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Bernanke: Fed to take dramatic steps if economy deteriorates more than expected

By Neil Irwin
Washington Post Staff Writer
Friday, August 27, 2010; 10:01 PM

JACKSON, WYO. - With the economy faltering, Federal Reserve Chairman Ben S. Bernanke said Friday he was prepared to take dramatic steps to boost the recovery but only if conditions get worse than he now expects.

In much-anticipated remarks, Bernanke sought to clarify the actions the Fed might take and what would trigger them - and to dispel the confusion that has resulted during his recent public silence, as other top Fed policymakers have aired dissonant views amid conflicting economic signs.

New government data released just before his speech at an economic symposium in Jackson Hole underscored how much economic momentum the nation has lost. Gross domestic product rose at only a 1.6 percent pace in the April-through-June quarter, the Commerce Department said, down from an preliminary estimate of 2.4 percent.

The reaction to Bernanke's remarks, both in financial markets and among economists who follow the Fed, was largely positive. The Standard & Poor's 500-stock index rose 1.66 percent for the day. Analysts said they now have a clearer sense of the direction of Fed policy, even though Bernanke stopped short of making any definitive promises of what is to come.

"He was completely clear and his body language emphatic, that they are willing to take more steps if the economic data justify it," said Allen Sinai, chief economist of Decision Economics, who attended the annual economic symposium sponsored by the Kansas City Fed.

Instead of pledging any particular policy course, Bernanke spelled out the options the Fed has should it look as if the recovery is petering out or a dangerous cycle of falling prices is taking hold. He said he does not expect either scenario.

With its target for short-term interest rates near zero, the Fed can no longer use its favorite tool to stimulate the recovery. That leaves policy in the realm of unconventional and untested alternatives.

For example, the Fed could buy hundreds of billions of dollars in Treasury bonds and other securities, aiming to lower long-term interest rates and keep a cycle of falling prices known as deflation from taking hold.

Other options include cutting the interest rate the Fed pays on reserves banks hold there and pledging to keep short-term rates very low for even longer than the Fed has already signaled.

But the exact impact of that and other remaining tools the Fed has are hard to predict.

"The issue at the stage is not whether we have the tools to help support economic activity and guard against disinflation," Bernanke said. "We do. . . . The issue is instead whether, at any given juncture, the benefits of each tool, in terms of additional stimulus, outweigh the associated costs or risks of using the tool."

In the case of bond purchases, for example, it is not clear that spending even $1 trillion or more would bring down interest rates much for ordinary consumers or businesses, since rates are already very low. But such an expensive bond program could fuel inflation down the road and spark worries that the Fed is "monetizing the debt," or printing money to fund large budget deficits.

Bernanke said that the Fed's policy committee has not agreed on "specific criteria or triggers for further action" but stressed that action would be taken if the economy seemed headed into a new recession or deflationary cycle.

Meanwhile, Jean Claude Trichet, the world's other most powerful central banker, told conference participants that the global economy would have to shed debts incurred during the past three decades. He called this indebtedness an underlying cause of the financial crisis.

"The key challenge for stability and growth over the coming decade is to ensure a progressive reduction in the debt overhang and the orderly restructuring and strengthening of the balance sheets of banks, households, firms, governments and central banks," said Trichet, president of the European Central Bank.

In advocating that governments adopt a cautious approach to fiscal policy and bring budget deficits down, Trichet was again underlining his differences with many American leaders who argue that now is not the time for fiscal restraint. "Fiscal consolidation pushes the economy towards a durable recovery," he said.

With Bernanke signaling that no major Fed actions are imminent, the U.S. government is now hard-pressed to offer any immediate solutions to the nation's economic weakness.

Fiscal policy is largely stalemated ahead of midterm Congressional elections in November, with no new significant spending programs or tax cuts under discussion on Capitol Hill.

With Democrats looking for any way to pump more money into the economy, some senior members of the party are having second thoughts about raising taxes on the nation's wealthiest families and are pressing Democratic leaders to consider extending the full array of Bush administration tax cuts, at least through next year. The White House and Democratic leaders in Congress have been planning to let the Bush-era tax cuts for the wealthiest families expire as planned in December.

Seeking to capitalize on popular frustration over the tepid recovery, House Minority Leader John Boehner (R-Ohio) called earlier this week for President Obama to fire his entire economic team.

In his speech, Bernanke acknowledged that the recovery is "somewhat less vigorous" than he and his Fed colleagues had expected. But he offered some modestly reassuring words about the outlook for growth.

"I expect the economy to continue to expand in the second half of this year, albeit at a relatively modest pace," the Fed chairman said, adding that the conditions needed for an acceleration of growth in 2011 "appear to remain in place."

Bernanke stressed that the Fed does not have the power to single-handedly rescue the U.S. economy.

"A return to strong and stable economic growth will require appropriate and effective responses from economic policymakers across a wide spectrum, as well as leaders from the private sector," Bernanke told the assembled crowd of economists and policymakers from around the world. "Central bankers alone cannot solve the world's economic problems."

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