U.S. Fed official says time ripe for inflation target

By Alister Bull and Ros Krasny

SAN FRANCISCO (Reuters) - Setting an explicit inflation target would help the U.S. Federal Reserve keep deflation at bay now that interest rates have been cut to almost zero, a top central banker said on Saturday.

"Now would be a particularly good time to do that because you have this possibility of expectations drifting off to deflation or a lot of inflation," James Bullard, president of the St Louis Federal Reserve Bank, told a panel discussion during the annual meeting of the American Economics Association.

Deflation, a sustained period of widespread falling prices, is considered a threat to the economy because it can cause consumers to delay purchases on expectations that prices will fall further, causing the economy to contract.

Bullard said that the Fed is limited in its ability to flag policy preferences by the very low level of rates and needs to find another tool to communicate with markets.

"You can't count on your nominal interest movements to signal to the private sector about how you are reacting to events. So my main concern for the Fed in the medium term...is how to keep inflation expectations anchored. ... We can no longer send signals by moving interest rates," he said.

Fed Chairman Ben Bernanke is a long-standing advocate of adopting an explicit inflation target, but he put this goal on hold after failing to convince other policy-makers that it was worth the loss in flexibility.

Bullard said aggressive Fed policy action to restore growth means the U.S. central bank has a real opportunity to introduce the target at a time when communication is extremely tough.

The Fed last month cut its overnight funds rate target to a range between zero and 0.25 percent and said it would focus on unconventional tools to end the year-long U.S. recession.