The U.S. Federal Reserve should begin raising rates soon or risk stoking future inflation and further distorting financial markets where too many investors are already taking excessive risks, a top Fed official said on Tuesday.
But it should also do so gradually so as not to roil markets or hurt the economy, Kansas City Federal Reserve President Esther George said.
"My objective is not to raise rates quickly - I do not want to derail this recovery," George said at a dinner. "I think it is critical that we begin now to normalize those interest rates, to begin to allow the economy and the markets to allocate credit, to price risks the way they are intended to do."
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George, who does not have a vote on the Fed's policy-setting committee this year, has consistently called for tighter monetary policy even as the Fed expanded its stimulus over the last few years.
The Fed has kept short-term interest-rates near zero since 2008, and has quadrupled its balance sheet to $4.5 trillion with purchases of bonds aimed at pushing down borrowing costs further.
George said the U.S. economy is headed for about 3 percent growth, buoyed by consumer spending and, increasingly, a pickup in business investment. With the unemployment rate, now at 6.1 percent, just half a percentage point above what she sees as "full employment for the U.S. economy, the time is now to begin lifting rates.
"I am most anxious, as we go through this process, to begin the normalization process," George said.
Leaving rates low for too long leaves the Fed few options for dealing with any new economic shocks, and fosters risk-taking that is distorting financial markets, she said.
Last week, the Fed published a set of "normalization" principles laying out the steps it will take to raise rates and trim its bloated balance sheet.
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But the strategy it outlined will take years to carry out, and rates will likely stay near zero for a "considerable time" after the Fed completely winds down its current bond-buying program next month, the Fed said.
George called that guidance "vague," adding that "you will have to wait and see when that liftoff occurs." Once it does, she said, "the public should expect that this could be a volatile time" as markets adjust to the first Fed tightening cycle in a decade.