By Kristina Cooke and Jonathan Spicer
NEW YORK (Reuters) - More action by the Federal Reserve to boost growth will likely be needed if the economic outlook doesn't improve, a top Federal Reserve official said on Friday.
William Dudley, president of the Federal Reserve Bank of New York, said current conditions of high unemployment and low inflation are "unacceptable".
"Further action is likely to be warranted unless the economic outlook evolves in such a way that makes me more confident that we will see better outcomes for both employment and inflation before too long," Dudley told a conference of business journalists in New York.
Dudley, seen as one of the more dovish Fed presidents, said the costs of the tools the Fed has available to ease policy further "do not appear prohibitive".
The U.S. central bank said at its most recent policy-setting meeting that it stands ready to help the recovery if necessary. It has already cut interest rates to near zero and pumped $1.7 trillion into the financial system through purchases of longer-term Treasury securities and mortgage-related debt.
Many analysts expect the Fed to start a new round of bond purchases, or quantitative easing, as soon as its next meeting in early November.
Dudley said $500 billion of purchases would likely have about the same impact as a 0.5 or 0.75 percentage point decline in the Fed's benchmark federal funds rate.
He described as too dark the view that lowering borrowing costs further would be ineffective, or akin to "pushing on a string".
"Although the responsiveness of demand to reductions in interest rates is probably lower in a world in which balance sheet constraints are important, the responsiveness is not zero," he said. "I believe that it remains significant."
Dudley said the Fed could also clarify its commitment to stimulating the economy by clarifying its statement language.
"By clarifying our intentions, we can reduce the risk of further disinflation," he said. Disinflation is a problem, he said, as it can cause inflation expectations to fall, increasing the real cost of credit.
He said the Fed could be more explicit as to what constitutes overly low inflation by stating an explicit inflation objective. He did caution, however, that if the Fed were to do this it would not be a sign that inflation was more important to the Fed than employment. The Fed has a dual mandate of full employment and price stability.
"If we judged it desirable, we could go still further and provide more guidance on how monetary policy would react to deviations from any stated inflation objective," he said.
Dudley addressed some of the costs of providing more stimulus to the economy. He said a risk is that a bigger balance sheet could cause inflation expectations to become unanchored. He said the Fed would have to be clear it has a credible exit strategy in place.
The talk of more quantitative easing has undermined the dollar in recent weeks and added to the cash flooding into emerging markets as investors search for yield.
He said he was "very mindful" of concerns that more Fed purchases could be seen as a policy of monetizing the debt, but said this view is "fundamentally mistaken".
The longer the U.S. economy is "stuck with the current level of slack and disinflationary pressure, Dudley said, the greater the likelihood that a further shock could push us still further from our dual mandate objectives and closer to outright deflation."
"We have tools that can provide additional stimulus at costs that do not appear prohibitive."
The president of the New York Fed has a permanent voting seat on the Fed's policy-setting committee.
(Reporting by Kristina Cooke, Editing by Chizu Nomiyama)
