WILMINGTON, Del. - Philadelphia Federal Reserve Bank President Charles Plosser said Thursday he could foresee a situation where the Fed could start to unwind its exceptionally accommodative monetary stance by the end of 2012.

"I think there's a scenario where you could raise rates by the end of this year," Plosser told reporters after a speech to business leaders. "If growth continues to improve and unemployment continues to fall there will be increasing pressure on us to begin easing off our policy stance."

Plosser has repeatedly warned of the dangers of rising inflation as the U.S. economy recovers, and has dissented from the Fed's statements that it will keep rates exceptionally low until the end of 2014.

If the Fed raised rates by 75 basis points, for example, its policy stance would still be "very accommodative," Plosser said.

He cited rising oil prices as having a higher inflationary risk if monetary policy is too loose because lower interest rates will allow the oil prices to affect the rest of the economy.

"It's not that oil prices cause inflation," he said. "Inflation is a monetary phenomenon. It was accommodative monetary policy in response to the oil-price rise that allowed inflation to rise in the 1970s.

"I'm more concerned with the stance of very accommodative policy. It allows those price increases to get translated into other goods and services," Plosser said.

Even without rising energy prices, there has been an increase in core inflation lately, he said, unlike conditions in 2008 when the oil price spiked but other prices were not affected.

"We've also seen a more steady rise in core inflation. What that suggests is that there's some pass-through here that's different than it was in 2008," Plosser said.

Offsetting the rise in oil prices has been the fall in natural gas prices which has helped the recovery, he added. "The decline in natural gas prices has been a benefit to the economy, and probably made the economy less sensitive to oil price spikes than it otherwise used to be.

Plosser, who expects U.S. unemployment to fall to 7.8% by the end of 2012, said he has been encouraged by broad-based improvements in the labor market, and by growth in the manufacturing sector.

"When you look at the employment numbers, what's been encouraging to me is that the growth in employment is becoming more broad-based," suggesting more strongly that the labor-market recovery is sustainable, he said, adding that he also is encouraged by manufacturing growth.

Asked whether the U.S. still faces a threat from banks that are "too big to fail", Plosser said that policymakers have failed to fix the problem since the 2008 financial meltdown, and that banks should be allowed to fail in an orderly fashion using the bankruptcy courts.

"I'm concerned that we haven't solved that problem," he said. "In some sense we have made it worse because we have bigger banks. I really think we need banks to fail in an orderly way and that the bankruptcy process resolves who gets what, not a bunch of regulators or politicians.

"I would prefer not to have institutions to lobby regulators or politicians. I want those decisions to be made according to law and what a bankruptcy judge says," he said.

Market News International is a real-time global news service for fixed-income and foreign exchange market professionals. See www.marketnews.com.

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