Fed will respond if oil prices trigger inflation, Bernanke says

Just as the U.S. and global economies are finally strengthening, they face a new danger: Rocketing oil prices. (Feb. 24)
Washington Post Staff Writer
Wednesday, March 2, 2011; 12:00 AM

Federal Reserve Chairman Ben S. Bernanke said Tuesday for the first time that the central bank is prepared to take action if rising prices for oil and other commodities either slow the economy or spark inflation.

Bernanke, testifying before a Senate committee, did not specify whether this action would entail adjusting interest rates, revising plans for buying securities on the open market or other strategies, and he said that economic growth remains on track and that inflation is likely to stay low.

But the rapid rise in commodity - oil closed above $100 a barrel Tuesday for the first time since 2008 - poses new challenges for the Fed. If these prices continue their steep rise, this would simultaneously endanger U.S. growth and put the credibility of the Fed as an inflation-fighter at risk.

Tuesday's rise, a 3.6 percent increase to $100.47 a barrel, was enough to drive the stock market down 1.6 percent as measured by the Standard & Poor's 500, with investors anxious about the impact of higher energy prices on companies' profits and consumers' purchasing power.

In his twice-a-year testimony on monetary policy before the Senate Banking Committee, Bernanke attributed the rise mainly to global forces and said he expects it to cause only a "temporary and relatively modest" increase in inflation for U.S. consumers.

But he also acknowledged that continued price increases could endanger the economy.

"Sustained rises in the prices of oil or other commodities would represent a threat both to economic growth and to overall price stability," Bernanke said. He added that the danger would be especially great if rises in fuel price prompted Americans to begin expecting even more increases in the future. The Fed, he said, is "prepared to respond as necessary to best support the ongoing recovery in a context of price stability."

A slowdown in economic growth would usually lead the Fed to extend its easy money policies or expand them. But rising prices can prompt the Fed to do the reverse by raising interest rates or otherwise make monetary policy tighter. In his comments Tuesday, Bernanke did not make clear which threat he considers more serious.

The message from senators was that higher prices are pinching their constituents.

"I appreciate the [stock] market going up," said Sen. Robert Menendez (D-N.J.). "We're thrilled to see that. But to be honest with you, if you talk to an average family in New Jersey and you say, 'What is your food bill? What is your gas price? What is your tuition rising?' "

In the testimony, the Fed chief remained guardedly optimistic about the economy, maintaining the same tone he had adopted in other recent public comments.

"We have seen increased evidence that a self-sustaining recovery in consumer and business spending may be taking hold," he said in written testimony. But "job growth remains relatively weak, and the unemployment rate is still high."

On Tuesday, the Institute for Supply Management offered the latest reason for optimism, reporting that its index of activity at manufacturing firms showed the fastest pace of expansion last month since 2004.

In response to questions, Bernanke again found himself pulled into the political debate over raising the United States's debt ceiling. With the U.S. debt on track to surpass its legal limit this spring, Republicans say they will not raise the ceiling unless the federal government makes additional spending cuts. Bernanke has become a key figure in arguing that leaving the limit in place, which could prompt a U.S. default on its obligations, would have catastrophic consequences.

"It would be an extremely dangerous and very likely recovery-ending event," Bernanke said, using his strongest language yet to describe a U.S. default. "First, it would almost certainly create a new financial crisis. . . . That problem would cascade through the financial markets. "

Sen. Patrick J. Toomey (R-Pa.) took Bernanke to task, arguing that the Treasury could delay payments other than interest on Treasury bonds without much broader disruption.

"I have to tell you, the market knows the difference between delaying a payment to the guys who cut the grass on the Mall and failure to make a bond payment," said Toomey, a former bond trader. "It's a huge difference, and I really don't think we should be even pretending that there's any equivalence between those two."

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