Fed's Yellen: U.S. economy stalled, could contract

By Ros Krasny

PALO ALTO, California (Reuters) - The U.S. economy has "all but stalled and could contract" in the first half of 2008, San Francisco Federal Reserve President Janet Yellen said on Thursday.

"Current indicators suggest that, starting in the fourth quarter, the economy, at best, slowed to a crawl," Yellen said in remarks prepared for an outlook presentation to the Stanford Institute for Economic Policy Research.

"Economic prospects remain unusually uncertain, and the downside risks to growth are significant," she said.

A copy of her remarks was provided in advance.

Given those risks, Yellen said the Federal Open Market Committee must be "prepared to act in a timely manner to promote a return of the economy to a sustainable path."

The remark hinted that Yellen might favor additional cuts to the federal funds rate, the Fed's main monetary policy tool. Yellen is not a voter on the policy-setting FOMC in 2008.

On Tuesday, testifying to a Congressional committee, Fed Chairman Ben Bernanke raised eyebrows by omitting the comment on "timely" actions that has characterized his comments and FOMC statements of late.

Bernanke's choice of words was seen by some Fed watchers as suggesting the central bank's string of interest rate cuts might be close to an end.

The funds rate has been slashed to its current 2.25 percent from 5.25 percent since mid-September.

Yellen said the funds rate is now "accommodative," at a real, or inflation-adjusted, level of zero or slightly above zero.

"I consider such accommodation an appropriate response to the contractionary effects of the ongoing financial shock and the housing downturn," she said.

Weakness in the housing market is expected to be a drag on the overall economy into 2009, she said.

Yellen said the bursting housing bubble only recently spilled over into the rest of the economy, and that lower housing prices were just one of several factors hitting consumer spending.

Given the weak growth, the U.S. jobless rate is likely to rise "into a range indicating the presence of some slack" from its February level of 4.8 percent, Yellen said.

Yellen said much recent news on inflation has been "disappointing," with core inflation hovering at the top end of a range consistent with price stability.