San Francisco Federal Reserve President Janet Yellen said the Fed could lower rates below 1%, and that they could reach as low as zero amid a weak economy.

Speaking at an event hosted by the University of California at Berkley and UCLA, Yellen said that loan rates would be substantially higher without the Federal Reserve's aggressive rate cuts.

"We've seen very tentative signs of an easing of stress in money markets," Yellen said, pointing to lower LIBOR-OIS and credit default swap spreads. "However, these spreads remain at levels that are well above normal and other measures of stress have risen even further. Clearly, we have a long way to go before the credit crunch shows significant healing."

Although inflation risks have diminished greatly, recent economic data is "deeply worrisome", she said.



She added that it is worth considering other types of policies to address the crisis.

Yellen said that the credit crunch is one of the factors affecting consumer spending, and added that the credit crisis is also dragging local governments "deeper into the financial mess".

Yellen commented that fed's liquidity steps are "extremely constructive" and that credit markets will thaw over time. She noted that there are "very tentative signs" that money market stress is easing.

Yellen also acknowledged that the Fed's bailout package is a key step in breaking the economy's negative momentum.

On housing, Yellen said a bottom is "not yet in sight" and that the Federal Reserve should give more direct assistance to homeowners.

In a question and answer session following her speech, Yellen said adopting policies that recreate a bubble condition is "not wise" and that there is the danger of an "over-correction" in housing.

By Steve Stecyk and edited by Stephen Huebl
©CEP News Ltd. 2008