Federal Reserve Governor Kevin Warsh (voter) said rate cuts and liquidity injections are working to partially offset the impact of the current market turmoil, but cautioned that there are limits to what the Fed's monetary policy can accomplish and that a full recovery is going to take some time.

While speaking at the Global Economic Forum in New York City, Warsh said an indication that market function has returned is when the Fed's supply of liquidity is replaced by private liquidity.

"Fed policy--both with respect to liquidity tools and monetary policy--is partially offsetting the consequences of the liquidity and credit pullback on real activity," he said. "But we must be careful to not ask policy to do more than it is rightly capable of accomplishing."

He noted the problems afflicting the financial markets have been "long-in-the-making," and as such recovery is unlikely to be "swift or smooth." However, he said the Fed has already cut the target rate by a cumulative 3% since August and has taken "significant actions" to support liquidity.

"Consistent with our dual mandate of promoting maximum employment and stable prices, we also need to be alert to risks to price stability," he said, noting that increases in food and energy prices have pushed up overall consumer prices and are putting upward pressure on core inflation and inflation expectations.

"We will continue to monitor the inflation situation closely. And, more broadly, in my view, as financial intermediation channels reset, monetary policy will become still more efficacious."

Also in his comments, Warsh said market function will only be restored when private firms resume their roles. He noted that share and dividend buyback cuts would help the economy.

He also said corporate bond risks have narrowed, the measures of secondary market function have improved and the labor and commercial paper spreads have elevated.

Speaking the recent volatility in markets, Warsh said volatility is "generally a friend, not foe" of market functioning. "It should not be treated as an externality from which we suffer. Volatility, absent destabilizing moves, should be allowed to effectuate change in the financial architecture of private markets," he said. "Only then, I suspect, will a more robust recovery in market liquidity, investor confidence, and real economic activity be achieved.

In a Q&A session following his speech, Warsh said the best the Federal Reserve can do is "mitigate" the impact of the economic crisis and that, without the rate cuts delivered to date, the real economy would be in worse shape. He also noted that the Fed's monetary policy tools "don't work overnight," saying policy-makers need to be patient.

He also said the Fed can't be "indifferent" to the value of the U.S. dollar.

By Stephen Huebl and edited by Cristina Markham