The Federal Reserve is probably not yet finished raising interest rates and must fight any temptation to adopt policies that would stoke inflation, top central bank officials said Friday.
They stressed the importance of containing the federal budget deficit while at the same time maintaining their pledge to curb inflation.
Janet Yellen, president of the San Francisco Federal Reserve Bank, said a change in the Fed's post-meeting statement will eventually be required to reflect recent changes in monetary policy.
In particular, she said, the phrases "remove accommodation" and "measured pace" must be reconsidered as policy becomes less stimulative to economic growth.
"While it seems unlikely that the end of the current tightening phase is yet at hand, there obviously will come a time when these two phrases are no longer appropriate," Yellen said in remarks to the California Chamber of Commerce in San Francisco.
The federal funds rate is still at the bottom of what could be considered a neutral range, or a rate that neither stokes growth nor chokes it, Yellen said in response to reporters' questions. Such a range is between 3.5 percent to 5.5 percent, she noted.
The Fed has boosted rates 12 consecutive times since beginning the current tightening cycle in June 2004, to 4.0 percent.
The futures market has fully priced in an additional half percentage point more of tightening by February 2006.
Yellen also sounded optimistic about the nation's economic prospects, saying consumer spending and industrial activity had remained resilient to shocks from higher energy costs and the Gulf Coast hurricanes.
Speaking in London, Fed Chairman Alan Greenspan addressed longer-term issues, warning that a "pernicious drift" toward unstable budgets and trade protectionism risks a painful unwinding of world financial imbalances and must be checked.
Hammering home a message on budget deficits, Dallas Fed President Richard Fisher said the central bank must not compromise its pledge to fight inflation by accommodating federal budget shortfalls.
"It is the duty of the Fed to refrain from the slightest temptation to monetize deficits or embrace any other inflationary policy," Fisher told a conference in Philadelphia.
Monetizing deficits means to print money to reduce them, which normally leads to inflation.
Fiscal policy gets "out of whack" when monetary authorities are pressured to keep interest rates from rising and to print money to monetize debt, he added. Doing so would ruin the dollar's value and undermine the economy's potential to expand, he said.
The U.S. government ran a budget deficit of $318.47 billion for the fiscal year 2005, the third-largest on record. The White House expects the current fiscal budget gap to expand to $341 billion.
In her speech, Yellen also said reconstruction in the hurricane-affected areas could extend a recent growth spurt in the U.S. economy into the first half of 2006.
Regarding inflation, she said current readings excluding food and energy were still consistent with the Fed's goal of maintaining price stability.
But she added that any pass-through effects from higher energy costs into the broader economy, while still scant, must be monitored closely.
Boston Fed President Cathy Minehan also delivered remarks on Wednesday, noting the initial spike in energy prices after Hurricane Katrina had affected New England much in the same manner as the rest of the country.