Record-low interest rates are still needed to energize the economic recovery, a Federal Reserve official said Tuesday.
Janet Yellen, head of the Federal Reserve Bank of San Francisco and President Barack Obama's top pick to be vice chair of the central bank, said the sluggish recovery she anticipates means unemployment will stay high for years.
The jobless rate — now at 9.7 percent — will dip only to 9.25 percent by the end of this year and then to 8 percent by the end of 2011, she predicted, calling the scenario a "very disappointing prospect."
Despite encouraging signs late last year, the housing market now "seems to have stalled," she observed in a speech delivered in Los Angeles.
Still, Yellen said she is hopeful that mortgages will stay affordable even after the Fed shuts down a $1.25 trillion program at the end of this month that lowered mortgage rates and bolstered the housing market.
"Any significant run-up in mortgage rates would create risks for a housing recovery," she said. The Fed has left the door open to reviving the program if the economy were to weaken.
Given fragile economic conditions, Yellen said the Fed was right last week to keep a pledge to hold rates at record lows for an "extended period" — thought to mean six more months. That decision, however, drew one dissent.
Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, expressed concern that low rates could cause a buildup of "financial imbalances" and put the economy's stability at risk.
Yellen said rock-bottom rates are justified because the recovery faces "headwinds" from the wobbly housing market, hard-to-get credit and a job market that, despite some recent improvements, is still weak.
"I don't believe this is yet the time to be tightening policy," Yellen said. "But as recovery takes firm root and economic output moves toward its potential, a time will come when it is appropriate to boost short-term interest rates," she added.
The Fed's biggest challenge will be deciding when to reverse course and start raising rates. Moving too soon could derail the recovery. Waiting too long could unleash inflation.
Because companies are still operating well below full throttle and there isn't a big demand to ramp up hiring, Yellen said she isn't worried about inflation getting out of hand any time soon.
"I don't think we're due for an outbreak of inflation," in the short run because of the Fed's stimulative actions or in the long run because of the federal government's record-high budget deficits, she said.
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