Dec. 2 (Bloomberg) -- The Federal Reserve faces limits to cutting interest rates to historic lows, and may need to rely on other tools to revive the economy, said James Bullard, president of the Federal Reserve Bank of St. Louis.

“I have not been a fan to going to really low levels,” Bullard said today in a Bloomberg Television interview. “Why is it zero this time? I don’t quite get that, though I know some people want to go in that direction.”

Fed policy makers, confronting what may be the worst recession since World War II, will reduce the target interest rate at a Dec. 16 meeting by a quarter-point to 0.75 percent, according to economists surveyed by Bloomberg News. While Bullard himself may not support another cut, he said the Fed is debating how to use its other policy tools and communicate its intentions.

“There are limits of what you can do with interest rate policy,” he said. “We have a market conditioned to think of interest rates as the definition of monetary policy.”

Noting that the Fed cut rates to 1 percent in 2003, Bullard said some analysts believe “that created problems.”

The central bank may reduce its target interest rate to zero percent, according to economists at Macroeconomic Advisers LLC, JPMorgan Chase & Co. and HSBC Securities USA Inc. Macroeconomic Advisers on Nov. 24 predicted the Fed may reach zero in January and will also consider unconventional policy actions, including purchasing private assets.

Policy makers are discussing how to pursue a policy of quantitative easing, or adding more than enough reserves to keep rates close to zero, Bullard said. “The Fed is wrestling with that right now.”

‘Limited’ Room

Fed Chairman Ben S. Bernanke said yesterday he has “obviously limited” room to lower interest rates further and may use less conventional policies, such as buying Treasury securities, to revive the economy.

The U.S. economy “will probably remain weak for a time,” Bernanke said in a speech in Austin, Texas. While the Fed can’t push interest rates below zero, “the second arrow in the Federal Reserve’s quiver -- the provision of liquidity -- remains effective,” he said.

The central bank announced today it extended the term of three emergency programs with about $304 billion in total loans outstanding to calm financial markets amid the most severe credit crisis in seven decades. The programs, originally set to end on Jan. 30, will run until April 30.

The Fed announced last week it will purchase as much as $600 billion of debt issued or backed by government-chartered housing-finance companies to help to ease the housing slump. That prompted the biggest drop in U.S. mortgage rates in at least seven years.

Deflation Risks

Fed policy makers predicted the U.S. economy will shrink until the middle of next year, with some officials concerned about the risks of deflation, according minutes of the Oct. 28- 29 meeting. Fed policy makers cut the benchmark interest rate to 1 percent at the gathering.

Bullard took over as president from William Poole, who retired on March 31. He had been in the St. Louis Fed’s research department for more than 18 years. He won’t vote this year on interest rates on the Federal Open Market Committee and his turn in the rotation among Fed bank presidents will be in 2010.

Consumer prices excluding food and fuel costs fell in October for the first time since 1982, according to government figures. The consumer price index plunged 1 percent in October, the most since records began in 1947, the Labor Department said.

Declining Prices

Bullard, noting that prices are rising on a year-over-year basis, said he doesn’t share the concern of some economists about deflation, or declining prices.

“It would take a lot to drive that down to deflationary levels,” he said.

Meanwhile, “inflation expectations are fanning out,” Bullard said. “There are some people thinking that there might be a lot of inflation,” while others see a chance of deflation, he said.

The Fed must “control both sides of that,” he said.

The Fed has reduced its benchmark rate by 4.25 percentage points since September 2007, to 1 percent, and rescued Bear Stearns Cos. and American International Group Inc. from failure with emergency loans.

To contact the reporter on this story: Steve Matthews at smatthews@bloomberg.net; Kathleen Hays in New York at Khays4@bloomberg.net.

Last Updated: December 2, 2008 15:32 EST