Aug. 21 (Bloomberg) -- Federal Reserve policy makers are concerned about making “a colossal policy error” leading to higher inflation if they don’t withdraw extraordinary monetary stimulus soon enough, said Laurence Meyer, vice chairman of Macroeconomic Advisers LLC and a former Fed governor.

“When you talk to committee members you see a little bit more angst than you’d expect,” Meyer said in an interview yesterday at the Kansas City Fed’s monetary policy conference in Jackson Hole, Wyoming. “In public they say they’re confident they’ll get it right, they’re confident they have the tools to get it right. But when you talk to them in private there’s some concern there.”

During the past two years, the Federal Open Market Committee has lowered its benchmark lending rate target to a range of zero to 0.25 percent and expanded the Fed’s balance sheet to more than $2 trillion to pump money into the financial system. Unless that stimulus is taken out of the economy at the right time, it could send inflation soaring.

“The Fed has aggressively expanded the balance sheet, and they’re now preparing the exit,” Meyer said. “Not from the zero funds rate, this is a long way off, but of shrinking the balance sheet.”

That strategy was evident in the FOMC’s Aug. 12 decision to end its program of purchasing longer-maturity Treasury bonds to hold down interest rates, Meyer said.

Balance Sheet

“Because they really do believe that the bigger the balance sheet the greater the challenge of exit, the bigger the chance of a policy error and higher inflation,” Meyer said. “And that is widespread throughout the committee.”

Meyer said his firm believes the recession ended in June, and that growth will be in the range of 2.5 percent to 3 percent over coming quarters. That will keep unemployment high and the Fed on hold for longer than usual following a recession.

“We’re having the weakest recovery we’ve ever had coming out of recession,” he said.

A protracted recovery will enable the FOMC to use a “rolling exit” strategy.

“We think it will be a very long time before the Fed raises the funds rate for the very first time,” Meyer said. “But in the meantime, the balance sheet will be shrinking. So we will have an exit.”

Fed Chairman Ben S. Bernanke should lead that exit and be appointed to a second four-year term at the helm of the central bank, he said.

“You have to take a step back and say the efforts and leadership he gave brought the economy back from the edge of the abyss,” Meyer said.

“It’s easy with hindsight to say well, it wasn’t perfect, he should have been faster here, he should have recognized the emerging crisis sooner, but this was a truly extraordinary time,” Meyer said. “And once he did recognize the crisis he moved extremely aggressively, very creatively.”

To contact the reporter on this story: Michael McKee in New York at mmckee@bloomberg.net.

Last Updated: August 21, 2009 10:51 EDT