The U.S. economy has improved, but a number of risks to growth remain and there is no near-term inflation threat, a top Fed official said on Thursday.
We're in much better shape than six months ago, but that does not mean everything is hunky-dory, Philadelphia Federal Reserve Bank president Charles Plosser told Market News in an interview.
Plosser, who is not a voter on the Fed's policy-setting committee this year, said that there are still issues facing the financial system, and that the ailing commercial real estate market is a concern.
Plosser, who is seen as one of the most hawkish Fed officials on inflation, reiterated he was not worried about inflation in the near-term; my worries about inflation are in the intermediate to long-term.
The Fed, the U.S. central bank, cut benchmark interest rates to near zero last December and has said it intends to keep them there for an extended period. The Fed also put in place a number of emergency programs, including the buying of mortgage-related debt and Treasuries.
Plosser told Market News the timing and pace of eventual policy tightening will depend on the economy.
It's contingent on the path of the economy and of inflation ... It's hard to predict now what that may look like, he said.
All the excess reserves in the banking system that are sitting there right now are not inflationary, but they could become inflationary if we're not careful, he said.
Asked by Market News about potential scenarios, he said that if excess reserves currently held at the Fed were to start flowing into the banking system in response to a rebound in economic growth, then the Fed would have to act pretty quickly to avert inflation.
However, if the reserve outflow were just a trickle, the economy remains weak and inflation stays well-anchored, you can imagine a scenario where it might not have to be rapid.
We need to be prepared for that to happen either quickly or not so quickly, he said.
But for now, inflation expectations seem pretty well-grounded, he said.
Plosser said no firm decisions have been made on which tools the Fed will use to tighten policy and in what order.
He said that the Fed cannot rely solely on paying interest on excess reserves to give financial institutions an incentive to keep their reserves at the Fed. Plosser said paying interest on reserves, which Congress gave the Fed the authority for last fall, was not thoroughly tested.
A Plan B, he said, is to sell the assets the Fed has accumulated during the crisis.
Asked about record gold prices and the decline of the dollar, Plosser said: I think we don't want to entirely dismiss that ... I do think from a policy standpoint that we need to be cognizant of what these asset markets are doing and ... better understand how they may or may not be giving us clues about what the future may hold.
But Plosser cautioned that interpreting asset price signals is a trickier business than a lot of people would have you believe.
Plosser, like Dallas Fed president Richard Fisher earlier this week, downplayed the significance of the U.S. dollar's recent declines.
People talk about the fall of the dollar, but we have to remember that the dollar is not even where it was before the crisis started, he said.
(Reporting by Kristina Cooke; Editing by Padraic Cassidy)