By Vivien Lou Chen and Scott Lanman May 24 (Bloomberg) -- Federal Reserve Governor Frederic Mishkin said estimates of the gap between actual growth and the economy's potential output may give misleading signals about the path of inflation and how the Fed should set interest rates. ``The bottom line is that we must never take our eye off of the inflation ball,'' Mishkin said today in a speech at a Dallas Fed Bank conference. ``Good policymaking requires that we acknowledge what we are unsure about, and this requirement applies particularly to measures of potential output.'' U.S. growth averaged 1.9 percent in the past three quarters. That's below the 3 percent pace many economists calculate is the economy's speed limit. In the same period, the Fed's preferred inflation gauge held at or above the top of officials' comfort range. Mishkin, reflecting most officials' views, said when output is below potential, inflation typically tends to slow. ``The substantial uncertainty in our measures of potential output implies that we need to be cautious about taking on board the implications of our current estimates of the output gap,'' Mishkin said. ``If inflation is moving in a different direction than the output gap would suggest, then we should take seriously the possibility that our output gap measure is not providing us with reliable information.'' Mishkin didn't comment on the current economic or interest- rate outlook in his remarks. `Exciting' Research The Fed governor said officials still need to use estimates of potential output as a guide for setting policy and noted that Fed economists research the subject. ``Exciting'' recent research in the area has yielded ``theoretically elegant'' frameworks, he said. Economists measure the so-called output gap in different ways and each method has challenges, said Mishkin, 56, a former economics professor at Columbia University. One problem is that economic figures are often revised from their initial estimates, reducing the reliability of the latest reports. Economists now estimate first-quarter growth may have been as low as 0.5 percent. The Commerce Department will revise the gross domestic product figure on May 31 and June 28. Fourth- quarter growth was first calculated at 3.5 percent, a figure that was later reduced to 2.5 percent. ``Measures of potential output and output gaps are so uncertain, we must always be aware that they might be providing misleading signals as to the future course of inflation and the appropriateness of the stance of policy,'' Mishkin said. Inflation Expectations Mishkin also said that central banks derive ``tremendous benefits'' from anchoring expectations for future inflation. That helps policy makers control price shocks more effectively, he said. Investors won't worry that officials will allow inflation to climb as a result of such shocks. ``People understand what we're going to do in the future, that if inflation starts to get out of hand, that in fact the Federal Reserve has to take the appropriate steps,'' Mishkin said. The personal consumption expenditures price index, minus food and energy, rose 2.1 percent in March from a year before, matching the lowest rate in the past year. Fed Chairman Ben S. Bernanke and other policy makers have stated a preference for a 1 percent to 2 percent range for the measure. Fed policy makers have kept their benchmark rate unchanged at 5.25 percent since August and next meet June 27-28 in Washington. Mishkin, who joined the Fed board in September 2006, appeared at a conference today sponsored by the Dallas and Cleveland Federal Reserve Banks. Dallas Fed President Richard Fisher and Cleveland Fed President Sandra Pianalto gave introductory remarks. To contact the reporters on this story: Vivien Lou Chen in San Francisco at vchen1@bloomberg.net ; Scott Lanman in Dallas at slanman@bloomberg.net Last Updated: May 24, 2007 20:56 EDT http://www.bloomberg.com/apps/news?pid=20601068&sid=aYnwlBzpHyBA&refer=economy