Oct. 21 (Bloomberg) -- Federal Reserve Bank of Philadelphia President Charles Plosser said the central bank should limit the securities on its balance sheet to Treasuries and create a policy for serving as lender of last resort.

The Fed’s emergency-credit programs and inconsistency in bailout decisions created confusion and showed the central bank “lacked a well-communicated, systematic approach,” Plosser said yesterday in a panel discussion at Palo Alto, California. Policy rules “would yield better economic outcomes for both monetary policy and financial stability policy,” he said.

Plosser’s comments rank him among the strong internal critics of the Fed’s efforts to stem the worst financial crisis in seven decades. The Fed “strayed into credit allocation” that should be the purview of fiscal authorities, not the central bank, he said at Stanford University.

“Developing such a systematic approach is not easy,” Plosser said at a forum hosted by the Stanford Institute for Economic Policy Research.

“Making a credible commitment to stick to such a lending policy in good times and bad is even more difficult,” he said. “Nevertheless, that is what we must tackle if we are going to achieve better results the next time a crisis arises.”

Last year, the Fed, backed by the Treasury Department, rescued Bear Stearns Cos. and American International Group Inc. while declining to bail out Lehman Brothers Holdings Inc.

Seek Agreement

Referring to those decisions, Plosser said that the “lack of a clearly understood approach to the government’s and the Fed’s decisions about when assistance efforts would be provided created confusion and uncertainty.”

Plosser proposed in February that the Fed seek an agreement with the Treasury Department to swap non-Treasury assets and non-discount-window loans for Treasuries, transferring credit risk out of the central bank. He built on that plan yesterday by saying the Fed should hold only Treasuries among the securities on its balance sheet.

Plosser didn’t elaborate on how the Fed would dispose of the $1.25 trillion of mortgage-backed securities it plans to purchase through March. The Fed is also buying up to $200 billion of housing-finance debt as part of efforts to lower interest rates and revive home-buying.

This month the Fed is completing $300 billion in purchases of long-term Treasuries, begun in March and aimed at lowering private borrowing costs.

Critique Policy

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. Plosser didn’t comment yesterday on the outlook for the economy or interest rates in his prepared speech.

Chairman Ben S. Bernanke said Oct. 8 that the Fed will be prepared to tighten monetary policy when the outlook for the economy “has improved sufficiently.” The median forecast of economists surveyed by Bloomberg News is for the central bank to start raising its benchmark interest rate in August 2010.

William Poole, president of the St. Louis Fed bank from 1998 to 2008, also spoke on the panel and said Plosser’s remarks were “very important.” Thomas R. Keene, a Bloomberg News editor-at-large who also hosts programs on Bloomberg Radio, served as moderator.

Plosser, responding to a question from Keene after his speech, said tightening credit will be tougher than it was after past recessions. “It’s more difficult this time because of the composition of our balance sheet,” and there will be “hue and cry” from homebuilders and lawmakers if the Fed sells the mortgage-backed securities it’s purchased, he said.

‘Successful Point’

Poole said that “my fear is that we are going to do things during the transition that never allow us to get out to a successful point at the end of the day.”

Speaking with reporters later, Plosser reiterated his support for the Fed to adopt a formal inflation target, saying he prefers a figure of about 1.5 percent to 2 percent. “Publicly announcing a commitment that this is what you want, is what’s really valuable,” he said.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net; Ryan Flinn in Stanford, California, at rflinn@bloomberg.net.

Last Updated: October 21, 2009 00:13 EDT