But critics of the central bank’s policies — including some Fed officials — have warned that years of ultra-low interest rates and the Fed’s purchase of billions of dollars in bonds each month may lead to serious unintended consequences such as inflation. On Tuesday, Bernanke directly addressed those concerns and promised that the Fed would keep its easy-money policies in place “as long as needed.”
“Monetary policy is providing important support to the recovery,” he said.
Fed officials have already been debating how and when to stop spending $85 billion a month on government and mortgage bonds to prop up the economy, according to details of the Fed’s most recent policymaking meetings. And recent speeches by several Fed officials have focused on the risks of the program, known as quantitative easing, to inflation and financial stability. Even that whiff of potential change in Fed policy was enough to send markets tumbling last week.
At the hearing, however, Bernanke countered each argument in a spirited defense for staying the course. He noted the toll the recent spike in gas prices is taking on household budgets and emphasized that the job market “remains generally weak.”
“High unemployment has substantial costs, including not only the hardship faced by the unemployed and their families but also the harm done to the vitality and productive potential of our economy as a whole,” Bernanke said.
He acknowledged that low interest rates might force investors to hunt for higher returns on riskier products, a concern highlighted this month by Fed Governor Jeremy C. Stein. But Bernanke said the Fed has stepped up its monitoring of emerging risks. He also argued that low rates can help reduce financial instability by encouraging businesses to use longer-term funding and by lowering the cost of paying off debt.
“We do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more rapid job creation,” Bernanke said.
He also tried to assure lawmakers that the Fed would unwind its stimulus smoothly. Critics have worried that inflation expectations could rise if the Fed bungles its exit. But Bernanke said that the central bank’s profit would probably still be higher than it was before the financial crisis, even if it loses money on its bond purchases.
“I think we have the technical means to unwind at the appropriate time,” he said. “Picking the exact moment to do so, of course, is always difficult.”
Much of the lawmakers’ questions focused on the impact of the across-the-board federal spending cuts — also known as the sequester — set to start to take effect Friday. President Obama and Democratic lawmakers have been at a stalemate with Republicans over how to arrest the dramatic spending cuts, with virtually no sign of a deal to come before the end of the week. The Congressional Budget Office estimates that the cuts would shave six-tenths of a percentage point from economic growth this year.
“It seems that our fiscal policy is not complementary to your policy,” Sen. Jack Reed (D-R.I.) said. “In fact, [it is] contradictory.”
Bernanke called on lawmakers to replace the front-loaded cuts with more gradual reductions that grow over time. He also warned that monetary policy “cannot carry the entire burden of ensuring a speedier return to economic health.”
The testiest exchange during the hearing was prompted by Sen. Bob Corker (R-Tenn.), who accused the Fed of sparking a currency war and creating a “faux wealth effect.”
“None of the things you said are accurate,” Bernanke retorted.
But Corker persisted, arguing that the Fed’s effort to keep interest rates low penalized those living off savings.
It’s “punishing people who have done the right things and throwing seniors under the bus,” Corker said.
Bernanke also faced scrutiny from both sides of the aisle over the Fed’s progress in crafting regulations to prevent large banks from becoming “too big to fail.” Both Sens. Elizabeth Warren (D-Mass.) and David Vitter (R-La.) pointed out that the cost of funds for large banks is lower than for small ones because investors believe the government will bail the bigger ones out.
That is a sign that the Fed’s actions to curtail systemic risk from large institutions have not been credible, Vitter said.
“In my opinion, they’ve been digested and valued by the market. And the market still says there’s too big to fail,” he said.
Bernanke said he believes the market expectations were incorrect. He agreed that “too big to fail” should end but said the Fed’s rulemaking process is “moving in the right direction.”
Warren countered: “Any idea about when we’re going to arrive in the right direction?”