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Federal Reserve ready to step in if economy falters again, Bernanke says

By Neil Irwin
Washington Post Staff Writer
Thursday, July 22, 2010; A15

The Federal Reserve would take action if necessary to keep the economic recovery on track, Chairman Ben S. Bernanke said Wednesday, even as he asserted that he expects the expansion to continue.

It was the first time the Fed chairman has publicly opened the door to further policy steps to bolster the recovery, part of a dual message delivered in his high-profile, semiannual testimony on monetary policy: one of cautious optimism about continued growth and recognition that the risk of a faltering recovery has risen in recent months.

Bernanke and his Fed colleagues "recognize that the economic outlook remains unusually uncertain," he told the Senate banking committee. "We remain prepared to take further policy actions as needed to foster a return to full utilization of our nation's productive potential in a context of price stability."

Financial markets tumbled on Bernanke's testimony. Speculation had built among investors that the Fed chairman might signal that some policy action was imminent or even announce it at the testimony. The Standard & Poor's 500-stock index ended Wednesday down 1.3 percent.

Instead, Bernanke made it clear that new action was not on the table.

"If the recovery seems to be faltering, then we would at least need to review our options, and we have not fully done that review," he said, responding to a question.

Bernanke outlined the further actions he had in mind: cutting the interest rate paid on bank reserves, strengthening the Fed's promise to keep short-term interest rates low for the foreseeable future, or buying enough mortgage securities to replace those that are paid off. If the economy appeared at serious risk of returning to recession, the Fed would consider large-scale purchases of Treasury bonds or mortgage-related securities.

"We have not come to the point where we can tell you precisely what the leading options are," Bernanke said. "Clearly, each of these options has got drawbacks, potential costs. So we are going to continue to monitor the economy closely and continue to evaluate the alternatives that we have."

The banking committee's two senior members had differing tones as they discussed the policies they would like to see out of the Fed.

"It looks like our economy is in need of additional help," said Sen. Christopher J. Dodd (D-Conn.), chairman of the committee. "One of the issues I would like to explore with you today is whether the Fed can do more to help expand output and employment."

Sen. Richard Shelby (R-Ala.), the panel's ranking Republican, who has expressed greater concern about inflation than growth in the past, said that the shift toward considering options such as new asset purchases "is especially concerning because the purchase of even more long-term assets may channel credit to favored segments of the markets at the expense of others."

While Bernanke said he expected continued growth, his comments on the economy were subdued. The expansion that began last year "is proceeding at a moderate pace," he said, acknowledging that both the end of government fiscal stimulus and of businesses' restocking of inventories "will likely be providing less impetus to the recovery than they have in recent quarters."

He characterized the job market as showing continued weakness, which could weigh on the ability of households to drive the recovery in the years ahead. In particular, the 100,000 or so private jobs being created each month so far in 2010 is "a pace insufficient to reduce the unemployment rate materially," he said.

And Bernanke acknowledged the impact of millions of Americans being unemployed for six months or longer. "Long-term unemployment not only imposes exceptional near-term hardships on workers and their families, it also erodes skills and may have long-lasting effects on workers' employment and earnings prospects," he said.

He was more optimistic about the corporate sector, noting that investment in equipment and software "appears to have increased rapidly" in the first half of the year and that exports are rising.

Inflation appears to be a more distant concern; he noted that Fed leaders forecast that consumer prices will rise only about 1 percent this year, below the 2 percent or so targeted by Fed leaders.

Bernanke sought to avoid endorsing specific tax or spending policies. Responding to questions on fiscal policy in which senators tried to get him to endorse their preferred policies, he argued that the long-term budget deficit is unsustainable and that any effort to boost the economy in the short run should be paired with longer-term deficit reduction.

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