NEW YORK – The Federal Open Market Committee may need to raise rates before 2014, since unemployment levels dropped and inflation rose, leaving the economy needing less monetary accommodation than it has had, Federal Reserve Bank of Philadelphia President and Chief Executive Officer Charles I. Plosser said Thursday.

Reiterating his dissent from FOMC decisions in August and September, Plosser told the Rotary Club of Wilmington, Del., “it was not clear to me that further monetary policy accommodation was appropriate then,” according to prepared text of his remarks, released by the Fed.

Inflation, at that point, was higher than a year earlier, and the jobless rate was lower, he said. “Monetary policy should be responsive to economic conditions, and since that time, unemployment has decreased, and inflation is above target,” Plosser noted. “I believe monetary accommodation is still called for, but I do not believe it should be as accommodative or aggressive as it was at the height of the crisis, when unemployment was over 10 percent and inflation was just 1 percent. Now that unemployment is at 8.3 percent and falling and inflation is over 2 percent and drifting up, we should not anticipate additional accommodation. Indeed, in the absence of some shock that derails the recovery, we may well need to raise rates before the end of 2014.”

As he has stated previously, monetary policy should respond to economic conditions. “In my view, current conditions do not warrant further accommodation. Yet, should economic conditions significantly deteriorate or the upside risks to inflation I have stressed fall and significant risk of deflation emerge, we should rethink our policy stance,” he said. “But neither of these events seems likely to me at this juncture.”

Additional accommodation now “could lead us down a very treacherous path – one that would be ever more difficult for us to navigate and one that would increase the already substantial risk of higher inflation,” Plosser said. “Yet, the problem is not just inflation risk down the road.  Prolonged efforts to hold interest rates near zero can lead to financial market distortions and the misallocation of resources that could lead to more, not less, economic instability.”

He added, “We should resist any notion that we can solve all of our economic challenges simply by an ever more accommodative monetary policy.”

Turning to the economy, Plosser said it should grow 3% this year and next, which he termed as “moderate,” although “slightly more optimistic” than others. Business and consumer spending is rising and housing should stabilize, maybe even improve slightly this year. “We entered the Great Recession over-invested in residential real estate, and we are not likely to see a strong housing recovery until the surplus inventory of foreclosed and distressed properties declines,” he explained.

Even when housing recovers, Plosser warned, it will likely not hit pre-recession highs, which he called “unsustainable.” The crash led to losses for individuals and businesses, although they are progressively improving their balance sheets by paying down debt. “Moreover, monetary policy cannot paper over these losses, nor should it try to do so,” he said.

While the job market is improving, and recent data have been encouraging, “everyone would agree that there are still too many people unemployed.” Plosser foresees the jobless rate declining to less than 8% by yearend.

But, he warned, “there will undoubtedly be some bumps and setbacks along the way [to recovery], but I am generally optimistic.” The European debt crisis remains the “most significant and identifiable risk on the horizon,” but he said he expects European governments to work through the challenges, with limited drag on U.S. exports.

“We must continue to monitor events to ensure that these troubles do not spill over to U.S. financial institutions,” Plosser warned. “Of course, regardless of how the European situation plays out, it has already imposed considerable uncertainty on growth prospects for the global economy. Hopefully, some of that uncertainty is beginning to wane. Moreover, our own nation’s fiscal challenges contribute additional uncertainty to the economic landscape.”

Uncertainty will restrain spending and hiring, “thus limiting the pace of recovery, even while economic fundamentals in the U.S. continue to improve.”

Also, inflation must be monitored, as the core rate has been “drifting upward” and is “about 2% or a little higher today, depending on the particular index. Thus, we must monitor these inflation trends with some care and be prepared to take appropriate actions as necessary.”

Plosser added, “Inflation often develops gradually, and if monetary policy waits too long to respond, it can be very costly to correct. Measures of slack such as the unemployment rate are often thought to prevent inflation from rising. But, the lessons of the 1970s show that is not the case. As you may recall, we ended up with both high unemployment and high inflation, which became known as the misery index. That is not a place we want to find ourselves again.”

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