the Fed has taken aggressive steps in flooding the financial markets with liquidity during this crisis to reduce the possibility of a second Great Depression, it will also have to take the necessary steps to prevent a second Great Inflation. Our credibility depends on it," Plosser said.
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"As the economy and financial markets improve, the Fed will need to exit from this period of extraordinarily low interest rates and large amounts of liquidity. We recognize the costs that significantly higher inflation and the ensuing loss of credibility will impose on the economy if we fail to act promptly, and perhaps aggressively, when the time comes to do so. The Fed will need courage because I believe we will need to act well before unemployment rates and other measures of resource utilization have returned to acceptable levels."
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Plosser said he sees signs the U.S. economy is "turning a corner," and he predicted second-half economic growth of around 2.3%, followed by a 3% rate for next year and then a return to a long-term trend rate of around 2.7% in 2011.
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As for unemployment, he said the jobless rate "will continue to creep up for a little while longer." But he stressed that "the unemployment rate is a lagging indicator" and argued that it will ease "only well after the economy begins to recover."
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Commercial real estate is another potential risk, but writedowns from banks exposed to it may be less as the economy improves, he said.
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Plosser also stressed the importance of the Fed being free from political influence and that it provides a lot of information already. He noted to reporters after his speech that the decisions on monetary policy are made public the same day, which wasn't always the case.
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"It's very important to protect the independence of the monetary policy piece of what we do," he said.
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When asked about the prospect of the Fed having more regulatory oversight, Plosser said the goals and expectations for any institution charged with the task need to be better defined than they are now. "I think it would be a very risky strategy for the Fed or the Congress to be in a situation where we do anything or ask to do things" that would undermine the Fed's core responsibility of monetary policy, he said.
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-By Michael Casey, Dow Jones Newswires; 212-416-2209; michael.j.casey@dowjones.com
(Romy Varghese contributed to this article.)
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Click here to go to Dow Jones NewsPlus, a web front page of today's most important business and market news, analysis and commentary: http://www.djnewsplus.com/access/al?rnd=EcD%2BzY6KbOZIxjF%2FqGjJDw%3D%3D. You can use this link on the day this article is published and the following day.
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(END) Dow Jones Newswires
September 29, 2009 20:53 ET (00:53 GMT)
Copyright (c) 2009 Dow Jones & Company, Inc.- - 08 53 PM EDT 09-29-09
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