By Kayla Gahagan
RAPID CITY, South Dakota (Reuters) - A rise in U.S. inflation over the past year suggests the Federal Reserve has little firepower left to boost employment, a top Fed official said on Wednesday.
The U.S. unemployment rate, at 8.1 percent, is still high by historical standards, and many economists say employment is still well below the maximum level the economy can handle before inflationary pressures are likely to build.
But the fact that inflation is running above the Fed's 2-percent target means "our country's current labor market performance is much closer to 'maximum employment,' given the tools available to the (Fed), than the post-World War Two U.S. data alone would suggest," Minneapolis Fed President Narayana Kocherlakota told the Black Hills Knowledge Network here.
The comments were very similar to those Kocherlakota made two weeks ago in Minneapolis, where he said the Fed should probably begin to exit from its super-easy monetary policy in the next six to nine months.
The Fed has kept short-term interest rates near zero since December 2008 and last month reiterated its commitment to keep them there for the next two and half years.
Kocherlakota on Wednesday emphasized that while the Fed may be running out of steps to help employment, other policymakers still have tools at their disposal.
"Suppose that Congress and the president choose to reduce the payroll tax paid by employers," Kocherlakota said. "Such a move would provide an additional incentive to employers to hire more workers (albeit at the cost of increasing the deficit), and increase employment and reduce unemployment."
Kocherlakota said it's at least possible that the erosion in the labor market may be "highly persistent" even with extremely easy monetary policy.
And "distinctly higher" inflation in 2011 versus 2010, he suggested, may force the Fed's hand sooner than it now expects, he suggested, unless Congress takes steps like providing hiring subsidies that could boost jobs while reducing inflationary pressures.
"Such subsidies will increase the federal deficit, but they do have the power to increase 'maximum employment' for the (Fed)," Kocherlakota said.
If unemployment rises or inflation falls, there would be an argument to ease Fed policy even further, Kocherlakota said in answer to an audience question.
Those are possible outcomes if U.S. lawmakers allow a raft of tax breaks to expire on schedule at the end of the year, pushing the nation over a "fiscal cliff" in 2013, he said.
But, he added, "I don't see that that is a policy choice that the Congress and President wind up making," he said.
Kocherlakota also expressed confidence that lawmakers will fix the nation's long-term fiscal deficits and pointed to the current high prices of U.S. Treasuries as evidence that investors are betting lawmakers will.
(Reporting by Kayla Gahagan, writing by Ann Saphir; Editing by Diane Craft and Padraic Cassidy)