James Bullard is worried about “medium term” inflation and agitating for a subtle change in monetary policy, he said this morning at Commerce Bank’s annual economic breakfast. But Bullard, president of the St. Louis Federal Reserve Bank, saved his strongest criticism for the system of having some banks labeled “too big to fail.” Here’s an excerpt:

The key problem in the regulatory arena is too-big-to-fail. A lot of other issues are being discussed, but this is the one that really matters. … It’s just an intolerable situation, and it’s no way to run an economy.

Bullard said his first suggestion would be to set up a orderly way for big banks to be wound down if they got into trouble. If the “fail” part can’t be addressed, he said, we need to look at the “too big” aspect:

If you can’t set up a resolution regime for large financial institutions, then you have to make them smaller, break them up or sell off some pieces. You cannot let the situation continue where these firms make a lot of money in good times and go to the taxpayer in bad times.

Inflation isn’t an immediate concern, Bullard said, but may be a problem in the “medium term,” which he defined as two to four years from now. For that medium term, he said,

Inflation uncertainty is as high as it’s been in a long time in the U.S. economy.

The concern stems from the $1.7 trillion in mortgage-backed securities that the Fed has committed to purchase by the first quarter of next year. Bullard said that so-called quantitative easing policy appears to be successful in warding off deflation, but will have to be unwound at some point. He said of the asset-purchase commitment:

This is a big number even for the Fed. This is causing a large and persistent increase in the monetary base, and that’s what raises medium-term inflation concerns in the U.S.

He said the asset purchases, which began after the Fed pushed short-term interest rates to near zero, are a new policy tool for the central bank. Fed policy makers have always made clear that their interest rate moves are “state contingent,” meaning that they could change in response to new economic data, and Bullard said they need to communicate the same message about quantitative-easing targets.

That’s how we should communicate the asset purchase program. What we’re doing right now is to announce a big purchase and then not say much more. I’ve been pushing my colleagues on this issue.