San Francisco Fed President Janet Yellen (non-voter) said rates are "appropriate" for encouraging growth and that the real Fed funds rate is near zero.
Speaking to the Financial Planning Association of Northern California, Yellen said low interest rates and the fiscal stimulus should help to spur growth and that she expects a gradual return to moderate growth in 2008.
"I consider the current level of monetary accommodation to be appropriate," Yellen said in prepared remarks.
While inflation data has been disappointing, Yellen said she also expects headline and core inflation to moderate over the next couple years.
"I would expect that inflation will moderate in coming quarters as more slack in labor and product markets emerges and as commodity prices level off," she said in the text of her speech. "Of course, we will continue to monitor developments and act as needed to fulfill our mandate for sustainable economic growth and price stability."
She also said U.S. construction spending will continue to decline in 2009 and the U.S. unemployment will likely rise in the near term.
The Fed cannot afford to be complacent on inflation, she said, but noted that she sees "little reason" to believe the U.S. has entered or is about to enter a period of stagflation.
"For one thing, although current data on growth and inflation have departed from desirable levels, matters looked far worse 30 years ago than they do now," she said.
In a Q&A session following her speech, Yellen said some negative scenarios for the housing market remain and that the extent of the drop in housing prices is the biggest unknown. She also said she is concerned about an adverse feedback loop on home prices.
Yellen went on to say the Fed's additional credit risk is quite minimal and that the Fed's liquidity moves are appropriate, though some measures may not last.
She also said it could take months, if not years before it is known if this period of turmoil was indeed a recession. She added that Congress will consider oversight of investment banks.
In a question and answer with reporters, Yellen said weak economic growth in the United States was not enough to justify a further cutting of interest rates and that it would take some dramatic changes to change the Fed's mind. She also said that rising inflation would probably push the Fed to reverse interest rate sometime soon, but that the central bank would have to be cautious in doing so.
Yellen also said the decline of the U.S. dollar was not the main driver of commodity prices and that housing would probably rebound in 2009.
By Stephen Huebl with contributions from Erik Kevin Francoand edited by Nancy Girgis