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ECONOMYJULY 14, 2011, 12:32 P.M. ET
Bernanke Not Yet Ready to Step In
By JEFFREY SPARSHOTT, MICHAEL R. CRITTENDEN and JON HILSENRATH
Federal Reserve Chairman Ben Bernanke said Thursday that the central bank wasn't ready yet to take additional steps to boost the economy, acknowledging that the outlook for the recovery remains uncertain.
"We are not prepared at this point to take further action," Mr. Bernanke said, starting his second day of testimony on Capitol Hill as lawmakers focused on Moody's Investors Service's move to put the U.S. government on review for possible downgrade.
The Fed chairman said the economic situation was different now from the state of play in August 2010, when the central bank began to discuss its $600 billion bond-buying program. At that time, inflation was dropping, posing a serious risk to the economy, and the recovery appeared to be headed for a stall.
"Today the situation is more complex," Mr. Bernanke said, with inflation expectations closer to the Fed's target. "We are uncertain about the near-term developments in the economy. We would like to see if the economy does pick up as we are projecting."
Mr. Bernanke faced the Senate Banking Committee a day after cracking the door open to new actions to support a stumbling economy and acknowledging growing public worries about the sustainability of the recovery.
Sen. Richard Shelby (R., Ala.) cautioned that the Fed would be going in "the wrong direction" if it started a third round of bond purchases to boost the economy.
"The stage is set for a resurgence of inflation if the Fed is not real careful," Mr. Shelby, ranking Republican on the Senate panel, said at the start of the hearing. He said the Fed's first challenge should be determining how to unwind its balance sheet.
Mr. Bernanke also addressed the European debt crisis, saying the U.S. economy could face broad headwinds from a further decline in Europe's fortunes even if direct U.S. exposure to the region's problems was minimal. Still, he said the central bank had spent a good deal of time evaluating the potential exposure of U.S. financial institutions and didn't see a potential systemic risk.
"Were there to be a significant deterioration in conditions in Europe, we would see a general increase in risk aversion, declining asset prices, a lot of volatility," he said, adding: "The direct exposures ... are quite small and manageable, so we wouldn't expect those direct impacts to be the critical channel if there were problems—a default, for example."
European officials are trying to negotiate a rescue package for Greece to stave off a government debt default and damage to other European economies.
More
Bernanke: European Troubles 'as Much Political' as Economic
Sen. Shelby Cautions Bernanke Against QE3
Fed Chief Open to New Options
Bernanke Shifts Tone on Further Easing
Mr. Bernanke's testimony Wednesday to the House Financial Services Committee showed that in the wake of a recent drumbeat of disappointing economic data, the central-bank chairman has become less confident in his forecast that the economy will pick up speed soon. "There is uncertainty about whether there is a durable recovery," he conceded more than once.
The comments marked a change in tone. For much of the past few weeks, Mr. Bernanke has sought to be reassuring and has argued that the first-half economic slowdown would prove transitory and that growth would pick up in coming months. And he still expects an upturn. A recent retreat in oil prices "should ease the pressure on household budgets," and car manufacturers expect to increase production substantially this summer, he said. But he expressed considerable uncertainty.
Mr. Bernanke spent most of his House testimony addressing the fiscal worries now engrossing Congress as an Aug. 2 deadline approaches for lawmakers to raise the nation's debt limit or run short of funds needed to pay government bills. Mr. Bernanke said he believed the Obama administration would try to avoid defaulting on Treasury securities if the debt limit isn't raised, but the consequences for the recovery would still be severe.
"The assumption is that as long as possible that Treasury would want to try to make payments on the principal and interest of the government debt, because failure to do that would certainly throw the financial system into enormous disarray and have major impacts on the global economy," he said.
"It still would involve a very substantial reduction in government payments, including Social Security checks and military pay and things of that sort," he said. That could damage confidence and undermine a fragile recovery. "It would no doubt have a very adverse effect very quickly on the recovery. I'm quite certain of that," he said.
The Fed last month completed a controversial $600 billion bond-buying program which Mr. Bernanke and most Fed officials believe helped the economy by holding down long-term interest rates, lifting stock prices and reducing the risk of a Japan-style round of falling consumer prices, or deflation. Critics say the program drove down the value of the U.S. dollar and spurred inflation, hurting many households.
One option if the recovery falters would be to restart the bond-buying program. "We have to keep all of the options on the table," Mr. Bernanke said, although bond-buying wasn't the first possibility he mentioned.
The others include a shift in the Fed's communication strategy about the length of its commitment to keep short-term interest rates near zero or its plans for its holdings of Treasury and mortgage securities. Such assurances could hold down longer-term interest rates more broadly. The Fed could also lower the 0.25% interest rate it pays banks for money they keep on reserve at the central bank, and it could alter the makeup of its securities portfolio.
Mr. Bernanke has discussed these options before, but he hasn't acknowledged as explicitly as he did Wednesday that they might be needed. The Fed chairman made clear he is open to taking new steps only if the recovery falters and inflation, which has ticked up in recent months, retreats.
"The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might re-emerge, implying a need for additional policy support," the Fed chairman said. This isn't the Fed's current forecast, though. It projects growth at a rate of more than 3% in the second half of this year and a drop in the unemployment rate, now 9.2%, to between 8.6% and 8.9% by year end.
Fed officials are already charting different positions about next steps. "With fiscal austerity slowing down economies both here and abroad, it will, in my view, be important to maintain sufficiently accommodative U.S. monetary policy so that national labor market conditions can improve," the president of the Boston Federal Reserve bank, Eric Rosengren, said Wednesday.
But Dallas Fed president Richard Fisher said he wouldn't support more easing. "I firmly believe that the Federal Reserve has already pressed the limits of monetary policy," he said.
For now the Fed is on hold. And while talking about steps the central bank might take to help the economy, Mr. Bernanke added that it's possible the Fed will raise interest rates if the economy perks up.