NEW YORK (Reuters) - It would be wise to reduce the Federal Reserve's level of asset purchases before year end if the economy continues to improve, a top U.S. central bank policymaker said on Friday.
Cleveland Fed President Sandra Pianalto said she does in fact expect the world's biggest economy to improve in 2013, with economic growth of better than 2.5 percent and a drop in the unemployment rate to 7.5 percent.
In a speech to a business audience, she outlined a number of risks posed by the Fed's program of buying $85 billion in assets per month, including credit and interest-rate risks, as well as inflation and possible harm to the functioning of markets.
"To minimize some of these risks, we could aim for a smaller-sized balance sheet than would otherwise occur if we were to maintain the current pace of asset purchases through the end of this year, as some financial market participants are expecting," Pianalto told a business audience at Florida Gulf Coast University, reviewed by Reuters via audio feed.
"This course of action would be all the more attractive if the economic outlook continues to improve, as I expect it will."
While Pianalto did not specify when she would like to see a reduction in the Fed's third round of quantitative easing (QE3), nor by how much, her comments could give credence to those expecting the unprecedented monetary policy accommodation to taper or stop this year.
While the Fed is hesitant to remove its support for the economy, given the stop-and-start recovery from the 2007-2009 recession, worries are growing that the ultra-easy policies are setting the stage for a run-up in inflation, a painful contraction in bonds, or balance-sheet losses down the road.
At their December meeting, Fed officials were sharply split on whether the bond-buying should slow or stop well before the end of 2013, or carry on through year-end, according to the minutes.
WEIGHING COSTS, BENEFITS
Besides QE3, the central bank has promised to keep interest rates near zero until the unemployment rate falls to 6.5 percent, from 7.9 percent last month, as long as inflation remains contained.
Pianalto does not have a vote on Fed policy this year, but she is usually aligned with Fed Chairman Ben Bernanke's more dovish core on decisions.
"While our policies have been effective, our experience with our asset purchase programs is limited, and, as a result, we must analyze their benefits and costs carefully," Pianalto said in her first public comments on policy since September.
"Over time, the benefits of our asset purchases may be diminishing."
Turning to the economy, Pianalto predicted U.S. gross domestic product growth of about 3 percent in 2014, up from a little more than 2.5 percent this year.
That's not enough to heal the labor market, she said, predicting the unemployment rate to drop to 7 percent at the end of 2014, from 7.5 percent at the end of this year.
The U.S. economy likely expanded only slightly in the fourth quarter. Based on the latest estimates, overall GDP growth was just 2.2 percent in 2012, below the 3-percent pace to which the United States is accustomed.