Federal Reserve Vice Chairman Donald Kohn said on Wednesday policymakers would raise rates well before consumer spending and business investment overheats, adding that obstacles to borrowing are likely to subdue the recovery for some time.

We must begin to withdraw accommodation well before aggregate spending threatens to press against potential supply, and well before inflation as well as inflation expectations rise above levels consistent with price stability, he said in prepared remarks to the Cato Institute.

Kohn said he could not predict how rapidly the Fed would raise rates or withdraw its massive supply of money to the financial system. He said the central bank would watch carefully how its extraordinary efforts to support the economy are affecting spending decisions and inflation expectations in timing its exit strategy.

The Fed has the necessary tools to pull back its help for the economy, he said. Paying interest on bank reserves is chief among these, he added.

However, the Fed will also need to drain reserves at some point, he said.

The Fed might also consider sales of longer-term assets if it believes that longer-term rates are not responding appropriately to its removal of monetary stimulus, Kohn said.

(Reporting by Mark Felsenthal; Editing by Neil Stempleman)

Inflation