Bernanke Says Fed Won't Let Markets Disrupt U.S. Economy

By Neil Irwin
Washington Post Staff Writer
Friday, August 31, 2007; 4:16 PM

JACKSON HOLE, Wyo., Aug. 31 -- Federal Reserve Chairman Ben S. Bernanke Friday said that the central bank will take action to prevent problems in the financial markets from disrupting the U.S. economy, if necessary.

In the speech here, Bernanke laid out his thinking on the troubled credit markets publicly for the first time. He addressed a group of economists and other close students of the Fed at the Federal Reserve Bank of Kansas City's annual symposium here.

"Developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy," said Bernanke. Moreover, he said, the Fed's policymaking committee, he said, "continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets."

Both Bernanke's speech and one an hour later by President Bush were being closely watched following the recent disruption in global credit markets and the difficulties being faced by companies exposed to risky, subprime mortgage loans in the U.S.

As investors took in Bernanke's remarks, Bush's speech on the mortgage crisis, and new economic reports, the markets climbed through most of the afternoon. The Dow fell back after gaining more than 150 points to close up 119 points.

"It was a way to reassure the market," said Martin H. Barnes, who studies the Fed at BCA Research and attended the speech. "He did not do anything to dissuade the market from expecting a rate cut at next month's meeting."

But Bernanke also made clear that the Fed has no desire to bail out investors who made foolish bets. "It is not the responsibility of the Federal Reserve -- nor would it be appropriate -- to protect lenders and investors from the consequences of their financial decisions," Bernanke said, an apparent rebuke of critics on Wall Street who would like the Fed to cut its federal funds rate, a decision that would likely ease some of the locked up markets for home mortgage and other debt.

Indeed, he suggested that some of the price declines in securities backed by risky mortgages and other speculative assets is welcome.

"Some increase in the premiums that investors require to take risk is probably a healthy development as a whole, as these premiums have been exceptionally low for some time," he said..

Bernanke indicated that it is particularly challenging to forecast the economy right now using the Fed's usual analytical tools, as most economic data is issued with a lag. Thus, the Fed will be turning to a smaller number of more timely economic indicators and what business people around the U.S. say about how business conditions are progressing.

"In light of recent financial developments, economic data bearing on past months or quarters may be less useful than usual for our forecasts of economic activity and inflation," Bernanke said. "Consequently, we will pay particularly close attention to the timeliest indicators, as well as information gleaned from our business and banking contacts around the country."

On Aug. 7, when financial markets had only begun melting down, the Fed's policymaking arm decided not change its benchmark federal funds rate, indicating that inflation was its foremost worry. But conditions worried over the ensuing ten days, and on Aug. 17 the Federal Open Market Committee indicated that its primary concern had shifted and was a slowdown in growth due to turbulence in the markets.

The policymaking committee will meet again on Sept. 18, and speculation is rampant in financial circles about what the Fed will do next. A cut in the federal funds rate would stimulate the economy and calm financial markets, but might cause the economy to overheat down the road if businesses and consumers turn out to be not particularly affected by the credit crunch.

Even before the Bernanke and Bush speeches -- and amid continuing problems in the real estate industry and rising home defaults -- the markets had some positive news.

Personal income and consumer spending jumped more than expected in July while one measure of inflation remained tame The Bureau of Economic Analysis reported that personal income jumped 0.5 percent in July, the most since March and substantially above what analysts predicted. The extra money was put to use by consumers: spending jumped 0.4 percent, double the level of the month before.

One measure of inflation, meanwhile, increased just 0.1 percent in July excluding volatile food and energy prices, and is rising at a modest annualized rate of less than 2 percent for the first half of the year.

Though some recent economic indicators have been positive -- including a stronger than expected four percent jump in annualized gross domestic product between May and June -- statistics for August, when a global credit crunch hit in full, are expected to indicate a slowdown.

Staff writer Howard Schneider in Washington contributed to this report..

© 2007 The Washington Post Company