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Fed's Williams: Low neutral interest rates a "warning sign"

San Francisco Federal Reserve President John Williams said on Friday that low neutral interest rates are a warning sign of possible changes in the U.S. economy that the central bank does not fully understand.

"I see this as more of a warning, a red flag that there's something going on here that isn't in the models, that we maybe don't understand as well as we think, and we should dig down deep deeper and try to figure this out better," he said during a panel discussion at the Brookings Institute in Washington.

Williams, who is a voting member of the Fed's policy-setting panel through the end of the year, has said the central bank should begin to raise interest rates soon but thereafter go at a gradual pace.

He added that the low neutral interest rate had "pretty significant" implications for monetary policy, and put more focus on fiscaly policy as a response.

"If we could come up with better fiscal policy, find a way to have the economy grow faster or have a stronger natural rate of interest, then that takes the pressure off of us to try to come up with other ways to do it, like through a large balance sheet or having a higher inflation target," Williams said. "It also means we don't have to turn to quantitive easing and other policies as much."

On Wednesday, the Fed held interest rates near zero but signaled that a December rate rise remains firmly in play.

Also on Friday, Williams cautioned that the Fed has yet to decide when to raise interest rates even though it issued a statement this week that said a rate hike was possible in December.

He said he wants to study more economic data in coming weeks before deciding whether the economy is strong enough for the Fed to raise its key short-term rate from a record low, where it's been for seven years.

Williams said in an interview with The Associated Press that the Fed chose to mention in its policy statement this week that it could decide on a rate hike at its next meeting to avoid surprising investors in case it did raise rates then.

— The AP contributed to this report.