Bernanke Doesn't See Stagflation

By Neil Irwin
Washington Post Staff Writer
Friday, February 29, 2008

The economy is not close to a 1970s-style mix of stagnant growth and high inflation, Federal Reserve Chairman Ben S. Bernanke said yesterday, but he painted a generally dour outlook and cautioned that the downturn is likely to cause some small banks to go under.

"I don't anticipate stagflation," Bernanke told the Senate Banking Committee during his semiannual report to Congress on monetary policy. Some analysts have become increasingly worried about that possibility after recent high readings on inflation and weak readings on growth. "I don't think we're anywhere near the situation that prevailed in the 1970s," he said.

As Bernanke spoke, new data and activity on financial markets underscored the risks that the economy is facing. The Commerce Department said that the gross domestic product, the broadest measure of economic output, rose only 0.6 percent in the fourth quarter, disappointing analysts. The Labor Department said that the number of new unemployment claims rose to their second-highest weekly level since Hurricane Katrina struck in 2005. Almost every piece of economic data that has come out this week has been worse than economists had projected.

Those signs of a weaker economy led investors to buy up ultra-safe government bonds, driving the yield on two-year Treasury down 0.18 percentage points, to 1.82 percent, its lowest level in more than a month. The dollar fell to a new low against the euro for the third straight day, and the stock market was off 0.9 percent, as measured by the Standard & Poor's 500-stock index.

At a news conference, President Bush said, "I don't think we're headed to a recession, but no question we're in a slowdown." He criticized a bill in Congress that he said would bail out housing speculators and indicated that he wanted to let the $152 billion stimulus bill he signed this month have a chance to work before considering a second one.

In his second straight day of congressional testimony, Bernanke repeatedly made it clear that he believes the greatest risk facing the economy is slow growth, not high inflation. He said policymakers have fewer options for responding to the situation than they did in 2001 during the dot-com crash.

Then, the government was running large surpluses, which left more room to cut taxes or increase spending. And inflation was very low, giving the Fed leeway to cut interest rates. Finally, world credit markets held up well through that downturn, so Fed rate cuts resulted in lower borrowing costs for consumers and businesses, which is how they are intended to stimulate the economy.

"Am I hearing you correctly that we're in actually -- we're in a worse position today to respond to this than we were eight years ago?" asked the committee's chairman, Sen. Christopher J. Dodd (D-Conn.).

"I think that's fair," Bernanke said, "in that both fiscal and monetary face some additional constraints."

And when asked whether he expects the downturn to result in bank failures, his response was similarly straightforward.

"There probably will be some bank failures," Bernanke said. "There are, for example, some small, or, in many cases, [newly created] banks that are heavily invested in real estate in locales where prices have fallen and therefore they would be under some pressure."

He stressed that he was referring to smaller institutions, not the giant ones, many regulated by the Fed, that are at the center of the world's financial infrastructure.

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