Bernanke sees tighter policies as economy heals

WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke said on Thursday that while the U.S. central bank's vast support for the economy will likely be needed for a while, the Fed will have to remove those measures as the economy heals to ward off inflation.

The Fed has cut interest rates to near zero percent and pumped hundreds of billions into the financial system to counter the worst financial crisis since the Great Depression.

"Accommodative policies will likely be warranted for an extended period," he said in remarks prepared for delivery at a monetary policy conference at the Fed.

"At some point, however, as economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem down the road."

Bernanke, in a detailed description of the bank's balance sheet -- which has ballooned from around $900 billion to near $2.1 trillion -- said the Fed has the tools and the ability to pull back its flood of cash and loans to the economy and to raise interest rates when the time is right

"When the economic outlook has improved sufficiently, we will be prepared to tighten the stance of monetary policy and eventually return our balance sheet to a more normal configuration," Bernanke said.

As the economy appears to be pulling out of a painful and lengthy recession, observers are watching closely for signs of when and how quickly the Fed intends to pull back its help.

Bernanke said the Fed could remove its easy money policies even while its balance sheet remains bloated.

To do so, it would raise interest rates on reserve balances that banks keep at the Fed and by other actions -- specifically reverse repurchase agreements, term deposits to banks, and sales of holdings of longer-term assets. Those steps would drain cash from the system and help raise short-term interest rates, he said.

(Reporting by Mark Felsenthal; Editing by Leslie Adler)