Yellen said she was concerned by signals in the U.S. bond market that weak economic activity was again heightening the perceived risk of deflation.

She argued Europe's financial crisis threatens to spill over into the United States, potentially by forcing anxious banks to tighten credit at a time when the economic rebound remains tenuous.

"The potential for such adverse financial developments to derail the recovery creates, in my view, significant downside risks to the outlook," Yellen told a financial industry conference in prepared remarks.

She argued inflation is not an immediate concern, but that the nation's unemployment problem posed a persistent problem that needs to be addressed by policymakers.

"We are prepared to employ our tools as appropriate to foster a stronger economic recovery in a context of price stability," she said.

Yellen urged lawmakers not to cut back on spending too quickly, since this could also risk derailing the expansion.

Economic growth has been disappointing despite the Fed's unprecedented monetary support for the economy, including near zero interest rates and over $2 trillion in asset purchases.

Large-scale bond-buying by the Fed has proven a controversial practice, with many conservative economists and politicians — and a number of hawkish regional Fed presidents — saying the policy sows the seeds of future inflation.

But Yellen suggested the Fed is not ruling out the option of further bond purchases, although she indicated any additional program might have to include securities other than the long-term bond on which the central bank has recently chosen to focus.

In September, the Fed announced what has become known as Operation Twist, where it will sell $400 billion in short-term Treasurys to buy longer-dated ones, an attempt to keep long-term borrowing costs as low as possible.