By Ann Saphir
MINNEAPOLIS (Reuters) - Unemployment may not have too much farther to fall before inflation threatens, forcing the U.S. Federal Reserve to respond by raising interest rates sooner than expected, a top Fed official said on Thursday.
The fact that inflation continues to run above the Fed's 2-percent target, Minneapolis Fed President Narayana Kocherlakota told the Economic Club of Minnesota, is "a signal that our country's current labor market performance is much closer to 'maximum employment' than the post-World War II U.S. data alone would suggest."
The U.S. central bank's monetary policy "should be responsive to such signals," he said.
Fed has kept rates near zero since 2008 and has signaled it will keep them there through late 2014 to nurse a still weak recovery. The debate over the true level of "maximum employment" in the United States is an important one as the Fed weighs its next policy move.
Some inflation hawks like Kocherlakota believe that structural changes in the economy since the Great Recession mean that the unemployment rate may never decline to the levels that were typical before the crisis. They point to a rise in unfilled job openings that, they say, suggest workers' skills do not match the current needs of employers.
On Thursday, Kocherlakota used some of his speech to examine the experience of Sweden in the 1990s, where unemployment rose sharply after a severe financial crisis and has since then never declined to pre-crisis levels.
"At a minimum, Sweden's experiences forces us to contemplate the possibility that the erosion in the labor market performance that we've seen in the United States over the past five years may be highly persistent, even under appropriate monetary policy," said Kocherlakota, who is not a voter this year on the Fed's policy-setting panel.
Kocherlakota's view is in the minority at the central bank, where most policymakers see labor "slack" in the economy as the lever that is keeping inflation low, despite super-easy monetary policy.
San Francisco Fed President John Williams recently argued recently that the jobless rate is still at least 2 percentage points above that point, suggesting the Fed can keep monetary policy extremely easy for quite some time before risking a rise in inflation.
But Kocherlakota on Thursday said he believes it's at least possible that the erosion in the labor market may be "highly persistent" even with extremely easy monetary policy.
And "distinctly higher" inflation in 2011 versus 2010, he suggested, may force the Fed's hand sooner rather than later.
Kocherlakota said earlier this week he believes the Fed may need to raise rates as soon as late this year.
(Reporting by Ann Saphir, Editing by Chizu Nomiyama)