Fed's Kohn: Rates likely to remain near zero

PRINCETON, N.J. (Reuters) -- The U.S. Federal Reserve is likely to keep benchmark interest rates near zero for a while in an economy that is pulling out of a steep decline and appears on course for a very gradual recovery, Fed Vice Chairman Donald Kohn said Saturday.

"The economy is only now beginning to show signs that it might be stabilizing, and the upturn, when it begins, is likely to be gradual amid the balance sheet repair of financial intermediaries and households," Kohn told a conference at Princeton University.

"As a consequence, it probably will be some time before the FOMC will need to begin to raise its target for the federal funds rate," he said, referring to the Fed's policy-setting Federal Open Market Committee.

The U.S. central bank has cut interest rates to near zero and committed to massive lending and securities purchases to heal shattered financial markets and pull the economy out of the longest recession since the Great Depression.

Kohn said that in spite of the fragile state of the U.S. economy and the prospect for low rates for a while, the Fed must make plain its plans to pull back its lending when a recovery begins to take hold.

"To ensure confidence in our ability to sustain price stability, we need to have a framework for managing our balance sheet when it is time to move to contain inflation pressures," he said.

The Fed has said it is willing to expand extensive purchases of mortgage-related and longer-term Treasury securities to support any nascent recovery.

"The preliminary evidence suggests that our program so far has worked," Kohn said referring to the commitments to buy securities to date.

Kohn said government spending is likely to have a more powerful effect in helping pull the economy out of recession now -- with interest rates near zero -- than it would if the Fed were still in a position to lower interest rates further.

"In this situation, fiscal stimulus could lead to a considerably smaller increase in long-term interest rates and the foreign exchange value of the dollar, and to smaller decreases in asset prices, than under more normal circumstances," he added.