BOSTON - Federal Reserve Vice Chair Janet Yellen Wednesday night said she sees the chance of adverse shocks, downside risks and even an argument for extending zero rates through 2015.

Speaking to the Boston Economic Club, Yellen presented her reasons for more accommodation, from insurance against what might happen and to accelerate what hasn't happened yet, a return to full employment.

Answering questions after the speech, she said the FOMC has to "sort through" whether more stimulus is needed, and if so, what form it should take.

Yellen said she sees high unemployment and low inflation for a long time to come. "Labor market slack at present is so large that even a very large and favorable forecast error would not change the conclusion that slack will likely remain substantial for quite some time," she said.

Inflation, she said, outside of oil prices, "has been running near 2 percent over the past two years, and I expect it to remain at or below the Federal Open Market Committee's 2 percent objective for the foreseeable future."

The outlook is not only weak, it could be jeopardized, she said. "I see substantial risks to this outlook, particularly to the downside." Forecasters could be too optimistic, Europe could cause big problems and fiscal policy is already a threat. "Even without any political gridlock, fiscal policy is bound to become substantially less accommodative from early 2013 on." And, she added, "Federal fiscal policy could turn even more restrictive if the Congress does not reach agreement on several important tax and budget policy issues before the end of this year."

"It may well be appropriate to insure against adverse shocks that could push the economy into territory where a self-reinforcing downward spiral of economic weakness would be difficult to arrest," she said.

Using several charts to illustrate her heavily footnoted prepared remarks, Yellen -- a labor economist -- said alternate monetary policy that "involves keeping the federal funds rate close to zero until late 2015" would appear to improve the jobs picture faster.

Answering questions from the audience, Yellen only amplified her arguments for more accommodation. "In a sense the (banking) crisis really hasn't ended yet," she said. "So, I hope we get through this one and if we do, I hope we get through the next one."

She said that even if the recovery were to advance and the private sector started to increase the demand for funding, "the competition from the government would begin to drive up interest rates and begin to crowd out private investment" unless Congress takes the actions over time "that are necessary to put in place a sustainable budget."

Yellen acknowledged there are several other viewpoints represented on the Federa Open Market Committee, responding to a question by saying, "We have a very diverse (FOMC) committee with an extremely wide range of views ... so we're providing lots of information on the diversity of opinion on our committee." The diversity is "a healthy thing" since "group-think is one of the most serious problems committees can fall into."

"We have to analyze the data the economy has thrown up to us and what we've learned since we last met ... in April," she continued. "We have to see if we can come to an understanding of what its implications are and what it means going forward." So later this month, "the challenge that we have is that recent data we've seen on the economy is pretty disappointing."

"The labor-market readings of the last couple of months show limited job growth," she said, "but we need to sort through all of that."

"The challenge we have is to decide whether or not going forward with our present monetary policy in place if we expect to make sufficient progress in the next couple of years in bringing this economy back to full employment," Yellen said. "If people were to conclude that we're not going to make adequate progress, then we have to debate what is the appropriate response to that."

"We have a number of possible tools, each with their own particular advantages and limitations," she said. "And the committee will simply have to sort through (whether) it's appropriate to act, and if so, what should we do?"

Market News International is a real-time global news service for fixed-income and foreign exchange market professionals. See www.marketnews.com.

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