With the U.S. labor market "very strong" and high inflation acting as a "repressive tax" that puts a particular burden on the poor, the Federal Reserve should raise interest rates this year, San Francisco Fed President Mary Daly said Thursday.

Still, she added, with the U.S. economy supporting millions of fewer jobs than before the onset of the COVID-19 pandemic, in addition to many workers remain cautious in the face of the virus, the U.S. central bank's approach ought to be data-driven and "measured."

Sidestep 'Birdaling' the Economy

"If we act too aggressively to offset the high inflation that’s caused by the supply and demand imbalances, we won't actually do very much to solve the supply chain problems -- but we will absolutely bridal the economy in a way that will mean less job creation down the road," Daly said during an Irish central bank virtual event.

While the economy is "closing in" on full employment in the context of an ongoing pandemic, she added, "there's a difference in the short run and the long run ... balancing those things as we move forward in 2022 will be the critical point of business for monetary policy."

Inflation has been running at more than twice the Fed's 2% goal for months, and has broadened from sectors directly impacted by COVID-19, such as used cars, to most of the basket of goods that Americans buy regularly.

In response, and with the U.S. unemployment rate now at 4.2%, Fed policymakers in December decided to end their asset purchase program by March to make room for interest rate hikes later this year.

Trimming Balance Sheet a 'Different Conversation'

Minutes of the Dec. 14-15 meeting released Wednesday showed that some Fed policymakers want to move even faster to tighten policy, including by shrinking the Fed's $8 trillion-plus balance sheet.

"I'm of the mind that we might need to, likely will need to, raise interest rates ... in order to keep the economy in balance," Daly said.

But with interest rates as low as they are -- the Fed has kept its benchmark overnight interest rate pinned near zero since March of 2020 -- "raising them a little bit is not the same as constraining the economy," she said.

Daly added that it is a "very different conversation" from reducing the balance sheet, as doing so would only come after the Fed has begun normalizing interest rates.