Federal Reserve Bank of San Francisco President John Williams said gradual steps to tighten monetary policy and shrink the central bank’s $4.5 trillion balance sheet are needed to prevent the economy from overheating.

“The U.S. economy is about as close to the Fed’s dual mandate goals as we’ve ever been,” Williams said in remarks prepared for delivery in Singapore on Monday. “With the attainment of our dual mandate goals close at hand, it’s more important than ever for monetary policy to work toward what I like to call a ‘Goldilocks economy’ -– an economy that doesn’t run too hot or too cold.”

Williams doesn’t vote on monetary policy this year, but he worked closely with Fed Chair Janet Yellen when she led the San Francisco Fed and he was its director of research, and is seen as an influential voice at the central bank.

He has said that he’s expecting three or four rate increases in 2017, including the one that policy makers already made in March. Investors see a roughly 80 percent chance of an increase at the Fed’s next meeting, scheduled for June 13-14.

“Gradually raising interest rates to bring monetary policy back to normal prevents our economy from overheating,” Williams said at the Symposium on Asian Banking and Finance.

As the Fed looks toward tightening monetary policy further, it’s confronted with conflicting economic signals. On one hand, unemployment has dipped well below the level most officials think is sustainable in the longer run, dropping to 4.4 percent in April -- which Williams acknowledged in his remarks.

Meanwhile, inflation has failed to reach the Fed’s 2 percent target and is currently headed in the opposite direction. Fed policy makers prefer the Commerce Department’s inflation index, and by that gauge both headline and core price gains have slipped from earlier this year.

Williams reiterated his confidence that while inflation was running somewhat below 2 percent, “with the economy doing well and some of the factors that have held inflation down waning, I expect we’ll reach that goal by next year.” 

Gradual Exit

Fed officials are discussing how to begin unwinding their $4.5 trillion balance sheet, which remains swollen from three rounds of asset purchases in the years following the global financial crisis. They expect to release a plan detailing a gradual exit before starting the actual run-off later this year, based on policy maker comments and minutes from the Fed’s May meeting.

Officials want to make balance sheet draw-down as low-key as possible to avoid disrupting markets: the goal is to chart out a preset course and then leave it on autopilot. The minutes suggested that the Fed might set caps limiting how much rolls off each month, then gradually increase those caps every quarter until they reach a terminal level.

“We’re committed to slowly shrinking the balance sheet with the same sort of widely telegraphed, gradual, and -– frankly -– boring modus operandi that we’ve adopted for normalizing conventional monetary policy,” said Williams, who noted that he also expected the process to begin later this year.

“If there were to be some sort of deteriorating of the economic outlook, or another unforeseen circumstance, this timetable would, of course, have to be altered,” he said.