NEW YORK – Economic conditions, not the calendar, should drive monetary policy and the Fed needs to watch out for “inflation and further distortions” created by the accommodative policy that’s been in force for more than three years, Federal Reserve Bank of Philadelphia President and Chief Executive Officer Charles I. Plosser said Tuesday.

“While I believe monetary accommodation is still called for, in the absence of some shock that derails the recovery, we may well need to begin to gradually scale back the level of accommodation well before the end of 2014,” Plosser told the CFA Society of San Diego, according to prepared text of his remarks, released by the Fed.

But, Plosser warned, “…with the very accommodative stance of monetary policy that has now been in place for more than three years, we must guard against the medium- and longer-term risks of inflation and further distortions such accommodation can create.”

The economy “has been healing,” Plosser said and the financial crisis “substantially abated.”

The economy should “grow at a moderate pace,” near 3% this year and next, he said, noting that generally economists are a little more pessimistic. With 11 straight quarters of expansion since mid-2009, the economy has improved, albeit at a slower pace than officials would like. “To many, it occasionally feels like we take two steps forward only to take one step back,” Plosser said.

While he expects housing to stabilize or improve slightly this year, Plosser warned, “we must realize that even as the economy rebalances, housing and related sectors are not likely to return to those heady pre-recession highs, nor should we expect them to do so. Those highs were unsustainable, and the housing crash that ensued destroyed a great deal of wealth for consumers and the economy as a whole. The losses are real and the consequences severe for many individuals and many businesses. Moreover, monetary policy does not create real wealth so it cannot eliminate or offset these losses, nor should it try to do so.”

Labor markets also have “modestly” bettered. “So, we continue to make slow, steady progress, as evidenced by an unemployment rate that fell to 8.2% in March, down almost a full percentage point from the 9.1% in August,” Plosser said. “I expect further gradual declines in the unemployment rate, with the rate falling to about 7.8% by the end of this year.”

As for risks, Plosser believes “the continuing sovereign debt crisis in Europe” and rising energy prices are the largest threats to recovery.

Besides the European nations, a number of which “are unquestionably on fiscal paths that are unsustainable and that must be addressed,” Plosser said, “I might add that the U.S. is also on an unsustainable fiscal path that must be addressed. Let me stress that these are fiscal issues, not monetary issues. Thus, we should look to the fiscal authorities for solutions, not our central banks. I have come to believe that the European governments and their economies will muddle through this near-term crisis but at significant cost to the taxpayers all across the euro zone. Nevertheless, the turmoil has resulted in an economic slowdown in the euro zone that will likely cause a small drag on U.S. exports.”

As for energy costs, Plosser said unless oil prices continue to rise, it “is not likely to derail our recovery.”

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