By Neil Irwin
Washington Post Staff Writer
Thursday, February 28, 2008
Federal Reserve Chairman Ben S. Bernanke came to Capitol Hill yesterday during a swirl of new evidence that the economy is getting weaker and inflation is on the rise. But his message was the same as it has been since the beginning of the year: His foremost concern is the slumping economy, and more interest rate cuts could well be on the way.
Bernanke told the House Financial Services Committee about the risk that the housing market will get even worse than anticipated, that the labor market will soften more or that credit will become even less available than it is now. "The risks to this outlook remain to the downside," he said in a semiannual report to Congress on the state of the economy.
He repeated language from previous public comments that Fed policymakers "will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks." Translation: We are ready to continue cutting interest rates to try to prevent a dangerous downward spiral in the economy.
"He held pretty close to his script," said Scott Anderson, a senior economist at Wells Fargo. "He didn't say the word recession, but if you read between the lines, all this talk about further downside risk is dealing with the risk we may already be in one."
Bernanke's testimony was the clearest indication yet that a rush of bad news on the inflation front -- both consumer and wholesale prices rose more in January than expected -- has not deterred the Fed from the most aggressive campaign of interest rate cuts in decades. The central bank has cut the federal funds rate, which it controls directly, by 1.25 percentage points in 2008 and 2.25 percentage points since September.
Futures markets are pricing in a high likelihood of a half-percentage point rate cut at the Fed's March 18 policymaking meeting. The expectation of further rate cuts drove down the value of the dollar, whose value against the euro hit a new low. A euro cost $1.51 yesterday.
Underscoring the softening in the economy, the Commerce Department yesterday said that orders for big-ticket durable goods, a leading indicator of where the economy is heading, fell 5.3 percent in January, more than expected. New-home sales fell 2.8 percent in January, the department reported, also more than analysts had forecast.
Bernanke expressed more explicit concern about inflation than he did in testimony to the Senate two weeks ago. He and his Fed colleagues project that the most likely scenario is that inflation will come down this year, as food and energy prices level off on world commodity markets.
Bernanke acknowledged that there are rising risks that projection will prove wrong. He said that "the further increases in the prices of energy and other commodities in recent weeks, together with the latest data on consumer prices, suggest slightly greater upside risks to the projections of both overall and core inflation than we saw last month."
The Fed puts considerable importance on inflation expectations; if consumers and businesses expect prices to keep rising rapidly, it can become a self-fulfilling prophesy. Recently, indicators from the bond market show that investors' expectations of inflation over the coming years have been creeping up.
"Should high rates of overall inflation persist, the possibility also exists that inflation expectations could become less well anchored," Bernanke said, acknowledging this psychological dynamic.
Bernanke resisted taking a position in a hot debate in Congress over whether to allow bankruptcy courts to redefine terms of mortgages on primary residences. Democratic proponents say it would make it possible for many Americans to avoid foreclosure by having a judge redefine mortgage terms. Republican opponents, including the Bush administration, say this would interfere with existing contracts and would make lenders less willing to offer mortgages, raising rates for everyone.
"I think it would help some people," Bernanke said. "On the other hand, it would probably lead to concern about the value of existing mortgages and, probably, higher interest rates for mortgages in the future. And so it's a very difficult trade-off."
While committee members tried to gain Bernanke's seal of approval for various pet policies, he generally avoided giving it.
They took a largely deferential tone to Bernanke. House Financial Services Committee Chairman Barney Frank (D-Mass.) said this unconventional economic downturn -- rooted in the housing market, not in an overhang of business inventories -- makes Bernanke's job tougher.
Frank went out of his way to avoid putting words in Bernanke's mouth, however. "I don't want to impute to you the view that we're in a recession because I'm not going to be responsible for the nervous people at the stock market who overreact when you twitch your nose," Frank said.