May 13 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke and fellow policy makers said today financial markets are still unsettled, while several officials said the central bank is challenged by unacceptably high inflation.

Bernanke and San Francisco Fed President Janet Yellen, in separate speeches, both used the phrase ``far from normal'' to describe the state of markets while also saying conditions have improved. Yellen, Cleveland Fed President Sandra Pianalto, Kansas City Fed President Thomas Hoenig and the Dallas Fed's Richard Fisher said they're concerned about rising prices.

Together, the remarks affirm the April 30 statement by policy makers indicating they may pause from the most aggressive interest-rate cuts in two decades after last month's quarter- point reduction to 2 percent. They didn't rule out further measures to expand liquidity, such as auctions of cash loans to banks, to aid financial institutions.

``Financial market conditions have improved,'' John Lonski, chief economist at Moody's Investors Service, said in an interview with Bloomberg Television. ``Nevertheless, these various measures of corporate credit risk, of system risk, remain well above average.''

``There's no question that price inflation is faster than what the Fed would like,'' Lonski said. He said the Fed may need to lower interest rates again to counter the housing recession.

Bernanke, speaking via satellite to a conference hosted by the Atlanta Fed in Sea Island, Georgia, singled out the Term Auction Facility, or auctions of cash to banks, as a program for possible expansion. The Fed announced May 2 that it would boost the TAF to $150 billion per month from $100 billion, the third increase since the program began in December.

`Stand Ready'

``We stand ready to increase the size of the auctions if further warranted by financial developments,'' Bernanke said. Bernanke said the Fed's efforts have yielded ``some improvement,'' while also noting that the steps raise questions of ``moral hazard,'' or imply federal support for investors who take on risk.

Bernanke, 54, didn't comment on the outlook for interest rates or the economy.

In Vancouver, Yellen said the central bank's interest-rate stance is ``appropriate'' to revive economic growth this year as the credit crunch ``gradually'' eases. Yellen, 61, who doesn't vote on interest rates this year, also said she anticipates inflation will slow as the labor market weakens and ``commodity prices level off.''

Highlight Risk

The Fed can't be ``complacent about inflation,'' she told the CFA Institute Annual Conference. Recent measures of price expectations ``highlight the risk that our attempts to deal with problems in the real economy could lead to higher inflation expectations and an erosion of our credibility,'' she said.

Fisher, speaking in Midland, Texas, said the U.S. may be in for a ``prolonged'' period of slow growth, which may end with higher-than-desirable inflation.

``How deep that slowdown will be is a question mark,'' said Fisher, who voted against the last three interest-rate cuts. ``I am not sure it will be very deep at all, but it may be prolonged, because we have to correct the excesses of this credit crisis.''

The U.S. economy expanded at a 0.6 percent annual pace in the first quarter, reflecting an increase in inventories as consumers retrenched and companies cut investment. The last time the economy grew more slowly was in the fourth quarter of 2002.

The Fed's preferred measure of inflation, which strips out food and fuel prices, increased 2.1 percent in March from 12 months earlier. Including food and energy, prices climbed 3.2 percent, the fifth straight month in excess of 3 percent. Fed officials seek long-term inflation of 1.5 percent to 2 percent.

`Difficult Position'

Fisher, 59, in his fourth year as Dallas Fed president, said the FOMC is in a ``very difficult position'' and the U.S. ``might come out of this period of a slowdown at much higher base rates of inflation than we would want.''

Pianalto, who has voted for each interest-rate cut this year, said that while the reductions since September are ``compatible with a low and stable inflation rate,'' prices are rising ``somewhat faster than I would prefer.''

``Inflation presents a key risk to my outlook,'' Pianalto, 53, the Cleveland Fed's chief since 2003, said in a speech in Paris today.

Regarding the financial-market turmoil and the economy Kansas City's Hoenig said that ``it is not firm, but it has settled down.''

`Big Challenge'

``A big challenge will be to make sure we bring inflation in check and do not repeat some of the experiences we had in the late 1970s and 1980s when inflation was too high for any of us,'' Hoenig, 61, the second longest-serving member of the FOMC, said in Oklahoma City.

Yellen, the San Francisco Fed president, also didn't spare the Fed from blame in her discussion of the subprime mortgage crisis, delivering one of the most critical assessments of the central bank's performance by a sitting official.

``Financial supervisors and regulators, including the Federal Reserve, were behind the curve,'' she said. ``We missed some of the risky developments that were unfolding. Our consumer regulations were unfortunately insufficient to protect households from some egregious and unfair lending practices. And we took too long to ramp up some supervisory policies in the face of mounting risks.''

Yellen served as a Fed governor in Washington from 1994 to 1997, under Chairman Alan Greenspan, and has been her bank's leader since 2004.

Fed Governor Kevin Warsh and Philadelphia Fed President Charles Plosser today also spoke at the Atlanta Fed conference without commenting on interest rates or the economy. Later today, Chicago Fed President Charles Evans gives a talk on the economy in his home city. He said yesterday the Fed's interest-rate stance is ``appropriate'' and balances out ``substantial'' risks to both growth and inflation.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net

Last Updated: May 13, 2008 17:09 EDT