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Fed must keep acting "vigorously", says Williams

By Ann Saphir

SAN DIEGO (Reuters) - Despite signs the economic recovery is picking up steam, the Federal Reserve should keep its unprecedented easy-money policy in place to boost a jobs market that is still far below its potential, a top Fed official said on Tuesday.

"The Fed has acted vigorously to boost the economy," San Francisco Fed President John Williams said at the University of San Diego School of Business Administration. "It's critical that we keep doing so in order to achieve our statutory mandate."

The Fed, which is charged with both fighting inflation and fostering maximum employment, has kept short-term interest rates near zero since December 2008 to pull the economy from its worst downturn since the Great Depression.

The central bank has also bought $2.3 trillion in long-term securities and signaled it expects to keep rates low through late 2014 to bolster the recovery further.

Recent improvement in economic news, including a sharp drop in the unemployment rate to 8.3 percent in February from around 9 percent last summer, has prompted speculation among some analysts and traders that the Fed may need to raise rates sooner than that.

But Williams, a voting member of the Fed's policy-setting panel this year, sought to tamp down any such expectations.

"Eventually, as recovery picks up, we will trim our securities holdings and raise our interest rate target," he said. "We are not going to raise interest rates, based on what we know now, until at least 2014."

If economic conditions change, the Fed could move that date up, he added.

Williams' remarks came just after the Fed released minutes from its March policy-setting meeting, which signaled policymakers are less inclined to launch a fresh round of monetary stimulus as the U.S. economy gradually improves.

Williams said he sees U.S. economic growth picking up speed, to a 2.5 percent pace this year and 2.75 percent next year.

But that's not fast enough to keep cutting the jobless rate by much, he said, adding that he sees it dropping to about 8 percent at the end of the year, and still above 7 percent at the end of 2014.

"We haven't had such a long period of high unemployment since the Great Depression," he said.

Minneapolis Fed President Narayana Kocherlakota, a monetary policy hawk, has argued that mismatches between workers' skills and the needs of employers have boosted the "natural" rate of unemployment to close to its current level, suggesting that inflationary pressures are likely to start to build if the jobless rate falls any more.

But Williams, whose policy views are closer to those of Fed Chairman Ben Bernanke and the more dovish core of the U.S. central bank, said he does not believe the Fed will need to raise borrowing costs until the jobless rate falls to 7 percent, a level still well above the 5.5 percent that he estimates is the "natural" unemployment rate.

Meanwhile inflation, lifted by oil prices to 2.5 percent last year, will settle near the Fed's 2 percent target this year, and will likely drop to 1.5 percent next year, he predicted.

The housing crash behind the downturn has had far-reaching effects on economic growth, he said, holding back consumer spending. Tight credit, uncertainty about the future of the economy in the U.S. and Europe, and cuts in government spending have also kept back growth.

"Under these circumstances, it's essential that we keep strong monetary stimulus in place," he said.

(Reporting by Ann Saphir; Editing by Chizu Nomiyama and Andrew Hay)

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