Fed's Yellen: turmoil adds to risk for economy

By Ros Krasny

SAN FRANCISCO (Reuters) - San Francisco Federal Reserve Bank President Janet Yellen said on Monday that the current turmoil in financial markets has added "appreciably" to downside risks for the U.S. economy.

"Financial market turmoil seems likely to intensify the downturn in housing," and pose a risk to broader economy, especially consumer spending, Yellen said in a speech at the National Association of Business Economics annual meeting.

Still, Yellen said the goals of price stability and full employment must be the "unswerving focus" of policy-makers. "Monetary policy should not be used to shield investors from losses."

Yellen is not a voting member of the central bank's Federal Open Market Committee in 2007.

She said that declining home prices could hurt consumer spending, and that risks to economic growth would be "significant" if housing prices fall in the context of rising unemployment.

"The key point is that ... a drop in house prices is likely to restrain consumer spending to some extent," Yellen said.

The Fed's actions to shore up the credit markets so far have been "helpful" but not a panacea, Yellen said.

Ultimately, the bank must consider the role of lags in making any policy adjustment, she said. "It is critical to take a forward-looking approach."

Financial markets look for the FOMC to lower its target fed funds rate this month to 4.75 percent from 5.25 percent, where the rate has been since June 2006.

Yellen did not directly address the rate outlook, but referenced an updated FOMC statement made on Aug 17 that discussed increased risks to growth.

"This assessment apparently is similar to that of market participants," Yellen said, noting the decline in the implied fed funds rate shown in interest rate futures markets.

Yellen it was still possible that ultimately, the fallout from the credit market crisis could turn out to be small and that the market could be returning to more normal risk pricing.

"Keeping a cool head" is advisable, she said, while allowing that "the transition from one regime to another can be quite painful."

Yellen said that improvement in inflation pressures has been evident recently, and that core inflation was likely to edge down "slightly" in the next few years.