Fed's Yellen says key rate is probably low enough

By Ros Krasny

TACOMA, Washington (Reuters) - A top Federal Reserve official said on Wednesday that interest rates have "come way down" in recent months, and with inflation looming the central bank's key lending rate has probably been cut enough for now, despite risks to growth.

Janet Yellen, president of the San Francisco Federal Reserve Bank, said that the U.S. central bank is grappling with a complex mix of issues, but that inflation is weighing heavily on her mind.

"The 1970s were a horrible period. If there's one thing that has to be very high priority, we don't want to go back to a period that is anything like that," she said, critiquing presentations on the economy at a symposium for college students in Tacoma, Washington.

Yellen, who is often seen as one of the Fed's more dovish members, or worried about economic growth, spoke of the need to prevent 1970s-style inflation even as she warned of chance of a "horrid" downward growth spiral, adding that the Fed's policy choices could result in short-gain pain.

Her blunt comments on inflation came a day after she made similar remarks in Vancouver.

But she noted the Fed's policy dilemma in trying to both contain inflation and encourage growth, saying, "It's not a simple, straightforward set of issues that we face at the moment."

The Fed has cut its benchmark interest rate by a total of 3.25 percentage points since mid-September to stoke growth amid fears the United States could slide into recession.

Lately, financial markets have been guessing that the Fed thinks it has done enough to shore up growth and will stand aside for several months before possibly raising interest rates at year end.

Earlier, Eric Rosengren, president of the Boston Fed, said the months-long crisis in credit markets might not have yet claimed its final victim.

The U.S. economy has slowed noticeably, which along with falling house prices and surging food and energy costs poses further threats to financial institutions, Rosengren said in a speech in Boston.

NO 1970s NOSTALGIA

Yellen, who is not a voting member of the policy-setting Federal Open Market Committee in 2008, said policy-makers are determined to repeat flawed actions taken in the 1970s, when oil and other commodity prices were ratcheting higher.

"During the 1970s the Fed failed to keep inflation low in the face of supply shocks (which) became incorporated into inflation expectations," Yellen said.

Earlier on Wednesday, former Fed Chairman Paul Volcker warned a 1970s-style period of skyrocketing inflation was possible if investors lose confidence in the buying power of the U.S. dollar.

Yellen said that an inflation spiral or unchecked rise in inflation expectations has not developed so far.

Giving an overview of the FOMC at an event organized by the San Francisco Fed and the Pacific Northwest Regional Economic Conference, Yellen said the policy-setting committee still worried about a "negative feedback loop" of tight credit, weak retail sales and low consumer confidence that forces the economy into a downward spiral.

NO PAIN, NO GAIN

Yellen noted that the Fed needs to focus on long-term policy objectives, even at the risk of short-term pain.

The policy path chosen should "minimize societal losses," she said, while adding that the Fed's main tool, the federal funds rate, is not a cure for all ills.

"Monetary policy sometimes entails trade-offs. Sometimes the fed funds rate may not be able to achieve all you want," Yellen said.

Yellen said, though, that a string of "very inventive" moves by the FOMC to pump liquidity into financial markets has helped avoid monetary policy transmission to the economy from being "clogged up."

Yellen said the Fed has already started to discuss lessons learned from the liquidity crunch that started in August in the U.S. subprime mortgage market, and has threatened to drag the economy into recession.

Rosengren also mulled the lessons to be learned at a conference devoted to risk management.

Developments since the housing debacle erupted last year started with a focus on liquidity risk in financial markets, then moved to a period of heightened concern over credit risk and have since evolved into economic worry, he said.

"As we move to a third phase, the focus has shifted to concerns about the economic risks -- the risks generated by an economy that has slowed noticeably," Rosengren said.

Also speaking in Boston, Federal Reserve Governor Randall Kroszner said recent market turbulence has revealed inadequate risk management practices at some major financial institutions. "Institutions should never let their guard down when it comes to risk management," Kroszner said.

(Additional reporting by Burton Frierson in Boston; Editing by Leslie Adler)