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The Federal Reserve will have to raise interest rates as aggressively as it cut them when it becomes clear the economic recovery has taken hold, to avoid flaring up inflation, Charles Plosser, president of the Philadelphia Fed, told CNBC in an interview.
Analysts have been worried that the various stimulus programs and money-printing around the world will cause devaluation and price rises, and some European officials have suggested that all stimulus measures be pulled out at once to prevent that.
The Fed has an exit strategy, which it will apply when needed, Plosser said.
"Our exit strategy is really quite simple: we have to begin to pull back from our extraordinary programs, we have to begin to shrink our balance sheet, otherwise we will feel inflation in the months and years ahead," he said.
For the next few quarters inflation is not a problem but it may become so later unless the Fed orchestrates its exit carefully, according to Plosser.
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"We have the tools to do that, the question is will we be able to discern the appropriate time and the timing of that to do it in a way that will head off any future inflation," he said. "And that may mean raising interest rates very rapidly, at least as aggressively as we cut interest rates, if the time is right."
Asked whether rate rises are likely in 2009, Plosser said "probably not." About the possibility of hikes next year, he said "we'll have to wait and see how the recovery evolves."
The US economy is in transition from a period of very sharp contraction to an expansion and it will be helped by improved growth overseas, which will boost exports, as well as by renewal of depleted inventories, which will boost factories' output, Plosser predicted.
"Gradually over the course of the next few months I expect the good news to become more dominant and I'm looking for some growth in the second part of this year," he added.
The commercial real estate sector, where lowering valuations can end up affecting the banks, and unemployment, which is a lagging indicator, are the biggest clouds overshadowing the recovery, according to Plosser.
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