With the U.S. economy in a "sweet spot," it's time for the Federal Reserve to begin normalizing interest rates in order to fend off latent inflationary risks, said Richard Fisher, former president of the Federal Reserve Bank of Dallas.
"Monetary policy acts with a lag. You don't just step on the brakes and stop. I think it's important we begin the process of normalization, fully aware of the fact that others [including the European Central Bank and Bank of Japan] may be diverging in another direction, " Fisher, regarded by many as policy hawk during his tenure, told CNBC on Tuesday.
Fisher, who stepped down as president of the Federal Reserve Bank of Dallas last week, was appointed to Pepsi's board of directors on Monday.
"Even if we were to raise rates, whenever it happens, by 25 basis points, we still have significant accommodation. We're [still] providing the fuel for the American recovery," he said.
The timing of a Fed rate hike this year remains a matter of intense speculation. Last week, Fed Chair Janet Yellen indicated that a rate rise could be closer with the removal of the word "patient" from the Fed's post-meeting statement.
On Monday, Fed Vice Chairman Stanley Fischer, a voting member on the Fed's policymaking committee, said the U.S. federal funds rate will likely increase before year-end. A hike will be appropriate when the Fed sees "further improvement in the labor market" and is "reasonably confident" that inflation is moving back to 2 percent, he said.
An eye on inflation
While there are no signs of inflationary pressures at present, it remains a tangible risk down the road, said Fisher.
"With all this liquidity in the system once it gets activated into real investment and the velocity of money picks up, then what might happen? The real challenge to my successors and the FOMC (Federal Open Market Committee) is to manage that carefully, and to make sure it doesn't become inflationary fuel. It has that potential," he said.
Rock-bottom interest rates also raise the specter of financial instability when the Fed begins normalizing monetary policy, said Fisher.
The Fed's limitations
Adding to the case for policy normalization, Fischer said after more than six years of near zero interest rates and three rounds of quantitative easing, "there's a limit to what any central bank can do on behalf of the rest of the world."
"I like to think of Janet Yellen as Atlas with the world on her shoulders, it's a great responsibility, but in the end we answer to our congressman, the Bank of Japan answers to their diet, the Reserve Bank of Australia to their parliament and ultimately that does operate as a constraint in terms of how we can do the world's work," he said.
"But I would say this: a strong United States economy is in the interest of the entire world and that's our main objective at least at the FOMC. The idea of when we tighten will be decided by the committee, no one wants to repeat the error of 1937 when the Fed tightened too soon and drove us back downhill."