Federal Reserve officials clashed on Thursday over whether the central bank should be more aggressive in supporting the stumbling economy and one said the Fed's current policy may be contributing to worryingly low levels of inflation.

The Fed's promise to hold benchmark interest rates exceptionally low for an extended period -- a vow aimed at giving extra punch to rock-bottom borrowing costs -- may be increasing the probability of a Japanese-style outcome for the U.S., St. Louis Federal Reserve Bank President James Bullard said. Japan has struggled to break out of deflation and weak or no growth for years.

Bullard, a voter on the Fed's policy-setting panel this year, said the central bank should be ready to shift its focus to more aggressively pumping credit into the financial system to get the economy going if the recovery appears at risk.

On balance, the U.S. quantitative easing program offers the best tool to avoid such an outcome, he said, adding that his preferred route to provide additional easing would be through buying more long-term Treasury securities.

He told reporters on a teleconference call the Fed should only ease further if inflation ticks lower.

Highlighting the divide over how best to deal with concerns about a softening recovery, Dallas Fed President Richard Fisher said any further monetary accommodation would have as little effect in boosting the economy as pushing on a string.

We've done our job. We've restored liquidity to the market, we've leveraged up our balance sheets, Fisher, who rotates into a voting slot on the Fed's policy panel next year, told a business group in San Antonio, Texas.

Now, he said, it is time for lawmakers and regulators to provide clarity on what costs businesses will have to bear as a result of health care and financial reforms. Until then, U.S. economic growth will remain sub-optimal, he added.

DEFLATION RISK

The Fed cut overnight interest rates to near zero in December 2008 and has been promising to keep them ultra low for an extended period since March 2009 in an effort to try to hold down long-term rates. It has also expanded credit available to banks by $1.7 trillion with purchases of mortgage-related debt and longer-term Treasury securities.

Despite those measures, officials acknowledge the recovery has flagged in recent weeks. Fed Chairman Ben Bernanke told Congress on July 21 that the outlook was unusually uncertain and that the central bank stood ready to ease monetary policy further if the recovery withered.

Some Fed officials worry that if the recovery stumbles, already low inflation could slow further, raising the risk of a broad drop in prices that could further weaken the economy.

Consumer prices have fallen for the past three months and in the 12 months to June, were up just 1.1 percent. Officials would prefer to see inflation in a 1.5 percent to 2 percent range.

However, other policymakers are concerned the Fed's extraordinarily easy money policies, the culmination of steps aimed at buffering the economy from the worst financial crisis and recession in decades, are sowing the seeds for inflation.

Kansas City Fed President Thomas Hoenig has dissented at every policy meeting this year, saying the extended period language is setting the stage for another boom-and-bust cycle.

Bullard said he is not inclined to join Hoenig in dissent, preferring instead to persuade his colleagues through research and debate to drop the low-rates vow.

The St. Louis Fed chief said he continues to view a gradual recovery as the most likely course for the economy and that more easing of financial conditions likely will not be needed.

But he said the Fed should be prepared for further actions if unexpected shocks materialize..

(Additional reporting by Ann Saphir in San Antonio, Texas)

(Reporting by Mark Felsenthal; editing by Todd Eastham)

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