SAN FRANCISCO (Reuters) - John Williams, head of the San Francisco Federal Reserve Bank, on Wednesday became the third top Fed policymaker to join the push to provide clear economic guideposts for when the U.S. central bank should consider raising interest rates.
The Fed should consider keeping interest rates low until unemployment falls "somewhat below" 7 percent, Williams told Reuters in an interview, adding that he would tolerate a rise in inflation to 2.5 percent before he would see a need to reconsider the Fed's current zero-interest-rate policy.
"It's very desirable to try to explain our policy in terms of thresholds," Williams said in his office overlooking San Francisco Bay.
Williams has long been a proponent of more clarity on Fed policy decisions but this was the first time he offered his own view of the proper markers for monetary policy change.
The Fed last month unleashed a new round of monetary stimulus that kicks off with the purchase of $40 billion in new mortgage debt each month. It has promised to continue to make purchases and do even more if the outlook for the labor market does not improve substantially.
As the Fed goes deeper into uncharted territory with this latest round of quantitative easing, five years since the financial crisis began, questions about how and when it will extricate itself have become more pressing.
By designating milestones for a rethink of easy money policy, Williams and other Fed officials are seeking to provide a clearer policy roadmap.
The Fed did not define what it meant by substantial improvement in the labor market but minutes of its latest meeting released last week showed clear support for tying policy to specific economic conditions.
That would be a change from its current approach of picking a future date until which time it expects to keep rates low. The Fed currently says it expects to maintain ultra-low rates until at least mid-2015.
The president of the Chicago Federal Reserve Bank, Charles Evans, has been the Fed's most vocal champion of using specific economic markers for policy change. For the past year, Evans has called for the Fed to vow low rates until unemployment falls below 7 percent or inflation threatens to breach 3 percent.
Last month Minneapolis Fed President Narayana Kocherlakota came up with different guideposts, preferring to pledge low rates until unemployment reaches 5.5 percent as long as inflation does not look to top 2.25 percent.
Williams' own set of metrics for the Fed's low--rate policy lies squarely between the Evans and Kocherlakota plans.
To Williams, a centrist, keeping rates low until the jobless rate falls to 5.5 percent would risk over-heating the economy.
"It seems reasonable that you would start raising rates well before unemployment reached 5.5 percent, assuming inflation was around 2 percent" - the Fed's inflation target, Williams said.
But allowing inflation to run as high as 3 percent, he said, may be going too far.
"As long as inflation stays within half a percentage point of a 2 percent objective, I think you could argue for a lower unemployment rate" than the 7 percent threshold that Evans has proposed, Williams said.
Inflation is currently slightly below the Fed's 2 percent target. Unemployment fell to 7.8 percent last month, after being stuck above 8 percent for more than four years.
Arriving at numerical thresholds to guide Fed policy is "hard to do," he said, noting disagreement among policymakers about exact levels for them and the difficulty of ensuring the public sees such markers as guideposts and not as hard-and-fast triggers for policy change.
Policymakers have been talking about such a plan since last year, he said, and the process is still ongoing. "I don't think this is an issue that requires action immediately," he said.
Williams took over the top job at the Fed's westernmost regional bank in March 2011 after his predecessor, Janet Yellen, moved to Washington to become vice chair of the Fed Board.
Formerly the regional Fed bank's research director, he has spent much of his career exploring ways central banks can ease policy even when interest rates are near zero, and has argued that increasing central bank transparency is a key tool.
Williams also lent his support to developing a collective central bank view on the economy, a project on which the Fed has been hard at work.
The U.S. central bank currently publishes individual economic forecasts from all 19 policymakers, giving investors an idea of the disparity of views but no sense of how they inform policy.
By contrast, a consensus forecast from the 12 current voters on the Fed's policy-setting panel would help the Fed communicate "an internally coherent view of economic conditions that links up to the policy," he said.
Generating such a forecast, with a "confidence band" around it, would make it easier for the Fed to give investors a better idea of how far above or below 2 percent inflation would be tolerable, he said.
While for the last decade Williams has stated his preference for adopting a single-point inflation target rather than a range, he now believes there are benefits to saying the Fed would tolerate fluctuations in the rate from about 1.5 to 2.5 percent.
That's because it is impossible to hit a target exactly perfectly, he said.
Williams said he was sticking to his forecast that unemployment will likely improve little this year and will have fallen to about 7.25 percent by the end of 2014. Despite the improvement in the jobless rate last month, he said, the basic picture of slow economic growth has not changed.
He also repeated his view that the Fed will likely need to stop buying assets to push interest rates down "well before" the end of 2014 but would be keeping rates low until at least mid-2015.
(Editing by Leslie Adler and James Dalgleish)