U.S. labor markets could take years to recover from the setbacks of the current recession, which have pushed the unemployment rate to a 26-year high, top Federal Reserve policy-makers said on Wednesday.

But the officials said the Fed may need to end its ultra-accommodative policy stance long before the jobless rate starts to plummet if inflation starts to rise.

For now, though, that seems some way off given the tentative nature of the economic recovery.

Given the lag between the time monetary policy is initiated and when it impacts the economy, that wind-down process needs to begin as soon as there are convincing signs that economic growth is gaining traction, Dallas Federal Reserve Bank president Richard Fisher told a meeting of the North Dallas Chamber of Commerce.

It would be hard to determine just when that time would be though, Fisher said. It all depends on the economy, he told reporters after the event.

Speaking in New York, Chicago Federal Reserve president Charles Evans became the latest Fed official to suggest that the languid pace of the 2004-2005 policy tightening would not be repeated.

Although rate hikes are still some time off, as the economy continues to improve, and when we see rising inflation pressures, Fed policy will respond aggressively, Evans said.

Evans is a Federal Open Market Committee voting member in 2009, but will be off the voting rotation in 2010, when financial dealers guess the first rate hikes could come.

HALF OF REGIONAL FEDS CITE IMPROVEMENT

Also on Wednesday, the Fed issued its Beige Book survey, an anecdotal overview of the U.S. economy.

Half of the Fed's 12 districts -- Dallas, Boston, Richmond,

Cleveland, Philadelphia and San Francisco -- saw evidence the economy had improved by the end of August, although labor markets remained weak and retail sales were flat.

Most districts noted that the outlook for economic activity among their business contacts was cautiously positive.

The report was quite consistent with the recent dataflow, noting upside from manufacturing and residential real estate but continued weakness from commercial real estate and sluggish consumer spending, Michelle Meyer, economist at Barclays Capital, said in a note to clients.

FISHER: WRESTLE BALANCE SHEET DOWN

Fisher, whose next vote on the FOMC will be in 2011, said that getting the Fed's balance sheet back down to size by winding down the various emergency lending programs was the first order of business to blunt prospective inflation.

The Fed has held interest rates near zero since December 2008, but has massively expanded its balance sheet with a series of emergency lending programs aimed at getting credit markets to function more normally.

Unreversed, balance sheet growth is a reliable path to problems, Evans and Fisher agreed.

Economies running the printing presses on overdrive, usually to finance unsustainable fiscal deficits, typically end up with high inflation, Evans said.

ECONOMIC STAMINA?

Most economists guess that the U.S. economy started growing again in the current quarter, mostly on the back of unglamorous and temporary inventory adjustments.

GDP growth in the third and fourth quarters of 2009 could be in the 2.0 percent range, Fisher said, adding that the staying power of recovery is still in question.

But Fisher said he is less certain about longer-term prospects, especially since consumer spending is not expected to be a strong engine for the economy this time around.

In a second appearance on Wednesday, Evans echoed Fisher's downbeat assessment on the retail spending outlook.

Consumers are worried about their job prospects and whether or not they'll continue to have a job and that's restraining consumption spending, Evans said in comments taped for the PBS show Nightly Business Report.

Still, Evans said he does not expect a double-dip recession -- one where the economy grows for some time before contracting again.

The biggest worry for growth is the labor market, Evans said, adding that full employment could be years away.

I would guess that at the end of 2010 the unemployment rate is going to be above nine percent and 2011 its going to be uncomfortably, high probably in the seven's, he said.

August payrolls data showed that a large proportion of lay-offs are of a permanent rather than temporary basis, part of a reshaping of the U.S. economy.

Fisher said businesses trying to shore up profits will continue to focus on cost controls by shedding workers and attempting to drive up productivity.

That output gap meant deflation was still the biggest threat to price stability, Fisher said.

Evans disagreed. Deflation has been averted, he said, adding that a timely and deft Fed response can prevent the inflation spikes that some economists have predicted.

So far, the recession has prevented the sharp rise in bank lending that often triggers inflation, Evans said.

Even though the U.S. monetary base has nearly doubled in the past year as the Fed has rapidly expanded its balance sheet, sluggish growth in bank credit has held broader money growth to about 8.0 percent, he added.

(Additional reporting by Kristina Cooke in New York and Mark Felsenthal and Alister Bull in Washington)

Inflation