By David Bailey
MINNEAPOLIS, Minn. Jan 10 (Reuters) - The Federal Reserve's policy of zero interest rates and asset purchases is appropriate, perhaps even insufficient, given forecasts for weak economic growth and low inflation for years to come, a top central bank official said on Thursday.
The U.S. economy will continue to expand too slowly over the next two years to bring down unemployment substantially, said Narayana Kocherlakota, president of the Minneapolis Fed.
"Inflation will run below the Fed's target of 2 percent over the next two years and the unemployment rate will remain elevated. This forecast suggests that, if anything, monetary policy is currently too tight, not too easy," he told a meeting sponsored by Minneapolis Fed.
Kocherlakota predicts U.S. gross domestic product will expand at an annual pace of 2.5 percent in 2013 and 3 percent next year, estimates that put him on the low end of Fed policymakers' forecasts.
"This growth will do little in terms of returning the economy to the historical trend," Kocherlakota said in prepared remarks to a Minneapolis Fed event. "Consistent with this slow output growth, I expect unemployment to continue to fall only slowly."
The unemployment rate, currently at 7.8 percent, should fall to around 7.5 percent towards the end of this year and 7 percent in 2014. This will prevent wages from rising very quickly and keep inflation at bay.
Kocherlakota sees the Fed's preferred inflation measure remaining below the central bank's official 2 percent target over the next two years.
In response to the financial crisis and deep recession of 2007-2009, the Fed bought over $2 trillion in mortgage-backed securities and Treasury bonds, in an effort to keep long-term rates down and spur investment.
Kocherlakota said the Fed's expanded balance sheet, now at $2.9 trillion and over three times its pre-crisis size, does not raise the threat of future inflation as some analysts even some Fed officials have maintained.
That's because the central bank, beginning in 2008, was given the power to pay interest on the reserves banks park at the Fed. In that manner, he said, the Fed can control the path of price growth in the economy.
"By doing that we now have the ability to control inflationary pressures even if we have a very large balance sheet," he said.