NEW YORK, March 25 - The U.S. economy is on a firmer footing, and the U.S. central bank will have to reverse its easy money policy in the not-too-distant future to avoid sowing the seeds of inflation, a top Federal Reserve official said on Friday.
Speaking in New York, Philadelphia Federal Reserve Bank President Charles Plosser said the earthquake and nuclear crisis in Japan and the rise in oil prices because of turmoil in the Middle East pose a risk to the U.S. recovery -- but said he expected this risk to be small and short-term.
He said consumer spending continues to expand at a reasonably robust pace, and the labor market is improving. The overall economy, he said, has gained significant strength and momentum since the summer.
If this forecast is broadly accurate, then monetary policy will have to reverse course in the not-too-distant future and begin to remove the massive amount of accommodation it has supplied to the economy, Plosser, one of the central bank's biggest inflation hawks, said.
Failure to do so in a timely manner could have serious consequences for inflation and economic stability in the future, said Plosser, a voter on the Fed's policy-setting committee this year.
At its last meeting, the Federal Reserve voted unanimously to keep its plan to buy $600 billion in U.S. government bonds through June unchanged. The Fed cut interest rates to near zero during the crisis and is buying bonds to further ease monetary policy.
Plosser outlined his preferred strategy for eventually tightening policy.
He said he would like to raise interest rates and reduce the Fed's balance sheet -- which ballooned to more than $2 trillion during the crisis -- at the same time.
My proposed strategy involves raising rates and shrinking the balance sheet concurrently and tying the pace of asset sales to the pace and size of interest rate increases, Plosser said.
By tying sales to interest rate decisions, it allows the process for selling assets to be conditional on economic outcomes in ways that are familiar to market participants, he said.
He reiterated his call for an explicit inflation target and said it is important for the Fed to clearly communicate its exit strategy.
Doing so will help ensure that inflation expectations remain well anchored, thereby reducing the risks of undesirable inflation outcomes as we choreograph a graceful exit,
(Reporting by Kristina Cooke and Edith Honan; Editing by Padraic Cassidy)