Fed's Yellen says economic downturn possible

By Mark Felsenthal

WASHINGTON (Reuters) - There is the potential for a downturn in the U.S. economy that could have ripple effects around the world, San Francisco Federal Reserve President Janet Yellen said on Saturday.

The U.S. economy grew modestly in the first quarter but should accelerate in the second half of the year, she said in a speech to the American Academy of Arts and Sciences and the American Philosophical Society.

Enumerating the top current risks to stable economic conditions around the world, she said that in the U.S. economy "there is potential for a downturn that could have major spillover effects around the globe." The United States contributes roughly 25 percent to world economic output, she noted.

The U.S. economy expanded at a sluggish 1.3 percent in the first quarter of 2007, the Commerce Department said on Friday, reflecting declines in the housing market and a pickup in inflation. It was the fourth consecutive quarter of sub-par growth in the world's largest economy.

"I do think there are downside risks to the American economic growth, but in spite of those risks I really think it is quite likely that the U.S. economy is going to pick up steam and revert back to trend growth before 2007 comes to and end," Yellen said.

Given "slightly elevated" levels of inflation, a period of subpar output will help dispel inflationary pressures, she added.

In the event the U.S. economy experiences a downturn, other countries have economic policy tools to help cushion the impact, Yellen said. Such tools include the adoption of numerical targets for inflation at many central banks around the world, she noted.

The U.S. central bank does not use inflation targets but is discussing whether to adopt them.