July 1 (Bloomberg) -- Federal Reserve Bank of San Francisco President Janet Yellen said the prospect that policy makers will leave the benchmark U.S. interest rate near zero for the next several years is “not outside the realm of possibility.”

“We have a very serious recession, we have a 9.4 percent unemployment rate,” and inflation possibly falling further below the Fed’s preferred level, she told reporters yesterday after a speech in San Francisco. Given the recession’s severity, “we should want to do more. If we were not at zero, we would be lowering the funds rate.”

Yellen’s comments go beyond those made by other policy makers after a June 23-24 meeting, when they said the federal funds rate will likely stay at “exceptionally low levels” for “an extended period.” They have held the rate, also known as the overnight lending rate between banks, at between zero and 0.25 percent since December.

The Fed “did succeed in averting a full-blown meltdown,” Yellen said in the speech to the Commonwealth Club of California. Nevertheless, the threat of another financial shock, such as one from falling commercial real-estate prices, is “high on my worry list.”

Yellen said the U.S. economy may be about to “turn the corner” and reiterated her expectation that the recession will end later this year.

“Right now, we’re like a patient in intensive care whose condition has stabilized and whose fever is just starting to come down,” Yellen said in the speech. “We’re just completing the sixth quarter of recession, but the pace of decline has slowed markedly” and “confidence in the financial system is slowly returning.”

Hundred-Year Flood

The 62-year-old bank chief, who votes on monetary policy this year, compared the financial crisis to “a hundred-year flood: a disaster of the highest order which has put us on continuous emergency footing.”

“I expect that we will turn the growth corner sometime later this year, but I am not optimistic that the economy will spring back to normal anytime soon,” she said. Unemployment will “remain painfully high for several more years.”

The world’s largest economy has lost 6 million jobs since December 2007, the start of the deepest recession in 50 years.

Under Chairman Ben S. Bernanke, the central bank has doubled its balance sheet and created unprecedented emergency programs to unclog credit markets.

Recent Data

While recent data indicate a smaller pace of decline in some areas of the economy, such as housing and new construction, joblessness is climbing and the increasing cost of residential loans is impeding new lending. The unemployment rate reached 9.4 percent in May and new mortgage lending is at a 13-year low.

Rising mortgage rates may “place a drag on a still very sick housing market,” while increasing oil prices may hurt the recovery, Yellen said in her speech. Still, the fiscal stimulus and a rebound in consumer demand and housing construction will probably prompt a revival in economic growth, she said.

“We’ve seen encouraging signs lately that the economy is poised to turn the corner,” the bank president said. “Our major banks have made excellent progress in establishing the capital buffers needed to continue lending even through a downturn that is more serious than we anticipate. But they are still nursing their wounds and credit will remain tight for some time to come.”

Predominant Risk

As for inflation, the “predominant risk” is that it will “be too low, not too high, over the next several years,” Yellen said. Inflation excluding food and energy may fall to about 1 percent over the next year and remain below 2 percent, with an unlikely possibility of turning into deflation if the economy fails to recover soon, she said.

Another Fed district bank president, Charles Evans of Chicago, told reporters in London today that he also sees inflation falling “a bit from where we are now.”

The global financial crisis, which began with the collapse of the U.S. subprime-lending market in 2007, has led to $1.47 trillion of writedowns and credit losses at banks and other financial institutions, according to data compiled by Bloomberg.

The Fed “won’t hesitate” to withdraw the record stimulus it has put in place, when necessary, Yellen said. “If anything, I’m more concerned that we will be tempted to tighten policy too soon, thereby aborting recovery.”

Responding to audience questions after her speech, Yellen said China’s concern about the value of the dollar “is logical” given the country’s holdings in Treasuries.

China’s call for the creation of a reserve currency other than the dollar is “not practical at the current time,” and more of a “long-term” idea, she said.

To contact the reporter on this story: Vivien Lou Chen in San Francisco at vchen1@bloomberg.net

Last Updated: July 1, 2009 14:27 EDT