Yellen says Fed has the will to tighten when needed

COEUR D'ALENE, Idaho (Reuters) - The Federal Reserve will act "decisively" to tighten monetary policy and tamp down any prospects of inflation when the time is right, a top Fed policy-maker said on Tuesday.

But Janet Yellen, president of the San Francisco Fed, said the early stages of recovery will be painfully slow, helping to keep inflation low for now, and that a return to full employment could take several years.

Against that backdrop, Yellen hinted that she would not push for an immediate end to the Fed's program to buy long-term U.S. Treasury debt.

Speaking to reporters after a speech to Oregon and Idaho bankers, Yellen said the outlook for the program was an "open question" that would be discussed at the next meeting of the Fed's monetary policy-setting Federal Open Market Committee.

"I would not want to see it erased from the list of possible tools" available to the Fed, she said.

Yellen reiterated the Fed's outlook for a slow recovery from the current recession, and said that surprises in the data recently had, on balance, been positive.

"We glimpse the first solid signs ... that economic growth may be poised to resume. Indeed, I expect that to happen some time this year," Yellen told the bankers' meeting.

When the economy eventually recovers, "we have the tools to tighten policy when the time is right, and we have the will to use them," Yellen vowed.

Correctly timing the start of a tightening campaign is difficult, but will likely come while the labor market is still relatively weak, she said.

Yellen said the Fed -- the U.S. central bank -- would not repeat the policy mistakes of the 1970s, when inflation in the United States spiked dangerously. That episode had been a "formative" experience for her, she said.

But Yellen said the weak labor market, with payrolls still "shrinking at a dreadful pace" and downward pressure on wages, remains a concern.

"The job market is very much on my mind," she said.

A slide in the commercial real estate market poses a downside risk as well, Yellen added.

"A gradual recovery means that things won't feel very good for some time to come," she said. "I expect to see subdued consumer spending for some time." Many American households still face "tattered finances" after the loss of trillions of dollars of wealth, she said.

Yellen, a voting member of the FOMC in 2009, gave no hints about when the Fed might need to start raising benchmark interest rates. She reiterated the central bank's current view that rates are likely to be near zero for an extended period.

Meanwhile, Yellen dismissed suggestions that inflation is on the verge of jumping as a result of the Fed's expansionary monetary policies and massive balance sheet expansion.

"Will this expansion of credit and bank reserves create high inflation? My answer is no," she said.

Core inflation, stripped of food and energy price rises, will likely remain below 2 percent for several more years, Yellen added.

"Monetary policy fosters inflation when it loosens the stance of policy enough to create excess demand for goods and services. Right now, we have exactly the opposite."

The United States needs "more demand -- not less -- to offset slack in labor and product markets," Yellen added.

Fed watchers recently have noted that the "velocity" or circulation of money in the U.S. economy has not risen despite the billions of dollars it has pumped in.

Yellen said that trend was not especially surprising since banks are keen to hold onto reserves to guard against fresh shocks to the financial system or the economy.

Similarly, large budget deficits by themselves "do not cause high inflation automatically," the policy-maker said.

With the United States still in what could become the most severe recession since the Great Depression of the 1930s, current fiscal policy "in my view, is entirely appropriate," she said.

Yellen urged bankers in the audience, many from small and mid-sized community banks, to do their bit.

"Although my message is that you should plan for the worst and exercise caution, I want to stress that it is also critical that you continue to make loans to credit-worthy borrowers."

Additional regulatory powers being suggested for the Fed would not compromise the bank's ability to set monetary policy, Yellen told reporters.

(Editing by James Dalgleish)