By Ann Saphir and Balazs Koranyi
MINNEAPOLIS/OSLO (Reuters) - The Federal Reserve must be patient in deciding when to scale back bond purchases, two of its most dovish officials said on Friday, and one suggested that the central bank tolerate inflation as high as 3 percent to drive down unemployment.
The remarks by Chicago Fed President Charles Evans and Minneapolis Fed chief Narayana Kocherlakota came as investors review their expectations on whether the Fed will begin to taper bond buying this year or next, after the U.S. central bank unexpectedly decided to stand pat last week.
Evans, speaking in Oslo, said the economic outlook suggested that a reduction in the level of bond purchases was in order, but that when to begin that process is not yet certain.
"But whether or not we'll have enough confidence at the October meeting or the December meeting, I just can't say that with a lot of certainty," he told reporters. "I think there's a decent chance of that. But it could go a little bit longer," he said.
Financial markets were stunned when the Fed's policy-setting committee announced at the end of its meeting last week that it would keep buying bonds at an $85 billion monthly pace.
Kocherlakota, in an interview with Reuters, said the volatility in financial markets following the policy decision, which sparked complaints the central bank had failed to communicate properly, exposed the need for the Fed to re-think how it guides expectations.
"What went wrong is the fact that we don't have a comprehensive strategy in place that is credible. ... We do not have a comprehensive form of forward guidance."
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Video interview with Kocherlakota: http://reut.rs/1b9hHSy
WHATEVER IT TAKES
Kocherlakota said the Fed should do "whatever it takes" to achieve its goal of maximum sustainable employment.
"If that announcement is credible, (it) has enormous power in and of itself," said Kocherlakota, who does not vote on Fed policy in 2013.
Both Evans and Kocherlakota have been strong advocates of doing more to bring down the rate of unemployment, which fell to 7.3 percent in August. The jobless rate, however, remains historically high and even the decline in August to a 4-1/2-year low was attributed to the number of discouraged job-seekers who simply have given up looking for work.
Kocherlakota said scaling back the purchase program last week would have sent the wrong message to markets - that the Fed was satisfied with weak growth and slack employment.
"That doesn't make sense. That is not doing whatever it takes to bring employment up...to maximum as fast as possible," he said.
The Fed cut interest rates to almost zero in late 2008 and has more than tripled the size of its balance sheet to around $3.6 trillion, through three massive campaigns of bond buying, in a bid to spur growth and hiring by holding down borrowing costs.
However, long-term rates rose sharply after the Fed began talking about scaling back bond buying in May, and after Fed Chairman Ben Bernanke said in June that officials expected to begin tapering later this year, and end the program by mid-2014.
To hold down borrowing costs, the Fed also says it will keep its overnight funds rate near zero until unemployment hits 6.5 percent, provided that the outlook for inflation remains under 2.5 percent.
The Fed's stated goal for inflation, measured by the personal consumption expenditures index, or PCE, is 2 percent. The PCE ticked down to 1.2 percent in August, though it was still up from 0.9 percent in April.
Evans said that flexibility on inflation could well be necessary, and may require even greater forbearance from the central bank, as policy-makers pursue their other objective, of achieving maximum sustainable employment.
"That's not a goal but it could be a feature, in order to have accommodating conditions that support maximum employment, so that's really very helpful," Evans said. "We could even do this as long as inflation was below 3 percent, because I think symmetry around the inflation target is incredibly important."
(Additional reporting by Jonathan Spicer in New York; writing by Alister Bull; Editing by Leslie Adler)
