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Fed's Yellen Says Downturn in U.S. Economy Still Possible

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% 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.

Yellen said other risks to the global economy include large investment and savings imbalances and possible disruptions from the re-pricing of risks in international financial markets.

The Federal Reserve is pinned between slow growth, which would could call for lowering benchmark interest rates, and stubbornly elevated inflation, which would dictate raising rates.

Fed officials have said that holding overnight borrowing costs steady at 5.25%, where they have been since June, will allow growth to pick up as inflation eases.

Yellen is not a voter on the Fed's policy-setting Federal Open Market Committee, which meets on May 9.