Plosser: Fed Must Soon Tighten Policy To Prevent Inflation

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A high-ranking official of the U.S. central bank suggested Tuesday that the substantial liquidity that has been pumped into the financial system will have to be removed soon so that inflation expectations do not become a problem.

Philadelphia Federal Reserve President Charles Plosser said that the Fed will have to begin tightening monetary policy in order to convince markets that it is serious about keeping inflation in check.

Speaking at the 31st Annual Economic Outlook Seminar in Rochester, New York, Plosser said the Fed needs to act "to ensure that the public does not lose confidence in its commitment to keep inflation low and stable."

The Fed must "act in a manner that keeps expectations well-anchored near the Feds inflation objective," he added, noting that "if expectations do become unanchored, then the Fed will have lost its credibility and either inflation or deflation could arise."

For the economy, Plosser, who will be a voting member of the Fed's rate-setting committee in 2011, predicted growth in 2010 and 2011 of about 3 percent.

The Philly Fed president argued that as economic growth sets in, the federal funds rate, the central bank's benchmark interest rate, should be allowed to rise as well, so that inflation can be snuffed out before it takes root.

The Fed has put in place a series of stimulative programs meant to pump liquidity into the markets in the wake of last year's financial crisis. this included cutting the federal funds rate to near zero - a condition many economists worry will spark a spike in inflation.

However, with the economic recovery still fragile and unemployment still rising, the Fed has decided to keep rates low for the foreseeable future, betting that the risk of sliding back into recession is dangerous than that of stimulating inflation.

The central bank will get another key piece of data this Friday, when the government releases its monthly employment report. Signs that the labor market is stabilizing could give the Fed the go ahead to begin plotting an exit from its ultra-accommodative stance.

(Market News Provided by RTTNews)