HONOLULU, Hawaii Recent signs of improvement in the U.S. economy are encouraging but the rebound has been anemic and the Federal Reserve must "keep applying monetary policy stimulus vigorously," San Francisco Federal Reserve President John Williams said on Thursday.
"We are far short of maximum unemployment. And I expect inflation to fall this year below the 2 percent level that we view as consistent with our mandate," Williams said in a speech to a financial analysts' dinner in Honolulu.
Despite a recent drop in the unemployment rate to 8.3 percent, Williams said he expected it to remain above 8 percent into next year and to be "well over" 7 percent for several years to come.
Strained household finances, a weak housing market and tight credit conditions are likely to hold down spending growth for some time, he added.
"Let me emphasize, though, that overall things are turning for the better. You can sense greater optimism in the business community, although it is cautious optimism," said Williams, a voting member this year on the Fed's policy-setting panel.
Still, Williams said further stimulus may be needed if the economy stumbles again.
"We may need to do more if the recovery falters or if inflation stays well below 2 percent. If the economy needs more stimulus, restarting our program of purchasing mortgage-backed securities would probably be the best course of action."
The U.S. central bank has kept interest rates near zero for more than three years, and it has pushed down borrowing costs further by buying $2.3 trillion in long-term securities.
U.S. manufacturing cooled in February and consumer spending was flat for a third straight month in January, data showed on Thursday, suggesting the economy lost more steam early this year than expected. Yet other data was more upbeat, with new claims for jobless benefits hovering near four-year lows and retailers and automakers enjoying brisk sales.
Williams has supported recent moves by Fed to bolster what he has described as a "lackluster" recovery.
He joined the majority of his fellow policymakers in January's decision signaling interest rates will stay near zero through late 2014, a year and a half longer than the Fed had previously projected.
WHEN TO UNWIND?
Williams acknowledged on Thursday that there was a range of views among Fed policymakers as to when it should start to raise interest rates and a range of opinions on how quickly ultra-loose policy should be unwound.
"The time for exit is still well off into the future," he said in response to questions from audience members trying to pin down a more precise timeline for eventual policy tightening.
"My view is we'll not raise rates until early 2014 and not normalize the balance sheet until after that. It's always hard to normalize. I have confidence we know how to raise rates ... and hopefully do it in a way that will avoid another recession.
"Eventually, when we get to a normal economy typically people think that interest rates will be around 4.5 percent," he said, adding there would be no rapid moves to such a "long-run number".
He said policymakers would need to begin removing stimulus in advance of when the economy returns to maximum employment. That is believed to equate to a "natural" unemployment rate of around 5.2 to 6 percent.
"Of course, our statements are not an absolute commitment to keep rates near zero no matter what. It's simply our best judgment about the future course of policy. If the economic outlook changes, then the guidance should, too."
The San Francisco Fed chief is known as a monetary policy "dove" who is more concerned with the threat of high joblessness than high inflation.
"With the economy still underperforming and wage growth modest, inflation should remain relatively subdued," Williams said in the speech, adding he expected inflation to be about 1.75 percent this year and 1.5 percent next year, down from about 2.75 percent in 2011.
While the recent rise in oil prices was affecting consumer spending and confidence and curbing growth to some degree, other commodities have not seen a similar surge, he noted.
"The current level of oil prices isn't going to stall the recovery. It's built into the forecast" for modest growth, he said.
The economy should grow about 2.25 percent this year and 2.75 percent in 2013, he said, adding the main threat to his forecast was the debt crisis in Europe.
"That's not rip-roaring by any means. It's quite a modest recovery. But it's an improvement."
(Writing by Kim Coghill; Editing by Ramya Venugopal)