Fed's Plosser Calls for a Reversal in Monetary Policy

Inflation in the U.S. is "too high" and inconsistent with the goals of the Federal Reserve, whose accommodative policy must be reversed, said Charles Plosser, President of the Philadelphia Fed, on Tuesday.

Plosser, a well-known inflation hawk, said monetary policy is too loose and the Fed will likely have to hike rates before an economic turnaround has taken place.

"Keeping policy too accommodative for too long worsens our inflation problem. Inflation is already too high and inconsistent with our goal of - and responsibility to ensure - price stability. We will need to reverse course - the exact timing depends on how the economy evolves, but I anticipate the reversal will need to be started sooner rather than later. And I believe it will likely need to begin before either the labour market or the financial markets have completely turned around," he said in Pennsylvania.

Plosser expects to see "sluggish" growth in the second half of 2008, but he said his growth forecast for the year, at 1.7%, is a better picture than a few months earlier. However, he said there is uncertainty with all forecasts, as the crisis with Freddie Mac and Fannie Mae demonstrates. "(T)he road to recovery is likely to be a bumpy one," he added.

Plosser was "generally more optimistic" about 2009 as the completion of the housing market correction and a restoration of public confidence should allow growth to return to its long-term trend of 2.75%.

He said Fed officials must "back up their words with action," otherwise price expectations will become unanchored and people will lose confidence in the Fed, as they did in the 1970s.

"I want to make clear that the rise in inflation expectations in the 1970s was not caused by a wage-price spiral. That story has things backwards. The wage-price spiral was a consequence of the inflation and the unanchoring of expectations of inflation, not the other way around," he said.

Plosser also called for more emphasis on total inflation. He said the argument for looking at "core" inflation is "less compelling" now as other price components are more volatile than energy and food, and a focus on core inflation will not boost public confidence either.

"I don't believe we can be sanguine that the behavior of core inflation will keep the public's inflation expectations well anchored in the face of persistently high headline inflation," he added.

By Patrick McGee and edited by Nancy Girgis