Deflation key to more easing: Fed's Plosser

NEW YORK (Reuters) - The Federal Reserve should only embark upon further monetary easing if faced with a dangerous downward price spiral, otherwise it risks undermining its credibility, a top Fed official said on Wednesday.

Philadelphia Federal Reserve Bank President Charles Plosser, who said he does not see a deflation risk at this time, warned that more monetary stimulus would not be effective in tackling a "difficult and unpleasant" unemployment problem.

"Moving around the interest rate on long term bonds by 10 or 20 or 30 basis points is not going to solve the unemployment problems and it is dangerous to think that it will," Plosser told Reuters in an interview.

If the Fed were to send a signal that it is trying to control the unemployment rate and then fails to do so, it could hurt its ability to act to ensure price stability, he said.

"If we do need to act, if fears of deflation were to become real -- and I don't think that is the risk -- then we would need every ounce of credibility we can muster to convince markets we are not going to let deflation happen," Plosser said.

The U.S. central bank is charged by Congress to pursue both price stability and full employment.

Plosser, who rotates into a voting spot on the Fed's policy panel next year, said the economy has hit a soft patch but he still sees 2010 economic growth around 3 percent, with growth in 2011 between 3 percent and 3.5 percent.

"We're all disappointed that the economy is not doing as well as we'd like for it to do ... but the basis for a continued moderate recovery is more or less still in place," he said. "I don't really see a double-dip (recession) at this point."

A number of events over the past few months had sent some "confusing signals" about the economy, he said, making it difficult for policy-makers to read the underlying trends. These include financial market skittishness over the European debt crisis, the expiration of a housing tax credit and the impact of census-related hiring and firing, he said.

"The temptation for everybody is to want it to be over today, or next month, or next quarter but that's not something that's in fact feasible. We have to continue to acknowledge that this is going to be a slog," Plosser said.

"There is nothing the Fed can do in my book that could really change the path of the unemployment rate between now and the end of the year."

LATEST FED MOVE TO HAVE MINIMAL IMPACT

Plosser said the Fed's August 10 decision to buy Treasuries to stop its securities portfolio from shrinking and tightening monetary conditions as maturing mortgage-related debt rolls off is unlikely to have a "measurable impact" on the economy.

Plosser, who is considered one of the more hawkish Fed officials on inflation, said he would be open to further bond purchases if he saw deflation as a real risk.

"I would certainly entertain the solution if I feared deflation, which I don't, and I feared expectations were coming unglued in that direction, then we would have to take actions," he said.

But he warned that it was dangerous to view monetary policy as "a magic elixir" and said fiscal authorities are better placed to deal with long-term unemployment issues, such as skills mismatches.

The Fed has already gone to extraordinary lengths to support an economy reeling from the worst financial crisis since the Great Depression.

It cut benchmark interest rates to the bone and bought around $1.4 trillion of mortgage-related debt and $300 billion of longer-term Treasuries to further push down borrowing costs.

Plosser sees neither a near-term risk of inflation or deflation, though he worries about the impact of the Fed's accommodative monetary policy on inflation down the road.

"It's like a doctor administering medicine to a patient, if you don't get the disease right, you'll give them the wrong medicine and the wrong medicine can actually make them sicker," he said.