GOLDEN VALLEY, Minnesota (Reuters) - The Federal Reserve's interest rate cuts are aimed at shielding the economy from tight credit, and policy-makers will watch credit conditions closely as they mull their next move, Minneapolis Fed Reserve Bank President Gary Stern said on Tuesday.
"If you have these headwinds, they are going to have implications for credit availability, and ultimately ... economic performance," he told reporters after speaking to the Financial Planning Association of Minnesota.
Looking ahead, the Fed will monitor the interplay between benchmark interest rates and credit conditions, said Stern, who in 2008 is a voting member of the U.S. central bank's rate-setting Federal Open Market Committee.
"We have to try to understand as more information on both market conditions and the market becomes available ... how the two align, and what is the appropriate thing to do," he said.
"We've already taken some significant action in my judgment," he added.
The Fed has cut the benchmark federal funds rate to 3 percent from 5.25 percent since mid-September, including a two-step, 1.25 percentage point cut in January, to help the economy weather a sharp housing downturn and tighter credit.
Policy-makers will be sensitive to evolving financial conditions and to information on business activity to make decisions on how to proceed, Stern said.
The Fed's rate cuts were warranted in the wake of the housing downturn and tighter credit.
"Against the backdrop of the financial shocks that have beset the economy and their implications for the outlook, the reduction in the funds rate target appears wholly appropriate," Stern said in his speech.
Stern said the current situation is reminiscent of the early 1990s when the economy faced "headwinds" after the 1990-91 recession, particularly tighter credit and a real estate bust.
It is possible that an appreciable tightening of credit conditions could restrain the economy for a time, he said. He added that he expects the economy to grow at 2.5 percent a year over the long run, he added.
However, the possibility of a worsening credit crunch cannot be ruled out, Stern said.
Also, housing worries continue as a large number of unsold homes remain on the market, he said.
If headwinds gain momentum, there would probably be modest growth for a while, and also higher rates of unemployment, he said.
At the same time, it is important to note that inflation declined in the early 1990s, Stern said.
The Fed bank president said recent inflation readings have been higher than his preference but should go down over time.
Policy-makers should target inflation levels over the long run and should not try to affect month-to-month swings in inflation levels, he said in response to questions after his speech.
Inflation levels move slowly, he told reporters later.
"My own view is that core will diminish over the next several years, but I don't expect any material changes right away," he said. Core inflation excludes volatile food and energy prices.
