The government must impose regulatory reform of some type when the markets return to normal, Federal Reserve Bank of Philadelphia president Charles I. Plosser said yesterday. He added that while he doesn’t believe deflation is a serious threat to the U.S. economy, having the Fed announce an inflation target would be helpful.

Plosser said the Fed will need to withdraw the vast amounts of liquidity it has injected into the economy once markets stabilize if it’s to avoid an inflation flare-up.

“Because of the financial crisis and the response by the Treasury and the Fed, the financial services industry is restructuring,” Plosser told a University of Rochester seminar, according to a prepared text of the speech released by the Fed. “When some normality returns to the markets — which eventually it surely will — some type of regulatory reform will be needed.”

However, even if the Fed’s regulatory and supervisory authority expands, it would not prevent the types of financial crises we have been experiencing this year, according to Plosser. The public must recognize the limits of what a central bank can and should do, he said.

“A modern financial system will never be immune to all financial stress,” Plosser said. Creating expectations that the Fed can’t live up to undermines its ability to achieve its primary objectives regarding monetary policy and financial stability, he added.

“The exact outcome of this regulatory reform is unknown at this point,” Plosser said. “However, as we work on this reform, I believe we must strive to develop sound policies that obey the four principles I have discussed today — clear and feasible objectives; a commitment to systematic policies; transparency; and a healthy respect for the independence of the central bank.”

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