By Ann Saphir
CHICAGO (Reuters) - If the economy does not show signs of sustainable improvement this quarter, the Federal Reserve should dig into its toolbox to find new ways to help it along, a top Fed official said on Thursday.
The Fed has held short-term rates near zero since December 2008 and in an unprecedented move, bought a total of $2.3 trillion of long-term securities to stimulate an economy struggling to right itself after the worst downturn since the 1930s.
But signs the recovery is flagging, again, suggest the economy needs more gas, and soon, Chicago Federal Reserve Bank President Charles Evans told a small group of reporters in a joint interview.
"If it were easy to do, if we had a very effective policy tool like a positive funds rate, if we could cut that by 100 basis points, then I would almost surely be advocating something like that," Evans said. "But in the absence of that, I think we have to think about the other tools."
Just as it was last November, when the Fed embarked on its second round of asset purchases, the economy is suffering from high unemployment and inflation that is still below desirable levels, he said.
Unemployment registered 9.2 percent in June, and core inflation reached 1.6 percent in the 12 months ended last month, below the Fed's 2 percent target.
But the Fed has used up its best policy tools, including lowering short-term rates and buying long-term securities, an approach that was very effective at first but became less so over time, he said.
Fed Chairman Ben Bernanke has suggested that much of the recent weakness in the economy is down to transitory factors such as manufacturing disruptions after Japan's March earthquake and tsunami. Evans, a noted policy dove who votes on the Fed's policy-setting panel this year, said he is rethinking that idea.
"If we continue to have weakness in the third quarter, it's going to be harder to plausibly sustain this idea that, 'Oh well, the next six months, it's going to get better,' " Evans said. "We've been saying this for quite some time."
Some of Evans's colleagues on the Fed policy-setting panel have said the rise in inflation since the Fed's last round of bond-buying suggests the Fed's next move should be tightening, not easing.
But Evans, a former economics professor, compared the change to the performance of a "D" student who worked hard to up his grade substantially, to a "C minus."
"That's a pretty good improvement, but it's still woefully inadequate," he said. "I feel very strongly that when we say 'our inflation objective' -- you name a number, but I'll say 2 percent -- that should be an average. It's not a ceiling."
Given the weak economy and too-low inflation, it would not be surprising if the Fed does not raise its target rate until late 2012, Evans said.
Investors are not pricing in a hike until the fourth quarter of 2012, based on trading in fed funds futures at CME Group Inc's Chicago Board of Trade.
Rather than do more bond-buying to boost the economy, Evans said, the Fed should provide more precise guidance on how long the Fed will keep rates low. Currently, the central bank has vowed to keep rates low for an "extended period," and the bank could harden that commitment by setting an exact date, he said.
It could also institute price-level targeting, in which it explicitly allows for inflation to rise above the 2 percent target to make up for periods at which at ran below the target.
But Evans said he would support more bond buying should the circumstances call for it.
"In the situation where I think that it is appropriate and possible to embark on more appropriate monetary policies, I would be willing to support most any policy that arguably was going to be effective and more accommodative," he said.
Evans, meanwhile, said he was hopeful the United States would avert the crisis that could ensue if lawmakers do not break an impasse over deficits and raise the $14.3 trillion U.S. debt ceiling before an August 2 deadline. Failing to do so, he said, would likely drive up interest rates, undercutting the Fed's easy monetary policy and damage the economy.
"I'm hopeful" Congress will avoid that, he said.
(Editing by Chizu Nomiyama and Padraic Cassidy)