Aug. 26 (Bloomberg) -- The U.S. economy needs the stimulus from low interest rates for some time as it begins a “fragile” recovery from the worst recession since the 1930s, said Dennis Lockhart, president of the Federal Reserve Bank of Atlanta.

“Overall, the U.S. economy is improving but still fragile,” Lockhart said today in remarks prepared for a speech in Chattanooga, Tennessee. “The FOMC has stated its intention to keep the policy interest rate low for an extended period. I agree that this approach is needed.”

Fed Chairman Ben S. Bernanke said last week that the U.S. economy “appears to be leveling out” and may resume growth “in the near term.” A government report today showed purchases of new homes rose 9.6 percent in July, the most since February 2005, adding to evidence the housing slump that triggered the recession is hitting bottom.

“My forecast envisions a return to positive but subdued gross domestic product growth over the medium term weighed down by significant adjustments to our economy,” said Lockhart, a voting member on monetary policy this year. “Among these are the rewiring of the financial sector and the need for households to save more to repair their balance sheets. My forecast for a slow recovery implies a protracted period of high unemployment.”

Bernanke, nominated to a second four-year term yesterday, has expanded the central bank’s balance sheet by $1 trillion, providing emergency funding for banks and credit markets, and lowered the Fed’s target rate almost to zero.

Extending Plan

The Fed will probably consider extending its plan to buy mortgage-backed securities beyond the current expiration date of Dec. 31, Lockhart said. The central bank is pursuing a program to buy $1.25 trillion in agency MBS.

“This is going to be considered further in coming meetings,” Lockhart said. “At this time, I am biased toward more of a stay-the-course approach” of not increasing the amount of purchases, he said.

While credit is “loosening,” efforts by small businesses to obtain loans will remain “a challenge,” Lockhart said in response to an audience question.

The ability of the central bank to set interest rates free from political pressure is “very, very important,” Lockhart said, adding that audits of monetary policy wouldn’t be a “good idea.”

Economic Growth

Economic growth will average 2.1 percent in the July-to- December period, according to a Bloomberg News survey of economists this month.

“No policy is without risks,” Lockhart said at the annual meeting of the Chattanooga Area Chamber of Commerce.

“The challenge my colleagues and I face is navigating between the risk that early removal of monetary stimulus snuffs out the recovery and the risk that protracted monetary accommodation stokes inflation expectations that could ultimately fuel unwelcome inflationary pressures,” he said.

Among the obstacles to recovery are falling commercial real estate values, which pose a risk to the banking system, Lockhart said.

Inflation is less of a worry, he said.

“Firms have very little pricing power,” Lockhart said. “Looking ahead, I expect inflation will remain contained.”

Fed policy makers said they expect inflation to be “remain subdued for some time” because of slack in the U.S. and global economies, according to their statement in August.

The consumer price index fell 2.1 percent in the year ended in July, the biggest 12-month decrease since 1950.

To contact the reporters on this story: Steve Matthews in Atlanta at smatthews@bloomberg.net;

Last Updated: August 26, 2009 13:48 EDT