Fed's Stern: U.S. recession could end at mid-year

MINNEAPOLIS (Reuters) - The U.S. recession could end around midyear, giving way to a subdued recovery before "healthy" growth kicks in starting in mid-2010, Minneapolis Federal Reserve Bank President Gary Stern said on Thursday.

Stern, in a speech to the Economic Club of Minnesota, said the threat of deflation resulting from the downturn in global economic activity should fade as the economy recovers.

"I am guardedly optimistic that many pieces are now in place to contribute to improvement in financial market conditions and in business activity," Stern said. "There is reason to think that improvement is not too far off."

Stern's confidence in an imminent U.S. recovery was more upbeat than those from several other Fed officials this week.

Adjustments typically seen in a contraction are under way, he said.

The Obama administration's large stimulus package should add to aggregate demand in a timely way, complementing aggressive, often unprecedented, action from the Fed and other policymakers, Stern said.

It is still too early to tally results from the Fed's wide-ranging steps to help out credit markets, Stern said. "It is also unclear if further steps will be required," he said.

Stern is currently the Fed's longest-serving regional president but is not a voting member of the policy-setting Federal Open Market Committee this year.

Credit market conditions have improved unevenly in the past few months, although credit strains could continue to dog the economy for some time, he said.

Stern said that worries about the potential for near-term deflation or longer-term high inflation could not be dismissed out of hand but had self-correction mechanisms.

"If economic growth resumes in the U.S. as I expect, the threat of deflation should diminish commensurately," he said.

Regarding concern about inflation stemming from the Fed's providing huge amounts of liquidity in response to the financial crisis, Stern said there was ample time to withdraw excess liquidity.

"The relation between growth in the money supply and the path of prices holds in the long run, over periods of at least five and, more likely, 10 years," he added.

TOO BIG TO FAIL

Stern said the problem of some institutions being deemed too big, or too systematically interconnected, to fail has worsened.

Still, size is not the only factor determining whether banks become too unwieldy, he said in response to a question from the audience.

"It's not just a matter of size," he said. "It might be a matter of talent. It might be a matter of complexity. It might be a matter of good fortune or bad."

Timely responses and flexibility are key in responding to crises because the costs to the real economy continue to rise as problems are left to fester, Stern said.

"You want to deal with these things as quickly, and as forcefully, as you can," he said.

(Editing by Jonathan Oatis)