Yellen says economy risks "grim outcome"

SAN FRANCISCO (Reuters) - A top Federal Reserve official on Sunday urged "pulling out all the stops" by implementing a big fiscal stimulus program to turn around a possible long period of economic stagnation in the United States.

By Ros Krasny

"The financial and economic firestorm we face today poses a serious risk of an extended period of stagnation -- a very grim outcome," said Janet Yellen, president of the San Francisco Federal Reserve Bank.

"If ever, in my professional career, there was a time for active, discretionary fiscal stimulus, it is now," Yellen said in remarks prepared for the American Economics Association's annual meeting in San Francisco.

Yellen said she was skeptical about suggestions for broad-based, permanent tax cuts and instead urged "spending on goods and services with higher rather than lower social value."

Already bogged down by a year-long recession, Yellen said the United States faces a rising risk of deflation, or a persistent decline in prices that could cause consumers to delay purchases, dragging down the economy further.

"With an extended period of abnormally high unemployment in the forecast, it is increasingly likely that inflation will fall to undesirably low levels," she said.

That, in turn, would risk pushing up real interest rates as inflation expectations decline at a time the Fed has already reached the "zero bound" on official rates.

Yellen said the trigger for the current recession, the eruption of a severe financial crisis, suggested U.S. growth would remain weak "for an extended period."

"The current downturn is likely to be far longer and deeper than the 'garden-variety' recession in which GDP bounces back quickly," she said. "Many forecasters expect this to be one of the longest and deepest recessions since the Great Depression."

Yellen said the Fed has not run out of monetary policy options, despite having set its official lending rate at a rock-bottom range of zero to 0.25 percent in December.

The Fed's "nonconventional measures" would likely remain focused on improving the functioning of credit markets, complementing the actions of the Treasury and the Federal Deposit Insurance Corp.

A "thoroughgoing report of the financial system" is essential for a sustained economic recovery but will be "a long, drawn-out process," she said.

(Editing by Leslie Adler)