Kohn says Fed can prevent inflation surge

By Ros Krasny

NASHVILLE, Tenn (Reuters) - The Federal Reserve will not allow its unorthodox policies to trigger a surge in inflation, but may still need to do more to ease credit if the economy remains weak, the Fed's No. 2 official said on Saturday.

Donald Kohn, vice chairman of the Federal Reserve, said that six quarters into the recession, the path of the U.S. economy was unclear and the Fed must be flexible.

"That flexibility could entail doing more to ease credit if the economy proves resistant to the monetary and fiscal stimulus now in train," he said.

However, the central bank's attempts to heal ailing credit markets and spur an economic recovery have been working, Kohn said, in ways that include lowering mortgage interest rates.

"The situation in financial markets and the economy would have been far worse if the Federal Reserve hadn't taken the actions we did," Kohn told a conference at Vanderbilt University in Nashville.

As the economy begins to recover, suitable policy responses by the Fed will prevent a rise in inflation, he said.

"The key to preventing inflation will be reversing the programs, reducing reserves, and raising interest rates in a timely fashion," Kohn said.

He emphasized the importance of inflation expectations in holding down future inflation.