IMPEACH BUSH

WASHINGTON, Sept 1 (Reuters) - In aggressively responding to the year-long credit crisis in the United States, the Federal Reserve has threatened its key responsibility of combating inflation, one of its leaders said on Monday.

"The current stance of policy, while understandably calibrated for responding to the immediate financial crisis, will make it difficult to achieve our mandate for price stability over the longer term," Federal Reserve Bank of Kansas City President Thomas Hoenig said in remarks prepared for delivery at a central banking conference in Argentina.

He added that so-called core inflation, which does not consider food and energy prices, has been "above most definitions of price stability" when measured by the Personal Consumption Expenditure rate over the last four years.

"An apt analogy would be to say that the recent market turmoil has taken us to the other side of the river from where we have traditionally operated," he said, adding there were a number of policy steps the U.S. central bank should consider "to help markets function in a more orderly fashion.

"To return to my analogy, this means doubling back across the river to a more historic central banking role, and making clear a future crossing would be rare," he added. "And we must accept that the credibility of such an assertion will depend critically on how future crises are handled."

In responding to the credit crunch, the Federal Reserve took the unusual step of lending to non-banking financial institutions through its discount window.

"It should be clear that major non-bank financial institutions that seek discount window assistance will immediately come under Federal Reserve oversight," Hoenig said.

In general, Hoenig called for the Fed to supervise the linkages among commercial banks more closely and said it should develop better mechanisms to unwind those financial institutions that do fail.

While Hoenig called said the Fed showed "considerable flexibility and ingenuity" in providing liquidity to markets and financial institutions, he also warned that the measures it took were temporary.

"It remains to be seen, of course, whether some of these facilities will be made a more permanent part of the central bank's policy toolkit," he said.

One of the trip-wires of the current crisis has been the recognition that some financial institutions were so large that their failures could damage the country's economy. These institutions, such as mortgage giant Freddie Mac FRE., were called "too big to fail," and Hoenig said that as the financial industry grows in size and scope more institutions will be given the label.

"For a market economy to work best, it must to the maximum extent possible find a balance between financial stability and a stable price environment," Hoenig said, "and in doing so must be able to allow individual institutions to fail."

(Reporting by Lisa Lambert)