By Jonathan Spicer and Jason Lange
ROGERS, Ark./ASHEBORO, NC (Reuters) - As the Federal Reserve nears a decision to pare its bond-buying program, top policymakers on Thursday turned to a new monetary policy battlefront: a growing debate over how the Fed should signal the timing of eventual interest rate hikes.
Top Fed officials at opposite ends of the policy spectrum still disagree on the optimal future for the Fed's $85-billion-a-month bond-buying program.
The president of the St. Louis Federal Reserve Bank, James Bullard, on Thursday said accommodative bond-buying should continue because there are no signs of price rises so far, while Richmond Fed President Jeffrey Lacker at a separate event reiterated his opposition on grounds the program is ineffective.
But minutes from the Fed's last policy meeting suggest officials are preparing to reduce the pace of bond-buying in coming months as long as the economy continues to improve.
When they do, the policy debate may shift to "forward guidance": the language the Fed uses to tell markets how long it will keep short-term rates near zero, where they've been for nearly five years.
Already, policymakers are talking about it, and signs point to more muscular language around rate guidance, rather than adding numerical thresholds or adjusting current ones.
The Fed has promised to hold rates near zero until unemployment hits 6.5 percent, provided the outlook for inflation stays under 2.5 percent.
Bullard has long been an advocate of adding an inflation floor to assure markets that the Fed will not raise rates if inflation continues to linger at a level that is too low for comfort.
Inflation is running at just over 1 percent, about half the Fed's 2 percent target.
But on Thursday Bullard signaled his willingness to back a different option, "to not change the forward guidance at all but to describe how we will behave after we pass the 6.5 pct threshold.
"The chairman has done this, other members of the committee have done this," Bullard said. "That's maybe the simplest thing to do and possibly that will be the limits of what we could do with this forward guidance but we'll see."
Fed Chairman Ben Bernanke earlier this week said the U.S. central bank could be patient before raising rates, saying the policy target is likely to stay near zero "perhaps well after" unemployment falls below 6.5 percent.
In October, the rate was 7.3 percent.
Lacker for his part was less enthusiastic, saying the Fed should be cautious about making any changes to its pledges to keep interest rates low.
"If you go changing what you're saying about how you're likely to behave from time to time, you could erode people's confidence that you're going to follow through on what you say you're going to do," Lacker told reporters. "We ought to be really cautious about tweaking the forward guidance apparatus."
Bond-buying in the wake of the 2007-2009 recession has swelled the Fed's balance sheet to about $3.9 trillion. While it is meant to spur investment, hiring and economic growth, there are concerns that the money-printing is laying grounds for a run-up in inflation.
Bullard said such concerns should not keep the Fed from continuing its bond purchases.
"What we need to do is continue with the program for now as we have, but if an inflation problem starts to develop we have to be willing to move to arrest that problem," Bullard told a University of Arkansas event. "At that point I'd put on my inflation hawk hat and spring into action.
"We do want to get back to a normal-sized balance sheet," he said, adding the portfolio should consist of only U.S. Treasury bonds.
To Lacker, who has never taken off his inflation hawk hat, price gains are liable to accelerate.
"My sense is that inflation will move back toward 2 percent over the next year or two, in part because measures of expected inflation remain well contained," Lacker said. "This is not a certainty, however, and I believe the (Fed) will want to watch this closely."
(Writing by Ann Saphir; Editing by Leslie Adler)