The US faces the prospect of a jobless recovery, with painfully slow employment growth and the economy not operating at its full potential until 2013, a top Federal Reserve official said.

The official, Janet L. Yellen, president of the Federal Reserve Bank of San Francisco, said that a sharp increase in worker productivity was “here to stay”.

She predicted that unemployment, now at 9.7 per cent, would fall to 9.25 per cent by the end of the year and to around 8 per cent by the end of 2011. And she described the current inflation rate as “undesirably low”. The Fed has repeatedly said that it would not start to tighten credit for at least several months. When the time comes, Yellen said, the Fed will probably start by raising the interest rate it pays on bank reserves. Only after that will it gradually sell the Treasury securities and mortgage-related assets it bought to hold down long-term interest rates and support the recovery.

Markets are acutely interested in the timing and sequence of the Fed’s withdrawal of monetary stimulus, particularly after the Fed raised the rate it charges banks for short-term loans recently, a largely technical move but a crucial step toward the normalisation of lending.

Yellen, who was chairwoman of the Council of Economic Advisers during the Clinton administration and is one of the best-known economists among the Fed’s leaders, spoke at the University of San Diego.

Yellen offered a fairly grim outlook. Although gross domestic product rose at an annual rate of 5.7 per cent in the last quarter — the best gain in six years — the improvement was attributable to businesses reducing their inventories, rather than growth in sales, making a “V-shaped recovery” unlikely, she said.

She estimated that the economy would grow about 3.5 per cent this year and 4.5 per cent next year. Although the Fed lowered its benchmark interest rate to near zero in December 2008 and made big loans and asset purchases, Yellen said, “all in all, monetary policy can’t give the same kick to the economy that it delivered in past recoveries.” Yellen said she believed that the culprit was an increase in business efficiency and labour productivity.

“Strapped by tight credit and plummeting sales, businesses have overhauled the way they manage supply chains, inventory, production practices and staffing,” she said. “Stores don’t order merchandise unless they think they can sell it right away. Manufacturers and builders don’t produce unless they have buyers lined up. My business contacts describe this as a paradigm shift and they believe it’s permanent.”

Yellen believes that “economic slack and downward pressure on wages and prices are pushing inflation down”.

Large federal deficits have helped to buffer the economy from the financial crisis and the recession, but if they persist into the recovery, they could push interest rates up and absorb private savings that would be otherwise used in productive investments, Yellen said.

Still, she said there was “no evidence that government deficits cause high inflation in advanced economies with independent central banks, like the Fed.” If anything, Japan — which has run big deficits for years — has “suffered from persistent deflation, not inflation”.

She called the underutilisation in the American economy “the most worrisome challenge for price stability over the next few years”.