Economist: a nuanced Fed

Economist Steve Affinito said Plosser is attempting to "lay the groundwork for future, nuanced Fed actions."

"Plosser's comments underscore the quandary facing the Fed. The U.S. economy displays several signs of a pronounced economic slowing, but with inflation above the Fed's 'comfort zone' the response can't simply be rate cuts," Affinito told BloggingStocks Tuesday.

Affinito said he expects the Fed to continue to deploy the term auction facility and use other open market operations on money supply to "do what it can to encourage sound commercial activity, without really igniting inflation."

"Admittedly, it is a bit of trick for the Fed, because it will likely increase inflation some, minimally if we're lucky, but it's a risk the Fed has to take, given the contraction forces at work in the economy," Affinito said, adding that he's on-record with having favored larger rate cuts by the Fed starting in September 2007, despite the increased inflation risk.

"I would be considered a dove on inflation if I were on the Fed, and that usually draws criticism because of the inflation risk," Affinito said. "But there are times when you have to be dovish for the good of macroeconomic growth. This is one."

More rate cuts likely

Affinito said he expects and the Fed should cut its benchmark interest rates by at least 75 basis points, total, in its next two meetings, "to bring the Fed Funds rate down to 3.50% and the discount rate down to 4.00% or 3.75%."

The Fed has cut benchmark interest rates three times, starting in September 2007. The Fed Funds rate, the rate banks charge each other, now stands at 4.25%, and the discount rate, the rate Fed charges banks for short-term loans, is at 4.50%.

The Fed implemented the monetary policy easing to head-off a potential credit crunch stemming from subprime mortgage and related asset defaults. The Fed also initiated, in consultation with the ECB, the Bank of England, the Swiss National Bank, and the Bank of Canada, a term auction facility - - a mechanism to inject $40 billion via auctions, in two stages, into the financial system.

Later that fall, the Fed said it would keep its term auction facility open "as long as necessary" to enable banks to maintain sufficient, short-term liquidity and prevent the recurrence of credit crunch conditions that nearly paralyzed the bond market in August 2007.