She described the U.S. economy as "well positioned for continued growth," but at the same time highlighted a number of headwinds that threaten progress. Job wages have been disappointing, and too many people who want full-time jobs and instead working part-time, she said. She also noted a lacklustre housing recovery and modest business investment.
The Fed has kept its key benchmark rate at a record low near zero since December 2008.
"I think it will be appropriate at some point this year to take the initial step to raise the federal-funds rate target and begin the process of normalizing monetary policy," Yellen said to the Greater Providence Chamber of Commerce in Providence, Rhode Island.
But when the central bank finally begins to raise rates, Yellen said it would proceed cautiously, "which I expect would mean that it will be several years before the federal funds rate would be back to its normal, longer-run level."
Yellen's latest comments were made several weeks before the Fed's next policy meeting on June 16-17. Minutes from its April meeting released earlier this week all but ruled out a rate hike next month.
Economists now predict the Fed will wait until at least September and that the central bank will move very gradually with one or two quarter-point rate hikes this year.
Yellen reiterated that policymakers need to see "continued improvement in labour market conditions." They also want to be "reasonably confident" that inflation will approach its 2 per cent target in the medium term.
"The various headwinds that are still restraining the economy, as I said, will likely take some time to fully abate, and the pace of that improvement is highly uncertain," she said.
Earlier Friday, the government reported that core consumer prices rose a bigger-than-expected 0.3 per cent in April. It was the largest one-month gain since January 2013, although overall prices were up just 0.1 per cent, held back by a further drop in energy costs. Yellen did not mention the inflation report in her remarks.
Financial markets were closely watching the comments for any clues Yellen might provide about monetary policy. The initial market reaction was muted given that much of what she said was in line with market expectations.
AP reporter Jennifer McDermott contributed to this report from Providence, Rhode Island.Suggest a correction