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Fed officials offer dueling views on policy

By Ann Saphir

CHICAGO (Reuters) - Two top Federal Reserve officials offered differing views on monetary policy on Tuesday, with one warning the Fed's ultra-easy stance may soon backfire, and the other saying he is comfortable with it.

Both officials -- Philadelphia Federal Reserve Bank President Charles Plosser, who warned the Fed's aggressive bond-buying plan could stoke inflation, and Minneapolis Fed Bank President Narayana Kocherlakota, who said there's little evidence it is doing so -- have a vote this year on the Fed's policy-setting panel.

Their dueling perspectives suggest the kind of debate taking shape before Fed Chairman Ben Bernanke convenes the panel's first meeting this year on January 25-26.

The U.S. central bank has kept short-term interest rates at near zero for more than two years to combat the worst recession in decades, and used the purchase of $1.7 trillion in Treasuries and mortgage-backed securities to push borrowing costs still lower.

Faced with still-high unemployment, too-low inflation and a stumbling recovery, the Fed began a new round of so-called quantitative easing on November 3, saying it will purchase $600 billion of Treasuries through June.

Plosser, known for his hawkish stance on inflation, said the latest bond-buying would need to be reconsidered if the U.S. economy's current "moderate recovery" picks up steam.

"If the economy begins to grow more quickly and the sustainability of this recovery continues to gain traction, then the purchase program will need to be reconsidered along with other aspects of our very accommodative policy stance," Plosser said in a speech in Philadelphia.

"The aggressiveness of our accommodative policy may soon backfire on us if we don't begin to gradually reverse course," he said.

Kocherlakota by contrast said he was "comfortable" with the Fed's current monetary policy stance.

So far there is little evidence that lowering interest rates has fed inflation, he said, noting that core inflation is running at about 1 percent, down from 2.5 percent before the recession. Meanwhile, unemployment is at 9.4 percent.

"The situation I described, with ongoing disinflation and the high rate of unemployment, is such that this is not the time to start (tightening)," he said at an event in Madison, Wisconsin.

Kocherlakota said he expects unemployment to remain above 9 percent this year and above 8 percent next year.

There was some common ground between the two Fed officials, with Kocherlakota suggesting the Fed may need to grapple with the question of when to start removing stimulus as soon as this year.

"(T)hat's the question we have to confront in 2011 and thereafter," he said. "If we haven't started in 2011, we will have to confront it afterwards."

Kocherlakota said the Fed's eventual exit would follow a blueprint settled on last year, by draining reserves, then raising the interest it pays on excess reserves and then selling assets.

Both Plosser and Kocherlakota said they expect inflation to accelerate toward 1.5 to 2.0 percent -- a level the Fed sees as consistent with price stability -- and both noted the economic recovery is picking up a bit of steam.

Their views square with recent reports on U.S. consumer spending, manufacturing, and trade, which have in recent months suggested the world's biggest economy is healing.

While some have credited the Fed's latest bond-buying effort, dubbed QE2, for having already played a role in the rebound, Plosser said that argument likely "stretches things."

The regional Fed president said he was watching inflation expectations and any "downward trajectory" in the unemployment rate for a clear signal to reverse Fed policy.

Critics of the bond-buying, including many economists and Republican members of Congress who want it curbed, say it lays the groundwork for inflation and troublesome asset bubbles.

Kocherlakota disagreed, arguing that there is little evidence of a connection between U.S. monetary policy and bubble formation.

Plosser and Dallas Fed President Richard Fisher, also a voting member this year, are seen as most likely to vote against the majority -- though Fisher said in an interview on Monday that QE2 would likely run its course.

In an interview with the Wall Street Journal also published Monday, Kocherlakota said he has set a high bar for curtailing the Fed's latest bond-buying program. He also said he thought structural changes in the economy could mean unemployment may not easily dip much below 8 percent.

(With reporting by Jonathan Spicer in Philadelphia and Jeff Mayers in Madison; Editing by Andrew Hay)

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