Kohn says Fed can prevent inflation surge

By Ros Krasny

NASHVILLE, Tenn, April 18 (Reuters) - The Federal Reserve will not allow its unorthodox policies to lead to a surge in inflation as the U.S. economy recovers, Fed Vice Chairman Donald Kohn said on Saturday, though he said the U.S. central bank may need to do even more to ease credit if the economy fails to respond to stimulus measures.

"The key to preventing inflation will be reversing the programs, reducing reserves, and raising interest rates in a timely fashion," Kohn said in remarks prepared for a conference at Vanderbilt University in Nashville.

Kohn, the Fed's No. 2 policy-maker, emphasized the importance of inflation expectations in holding down future inflation.

"If expectations are not anchored -- if they vary in response to our actions or to persistent gaps between actual and potential output -- inflation itself will follow," he said.

On Friday, a survey-based forecast of one-year inflation expectations, from the University of Michigan, jumped surprisingly to 3 percent in April from 2 percent in March.

Kohn said the policy-setting Federal Open Market Committee is still mulling the value of setting an explicit objective for inflation -- a step further than it went earlier this year, in publishing "longer-run" inflation forecasts.

He did not discuss the economic outlook at length, but said the central bank's attempts to heal ailing credit markets have been working, in ways that include lowering mortgage interest rates. The U.S. economy is now in its sixth quarter of recession.

"The situation in financial markets and the economy would have been far worse if the Federal Reserve hadn't taken the actions we did," Kohn said.