A key Federal Reserve official said on Monday the economy can grow for a while before inflation pressures emerge and that policymakers should be wary of withdrawing their support for the economy too soon.

The economic outlook has improved considerably, New York Fed President William Dudley said at New York University's Stern School of Business.

Despite this, we are still very far from achieving our dual mandate of maximum sustainable employment and price stability, he added.

Dudley, who has a permanent vote on the central bank's policy-setting Federal Open Market Committee, has a reputation as being one of the strongest supporters of aggressive Fed actions to bolster the economy.

While seen as a dove on the spectrum of Fed officials, he is the vice-chairman of the FOMC and his views are influential in shaping the consensus behind policy.

The central shaper of that consensus, Fed Chairman Ben Bernanke, testifies before Congress on Tuesday and Wednesday and is expected to shed further light on how the strengthening recovery and rising energy and food prices will affect the Fed's $600 billion bond buying program.

Some at the central bank believe that evidence consumer spending and business spending is picking up should prompt the Fed to taper off or cut the amount of assets it will buy. One advocate of curbing bond buying, St. Louis Fed President James Bullard, repeated his suggestion on Monday that the Fed should consider stopping about $100 billion short of its commitment while it gauges the pace of the recovery.

We're in very good shape for 2011, Bullard said on CNBC, adding that risks to the outlook include turmoil in the Middle East and sovereign debt woes in Europe.

Bullard is not a voter on the FOMC this year, but he is viewed as a centrist and his support for curbing bond-buying portends a lively debate on the topic at the Fed's March 15 meeting.

Dudley said recent increases in commodity prices are among reasons for the central bank to keep careful track of inflation trends despite ample spare capacity in the economy. But he said there has been little pass through from higher commodity prices into core inflation.

The biggest risk, he said, is that of an inflationary psychology taking root, and he stressed that policymakers would be vigilant against that possibility.

A sustained rise in medium-term inflation expectations would represent a threat to our price stability mandate and would not be tolerated, he said.

With high levels of unemployment and the relatively slow recovery from a deep recession, the economy can continue to grow without igniting inflation, Dudley said.

The economy retains a very large amount of slack by virtually all measures, he said.

Another Fed official warned of underestimating risks from sovereign debt crises and state and local government woes.

Unlikely events can happen, and when they do, the outcomes can be quite costly for everyone, said Boston Fed President Eric Rosengren in remarks at Boston University.

Rosengren, also not a voter on the FOMC, did not comment directly on the outlook for the economy or monetary policy.

(Writing by Mark Felsenthal, Editing by Chizu Nomiyama)

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