"Market participants should expect and actually experience accountability for their decisions through natural market processes. It is not the role of monetary authorities to change the risk-reward tradeoff of investment instruments and markets," said Lockhart.
Concern that problems in the U.S. subprime market have impacted the wider availability of credit has roiled financial markets around the world since they surfaced last month.
Worry that credit markets might seize up forced the Fed to lower its discount rate by a half percentage point on Aug. 17 and acknowledge the turmoil might restrain growth, a shift in its judgment on the economy's prospects that Lockhart echoed.
"The balance of risk to the economy seems to have shifted. We're facing greater uncertainty in the economic outlook," he said. Before the mid-August financial tumult growth had looked to be on a solid path, he added.
He assured the audience that the Fed would not allow the U.S. economy to slip into a recession, and made plain that he believed strong world growth and the country's economic resilience would prevent that from happening.
"There is more of the adjustment process that needs to unfold. And as regards to a recession, I am not going to predict, but will tell you that our objective at the Federal Reserve is to do everything possible to avoid that," he told the audience in response to a post-speech question.
Markets believe that the shift in tone from the U.S. central bank paves the way for a cut in its key overnight funds rate by a quarter point to 5.0 percent at its next scheduled policy meeting, on Sept. 18. Lockhart said any decision must be carefully balanced with the Fed's duty to contain inflation.
"Fed intervention is appropriate if markets are clearly not working properly, I am aware of the potential pitfalls of such interventions ... I believe the Fed's longer-term objectives are well served by a deliberate and measured response to financial market turbulence," he said.
A speech by Fed Chairman Ben Bernanke at an annual central bankers' symposium last week in Jackson Hole, Wyo., pointedly separated the Fed's response to liquidity issues in financial markets and a wider macro-economic response if growth slows.
Lockhart made a similar distinction, which economists have interpreted as the hope it can deal with market problems through the discount window and other liquidity steps, rather than an interest rate cut it fears could lift inflation.
"Such a response should distinguish, as much as possible, between liquidity actions aimed at keeping markets orderly and monetary actions aimed at cushioning the economy from the impact of financial market instability," he said.
Lockhart said that growth had also been on a solid path before the subprime problems escalated, while he remained edgy about inflation.
"In my view, current readings of inflation represent progress, but not victory. I would like to see inflation sustained at a somewhat lower rate-with emphasis on 'sustained,' he said.
Some economists believe that market turmoil will dampen inflationary pressures and allow the Fed to ease monetary policy decisively if it wants. Lockhart did not agree there was an automatic link between markets and price pressure.
"My thought process would be that inflation is a phenomenon in the general economy; that one cannot necessarily link financial market turbulence to a prediction of the direction of inflation," he told reporters after the speech.