Oct. 22 (Bloomberg) -- Federal Reserve Bank of Philadelphia President Charles Plosser said he will be more aggressive in pressing for higher interest rates than other central bank policy makers.

“It’s always been a challenge for the Fed to know when to raise rates,” Plosser said in an interview today on Bloomberg Radio. “My instinct is the time for raising rates will be before many of my colleagues” think it is.

At their most recent meeting, on Sept. 23, members of the Fed’s policy making Open Market Committee agreed to keep the benchmark rate in a range of zero to 0.25 percent, where it’s been since December 2008. In a statement following the gathering they said economic conditions will warrant keeping the rate low “for an extended period.”

The low rates will risk creating future inflation, Plosser said, particularly given the more than $1 trillion the Fed has pumped into the economy by expanding its balance sheet.

“It’s a whole notion that ultimately monetary policy does work with a lag,” he said. “If you wait until inflation’s here, it’s too late, so you have to be forward looking.”

The Fed will have to bring its balance sheet down soon, Plosser said. “It cannot stay at that magnitude indefinitely. The question is not can we do it, the question is when, and will we decide before it’s too late?”

Plosser, 61, a former professor and business-school dean at the University of Rochester in New York, joined the Philadelphia Fed as its chief in 2006. Before that, he was a member of the Shadow Open Market Committee, a group of economists that critique Fed policy.

Lagging Indicator

The “health of the economy broadly” will be key to the timing of any rate increase, he said. Financial markets must be “stable” and housing markets recovering. One thing on which he will not focus is the unemployment rate, Plosser said.

“Unemployment rates we all know are a lagging indicator, they will come down later and slower than other indicators,” he said. “We have to prepare ourselves for the eventuality that we will have to be raising rates before the unemployment rate gets down to where we want it to be.”

Going forward, Plosser reiterated his call for the central bank to set an inflation target. “That’s making clear what our objective is,” he said. “And then we need to articulate a better path of policy that will get us there.”

‘Huge Problem’

The Fed and other regulators must also do something to dispel the idea that any financial institution is too big to fail, he said. “It’s a huge problem,” he said. “It’s going to be a difficult one to fix. Unless we deal with moral hazard, we could be very easily sowing the seeds of the next crisis.”

Politics becomes a problem in dealing with that issue, and with the additional powers the central bank has assumed during the crisis, he said.

“When Congress and the public believe the central bank is a source of funds to be used for purposes other than monetary policy, it’s not a good place to be in,” Plosser said. “And we have pushed on that envelope and we have to do something about it.”

Plosser rejected the idea that central banks should try to identify and head off developing asset bubbles. “I think that’s very hard to do,” he said. “That’s a very slippery slope to go down. Every time there’s a bubble in an asset class someone’s going to be asking the Fed to change interest rates. That’s a very blunt instrument.”

Plosser, who grew up in New York, said he would be caught in the middle should the New York Yankees join the Philadelphia Phillies in the World Series.

“Certainly growing up my baseball hero was Mickey Mantle,” Plosser said. “But I’ve learned Philly’s a great sports town. They are exciting teams, although frustrating at times.”

To contact the reporters on this story: Michael McKee in New York at mmckee@bloomberg.net; Thomas R. Keene in New York tkeene@bloomberg.net.

Last Updated: October 22, 2009 16:58 EDT