Based on his predictions of core personal-consumption expenditure inflation rising slowly this year, and remaining under 2%, a rate hike by the end of the year “would be desirable,” Federal Reserve Bank of Minneapolis president Narayana Kocherlakota said Thursday.

Should PCE core inflation rise to 1.5%, a hike of “around 50 basis points” would be called for, Kocherlakota told a Santa Barbara County Economic Summit, according to prepared text released by the Fed.

“Of course, a core inflation rate of 1.5% is still markedly below the Fed’s price stability objective of 2%,” he said. “Accordingly, an increase of 50 basis points in the fed funds rate would still leave the Fed in a highly accommodative stance. First, the fed funds rate would be extremely low — between 50 and 75 basis points. As well, the Fed’s holdings of long-term assets would continue to provide significant accommodation.”

“Thus, under my baseline forecast, it would be desirable for the FOMC to raise the fed funds target interest rate by a modest amount toward the end of 2011,” Kocherlakota said.

He noted that the Federal Open Market Committee could choose instead to shrink the Fed’s balance sheet by no longer reinvesting principal payments from its securities holdings into long-term Treasuries, or by selling some long-term assets.

Kocherlakota said he prefers using the federal funds target interest rate to adjust policy. “I have more confidence in that instrument of policy, based on our many years of experience with it,” he said. “I suspect that this confidence is shared by the public at large.”

He said shrinking the balance sheet is “a longer-term mission that can take place over the next five or six years or so.”

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