Sept. 29 (Bloomberg) -- Federal Reserve Bank of Philadelphia President Charles Plosser said the central bank should tighten credit “promptly” when necessary to avert a recurrence of the high U.S. inflation during the 1970s.

“Our credibility depends on it,” Plosser said today in a speech at Lafayette College in Easton, Pennsylvania. “We recognize the costs that significantly higher inflation and the ensuing loss of credibility will impose on the economy if we fail to act promptly, and perhaps aggressively, when the time comes to do so.”

Determining how quickly to move is “high on my list of priorities,” Plosser said. Policy makers unanimously decided on Sept. 23 to keep the benchmark interest rate near zero and repeated that rates will stay low for an “extended period.” The Fed also committed to complete its $1.25 trillion in purchases of mortgage securities and extended the end-date of the program to March from December.

The Fed must “take the necessary steps to prevent a second Great Inflation” and may need to act “well before unemployment rates and other measures of resource utilization have returned to acceptable levels,” Plosser said at an economic forum hosted by Lafayette. He doesn’t vote on Federal Open Market Committee decisions this year.

‘Eerily Similar’

The attributes of the economy “pose an eerily similar set of conditions to those in the mid-1970s,” said Plosser, who’s known for one of the toughest stances against inflation at the central bank. In his first major speech as a policy maker in 2006, he said interest rates at the time may need to be increased in the “best interests” of the U.S. economy over the long run. The Fed has since lowered its main rate almost to zero from 5.25 percent.

Answering reporters’ questions after the speech, Plosser said officials “need to be prepared” for the possibility they will have to raise interest rates in steps of 0.50 or 0.75 percentage point, as policy makers did when they cut rates. “That’s going to depend on the circumstances,” he said.

Paul Volcker became Fed chairman in 1979 and pushed the federal funds rate to as high as 20 percent to throttle inflation in 1980. The inflation rate, as measured by the consumer price index, rose to 14.8 percent in 1980 from 4.9 percent in 1976.

The central bank paid a “steep” price in the form of the 1981-82 recession to defeat inflation and regain credibility, Plosser said.

Raising Rates

Plosser joins other Fed officials who are arguing for raising interest rates potentially as fast as the Fed lowered them in 2007 and 2008.

Dallas Fed President Richard Fisher said today in a speech that “when it comes time to tighten monetary policy, my colleagues and I will move with an alacrity that, if needed, will be equal in speed and intensity to that with which we pursued monetary accommodation.”

Fed Governor Kevin Warsh said last week the central bank may need to raise interest rates with “greater force” than it has in the past to keep inflation in check.

Responding to audience questions after the speech, Plosser said the U.S. dollar is currently “weak,” while “not as weak as it’s sometimes portrayed.” The dollar is unlikely to lose its status soon as the world’s main reserve currency, he said.

Plosser, 61, a former professor and business-school dean at the University of Rochester in New York, voiced support for the Fed’s 12-district-bank structure and for keeping its policy decisions isolated from politics.

Right Number

Some lawmakers have discussed the idea of subjecting the appointment of district-bank presidents such as Plosser to Senate confirmation. The Senate passed a resolution in April calling for a review of the “appropriate number” of Fed banks.

“Research and history have shown that central banks that do not have independence from short-term political influences in the conduct of monetary policy tend to produce higher inflation rates and lower economic performance,” Plosser said.

Plosser said there are signs the U.S. economy “is turning a corner and prospects for a return to growth are increasing,” echoing assessments by other Fed officials that the worst contraction since the Great Depression ended in recent months.

Chairman Ben S. Bernanke said earlier this month that “even though from a technical perspective the recession is very likely over at this point, it’s still going to feel like a very weak economy for some time.”

‘Settle Down’

Plosser said his forecast for second-half economic growth is “similar” to the 2.3 percent from the Philadelphia Fed’s Survey of Professional Forecasters. He predicted growth will increase to about 3 percent in 2010 and “settle down to a long- term trend rate of about 2.7 percent in 2011.”

Fed officials in June predicted that gross domestic product will expand 2.1 percent to 3.3 percent next year after shrinking 1.5 percent to 1 percent this year, according to the central tendency of their forecasts.

The U.S. jobless rate will “continue to creep up for a little while longer” from its August level of 9.7 percent, and will fall “only well after the economy begins to recover” because it’s a lagging indicator, Plosser said.

Plosser said the inflation outlook “remains subdued” and that he sees “little risk of inflation in the near term.” At the same time, he foresees “greater risk of higher inflation in the intermediate to long term” because of the Fed’s “extremely accommodative,” or economy-stimulating, monetary policy.

May Pick Up

Inflation may pick up in the second half of 2010, Plosser told reporters. “That’s when I’ll be watching,” he said. “It’s not the near term I’m really worried about.”

Also, Plosser said he puts less stock than “many other economists do” in the notion that economic slack can reliably predict inflation. That compares with the Fed’s statement last week, which said the weakness in the economy is “likely to continue to dampen cost pressures” and keep inflation “subdued for some time.” Public expectations for price trends are “stable,” the FOMC said.

One “key element of the improving outlook” is the housing market, with sales and construction starts increasing over the past six months, Plosser said.

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

Last Updated: September 29, 2009 20:52 EDT