Fed's Plosser says recovery broad, forward guidance 'too passive'

WASHINGTON - The U.S. economy is approaching the Fed's economic targets faster than expected and might push the central bank to accelerate plans to increase interest rates, Philadelphia Federal Reserve Bank President Charles Plosser said on Tuesday.

Plosser said he had increasing confidence in economic growth, and added that inflation was trending higher and unemployment likely to fall faster than many of his central bank colleagues project.

"The current data suggest economic strength is fairly broad-based," Plosser, who is a voting member of the Fed's policy-setting committee this year, said in morning remarks at the Economic Club of New York.

"It is a steady, steady improvement, but not exuberant if you will, so to speak. Manufacturing is doing well, service sector has picked up," Plosser later told reporters

While he supported the Fed's most recent policy statement, which seems to place an initial interest rate increase sometime next year, Plosser said he had "growing concerns that we may have to adjust our communications in the not-too-distant future. Specifically, I believe the forward guidance in the statement may be too passive."

Using different variations of what is known as the Taylor Rule, for example, Plosser said the current economic projections of Fed officials would produce a target interest rate of anywhere from 1.5 percent to as much as 4 percent by the end of next year - higher than that currently expected by most policymakers. Depending on economic conditions, the appropriate rate could even be as much as 4.7 percent.

Plosser's comments reflect a widening spread of views among Fed officials about when and how fast interest rates should increase from the near zero level where they have been since the start of the financial crisis.

At the Fed's most recent policy meeting, the median interest rate projection among Fed officials moved somewhat higher, although there were also more members clustered around a slower pace for rate rises. That division could set the stage for a pivotal debate over how long to wait before increasing interest rates in the hope that employment and wages recover some of the ground lost in the recent downturn.

As the economy strengthens, the need for the Fed to explain its strategy on rates will be even more crucial in order to keep expectations about inflation under control, Plosser said.

He urged the Fed to move towards a more rule-based system to reduce confusion among investors and the public over the direction of policy. He noted that several commonly used monetary policy rules indicate rates should rise soon and his Fed colleagues should have to explain more clearly why they plan to keep the loose policy in place so much longer.

"Policymakers should describe the reaction function that determines how the current and future policy rate should be set," Plosser said.

If officials deviate from that because of a crisis, they "will be expected to explain the departures from the rule in these unusual circumstances. With a rule as a baseline, departures can be quantified and inform us how excessively tight or easy policy might be relative to normal."

(Additional reporting by Daniel Bases)