Fed's Dudley: The U.S. economy may be slowing

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NY Federal Reserve Bank of New York President William Dudley said he would favor a rate hike this year if the economy performs in line with forecasts.

However, William Dudley said recent data suggest the economy is slowing. Specifically, he said that inventories, dollar appreciation and sluggish global growth are holding the U.S. economy back.

He also said the central bank should favor a flexible approach to monetary policy.

In remarks at the Brookings Institution, Dudley said strict monetary policy rules would have slowed the Fed's response to the financial crisis. But the Federal Reserve Bank of New York president added that he does not support "total discretion" in monetary policy.

He spoke three days after release of a paper by the San Francisco Federal Reserve that questioned the efficacy of ultralow interest rates.

Read More Surprising Fed paper drops a dovish bombshell

For the Fed to effectively guide the economy, he said, "households and businesses need to be able to anticipate how the Federal Reserve is likely to respond to evolving conditions."

"Prescriptive rules will wind up being behind the curve," said Dudley.

He said the Fed must be clear about its plans for interest rate policy but should not be slave to mathematical formulas.

Speaking alongside a top proponent of the idea that central banks should follow clear rules, Dudley said such rules were useful but they oversimplified how the economy really works.

On the issues of inflation, Dudley said he is confident that falling unemployment will eventually lead to rising prices.

"I see more pressure on resources," he said. "I see a linkage between pressure on labor market resources and my confidence in inflation."

In an interview with CNBC last week, Dudley said market action in August had raised some questions about a slowing global economy for the second half of the year.

Dudley is a voting member of the Fed and vice chairman of the Federal Open Market Committee. His speeches are scrutinized for clues on how the central bank might act.

On Wednesday, a Fed report said U.S. labor markets continued to tighten but with little impact on wage growth while manufacturing across the United States is hurting from the recent strength of the dollar.

"A number of districts cite the strong dollar as restraining manufacturing activity as well as tourism spending," the Beige Book report said. In particular, the steel sector remained weak, as the dollar's appreciation increased import competition, especially from China.

Read More Fed Beige Book: Modest overall economic expansion continues

—Reuters contributed to this report.

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