By Yali N'Diaye

WASHINGTON (MNI) - The Federal Reserve needs to avoid "falling into a low nominal interest rate trap" and potentially deflation, St. Louis Federal Reserve Bank President James Bullard said Friday.

"The potential to become trapped in a low nominal interest rate steady state is very real," he stressed during a presentation at the Swiss National Bank Research Conference in Zurich, Switzerland.

That said, interest rates are likely to remain low "for some time depending on how the economy performs," Bullard said. He will be a voting member of the Fed's policymaking Federal Open Market Committee next year. During this time, he expects, the economy will likely experience further shock.

He added the central bank should better communicate about its policy, especially its quantitative policy, noting the likely path of monetary policy so far is "unclear" to financial markets, causing more uncertainty.

Going forward, "The key issue is how to think about the asset purchase program," Bullard said.

And in that regard, adopting quantitative rules might be the way to go.

"There has been little indication of how or whether these amounts might be adjusted given incoming information on economic performance," Bullard said, referring to the latest FOMC meeting when the Fed announced its intention to buy up to $1.75 trillion in asset-backed securities by the first quarter of next year.

What's more, "It is also unclear whether this policy is consistent with price stability," he added, noting the impact of unwinding the asset purchase policy on inflation depends on financial markets' expectations of future policy.

Given the low nominal rates that are likely to remain low for a while, Bullard urged to consider quantitative rules, which although not as "satisfactory" as interest rate rules, are worthy tools for running monetary policy.

In fact, quantitative rules could have prevented the Japanese slowdown and the Great Depression, he said.

Besides, models have been developed and "these rules do not recommend the rapid expansion of the monetary base that we have seen recently."

An optimal asset purchase program, Bullard said, is one that is "contingent" on the state of the economy, unlike the current U.S. asset purchase program.

"This may be an area where U.S. monetary policy could make improvements," he said, noting the U.S. "asset purchase program has made the doubling of the monetary base very persistent, as well as very large."

He also suggested the adoption of a Taylor-like rule to communicate how purchases would be adjusted to economic developments.

An optimal asset program, he continued, should reduce uncertainty and help communicate how it is consistent with price stability and growth sustainability.

** Market News International Washington Bureau: 202-371-2121 **