The Federal Reserve is very involved in financial stability, according to Federal Reserve Bank of Kansas City president Thomas Hoenig.

The Obama administration’s reform plan puts a “sharper point” on the Federal Reserve’s responsibility, making the Fed more responsible for keeping institutions’ instability from threatening the banking system, he said in an interview televised on CNBC.

But, he said the administration’s plans to create a new consumer protection agency in the financial sector could be “tricky” and create conflict because the Fed plays a role in consumer protection.

“There’s no really separating consumer protection from the quality of the loan,” he said.

“Institutions should not be too big to fail,” Hoenig said. “Such an attitude is harmful to the system both short-term and long-term. No legislation is needed to solve the 'too big to fail’ dilemma.”

As for slashing the Fed’s balance sheet to prevent inflation, Hoenig said: “As soon as you introduce methods to deal with the crisis, as we did, that are out of the norm, you should very quickly begin to think about what your exit strategy is, and that is the process we are in right now and we’re thinking it through.

“We’re very seriously thinking about it and I’m on the record as saying it’s really important,” he added.

He warned that reducing the liquidity can’t be done too quickly.

While inflation isn’t imminent, from liquidity issues, Hoenig said he believes inflation is an issue longer term and “the role of the central bank is to think longer term.”

If liquidity were not drained from the system, he added, “we do risk an inflation outbreak, not next year but in three to four years.”

Hoenig expressed confidence the economy will turn around. “The turning point? I don’t know at all. But I do know that with this amount of stimulus, both monetary and fiscal policy, it will turn around,” he said.

Having a 12-bank Fed system is “absolutely essential,” Hoenig said, so that regional differences are reflected when the Federal Open Market Committee meets.

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