RTTNews - San Francisco Federal Reserve Bank president Janet Yellen said Tuesday that despite the current recession, community banks must continue to make loans to credit worthy borrowers to generate profits so that they can safeguard capital while prices remain low.

Speaking at the annual Oregon Bankers Association Convention with the Idaho Bankers Association, Yellen said that expansion of credit and bank reserves will not create high inflation because an excess supply of goods in the markets is keeping demand and prices low.

Businesses are cutting prices to boost sales, she said. As a result, core inflation-a measure that excludes volatile food and energy prices-has drifted below 2 percent, a level that I and most of my colleagues consider consistent with price stability.

Yellen added that she expected core inflation to remain below two percent for several more years, diminishing the need for any urgent tightening of monetary policy.

With unemployment already substantial and likely to rise further, and industrial capacity utilization at record low levels, downward pressure on wages and prices isn't likely to go away soon, she said.

She did say, however, that the Fed would need to withdraw monetary accommodation to prevent higher inflation when the economy recovers, echoing comments made by Fed Chairman Bernanke earlier this month.

When the economy does come back, I can assure you that we will act decisively and appropriately to tighten the stance of policy and maintain price stability, she said.

In her speech, Yellen also downplayed the idea that ballooning deficits will cause runaway inflation noting that that since World War II large deficits have not resulted in spiraling prices in developed countries.

Remember that, in the 1980s, the United States ran large deficits just as inflation was coming down. And Japan has had huge deficits through much of the past two decades, yet its problem is persistent deflation-precisely the opposite of inflation, Yellen said.

She also added that a large part of the current deficit in the United States is temporary and it will fade as the stimulus phases out.

Taken in total, the recent comments of Bernanke and Yellen suggest that both are wary of suggesting interest rate hikes are imminent out of fear that it will snuff out any potential economic expansion.

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