The American public's swing from deflation to inflation worries in the past year is troubling as it suggests potential doubts about the Federal Reserve's ability to keep prices stable, a top Fed official said on Monday.

Confidence in the Fed is critical if the U.S. central bank is to exit from its easy money policy in a way that doesn't lead to higher inflation or hurt the recovery, Philadelphia Federal Reserve Bank President Charles Plosser told a conference in Helsinki.

It is troubling that the public's inflation concerns can be so volatile, he told a conference hosted by the Global Interdependence Center and the Bank of Finland, according to remarks prepared for delivery.

It suggests that there may be less confidence in the credibility of the Fed's commitment to price stability than we might desire, Plosser, a well-known inflation hawk, said.

Last summer, concerns the U.S. could face a sustained period of falling prices prompted the Fed to step in with a second round of so-called quantitative easing to further support the economy. That program, known as QE2, is scheduled to end this month.

Recently, rising food and energy prices have fueled concerns about inflation. The Fed believes commodity price rises will be temporary and won't have a lasting impact on inflation.

Plosser said these swings in the public debate shows the need for clear communication from the Fed. He repeated his long-standing call for an explicit inflation target and a systematic exit plan from the Fed's extraordinarily easy monetary policy.

Given the extraordinary amount of liquidity present in the U.S. banking system, it is reasonable for the public to be concerned about the prospects for inflation down the road, said Plosser, who has a vote on Fed policy this year.

The Fed cut interest rates at record lows near zero since December 2008 and has kept them there since. It has also bought bonds to further support the economic recovery, more than tripling its balance sheet to around $2.7 trillion.

At its April meeting, the Fed signaled it was in no rush to tighten monetary policy. But minutes of that meeting showed policymakers discussed potential exit strategy options at length.

Plosser said as the Fed normalizes policy, it should return to an operating framework in which the benchmark federal funds rate is the primary instrument of monetary policy. In this framework, the Fed's balance sheet should shrink to probably less than $1 trillion so that the fed funds rate trades above the interest on excess reserves.

The interest on excess reserves is a new tool that Congress gave the Federal Reserve's Washington-based Board of Governors -- not the Fed's policy-setting committee -- during the financial crisis.

Plosser said he would find a floor system framework in which the interest on excess reserves rate is the de facto policy rate troubling as it puts no limit on the size of the balance sheet.

If our operating framework divorces our balance-sheet decisions from monetary policy, it becomes a tempting instrument for future policymakers inside or outside the central bank to use it for non-monetary-policy purposes, Plosser said.

This could jeopardize the independence of the central bank and, if abused, would be a source of many unforeseen problems.

(Reporting by Kristina Cooke; Editing by Marguerita Choy)

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