Federal Reserve Chairman Ben S. Bernanke told Congress the central bank is prepared to take additional action, including buying more government bonds, if the economy appears to be in danger of stalling.
“The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support,” Bernanke told the House Financial Services Committee in Washington today. The Fed “remains prepared to respond should economic developments indicate that an adjustment of monetary policy would be appropriate.”
The comments are Bernanke’s first since a government report on July 8 showed employers added 18,000 jobs in June, less than the most pessimistic forecast in a Bloomberg News survey of economists. Bernanke said “disappointing” job growth in May and June was partly a result of temporary effects, such as high energy prices, and he predicted in response to a question that the pace of economic expansion would accelerate above 3 percent in the second half of 2011.
“Once the temporary shocks that have been holding down economic activity pass, we expect to again see the effects of policy accommodation reflected in stronger economic activity and job creation,” Bernanke said in his prepared remarks. He also said that “the economy could evolve in a way that would warrant a move toward less-accommodative policy.”
Stocks rallied on the comments before trimming gains. The Standard & Poor’s 500 Index rose 0.3 percent to 1,317.72 at 4 p.m. in New York after rising as much as 1.4 percent. The yield on the 10-year Treasury note was little changed at 2.88 percent.
Bernanke said the central bank still has ammunition to aid the recovery if the recent economic weakness proves more persistent than policy makers currently expect.
Responding to a question, he said the central bank must “keep all options on the table.”
Bernanke re-affirmed plans by the Fed to sustain record stimulus and to hold its benchmark interest rate near zero for an “extended period.” With unemployment at 9.2 percent, Bernanke told lawmakers that the “economy still needs a good deal of support.”
The committee’s chairman, Representative Spencer Bachus, a Republican from Alabama, told Bernanke he was glad that the Fed was keeping its options open. “You don’t want to get straight jacketed,” Bachus said. “Because we don’t know what tomorrow may bring.”
Bernanke acknowledged there are “uncertainties” in both directions -- about the strength of the economic recovery and the prospects for inflation -- over the medium term.
The Fed chief repeated his belief that inflation won’t be a problem for the economy because gasoline and food prices, which had surged earlier this year, are now moderating.
At the same time, he also reiterated that sagging home prices, high unemployment and hard-to-get loans pose long-term obstacles to growth.
One option for additional stimulus, Bernanke said, would be to pledge to hold interest rates at record lows and the Fed’s balance sheet at a record high close to $3 trillion for a longer period of time. Another option is to embark on a third round of government bond purchases or to increase the average maturity of the Fed’s current securities holdings. The Fed also could reduce the interest rate it pays banks on excess reserves parked at the central bank.
Bernanke said there is also the possibility that inflation could pick up in a way that would require the Fed to begin tightening credit and exit its record monetary stimulus.
The Fed last month completed a program to buy $600 billion worth of Treasury bonds aimed to stimulate the economy by reducing borrowing costs, boosting stock prices and spurring consumer spending.
Bernanke said a failure by Congress to raise the nation’s $14.3 trillion debt limit would lead to a “major crisis” and throw “shock waves” through the financial system. He avoided endorsing specific tax and spending proposals in response to questions from House members.
The debt ceiling should be raised “to prevent us from defaulting on obligations which we have already incurred,” Bernanke said. “We also need, of course, to take a serious attack on the unsustainability of our fiscal position.”
President Barack Obama and Republicans in Congress are scrambling to work out a deal to boost the legal debt limit in return for cutting federal deficits over the next decade. The Treasury Department has said the U.S. will reach the limit of its borrowing authority on Aug. 2.
For all the concern in Washington about the deficit, bond yields in the U.S. are lower now than when the government was running a budget surplus a decade ago. The yield on the benchmark 10-year Treasury note is below the average of 7 percent since 1980 and the average of 5.48 percent in the 1998 through 2001 period, according to Bloomberg Bond Trader.
Bernanke said the Fed’s bond purchases helped the economy. Stock prices are higher and bond yields have fallen. He estimated that effect of the program was roughly equivalent to a 40 to 120 basis-point reduction in the federal funds rate. And, the second round of bond buying lowered long-term interest rates by roughly 10 to 30 basis points.
Bernanke cited estimates made in the fall that the bond-buying could boost employment by about 700,000 over two years, or by about 30,000 extra jobs a month.
At a June 22 news conference, Bernanke didn’t rule out additional purchases if the economy were to weaken further. He and his colleagues pledged at a meeting the same day to hold the Fed’s benchmark interest rate in a range of zero to 0.25 percent, where it’s been since December 2008.
Minutes of the Fed’s meeting released yesterday showed that policy makers were divided on whether additional monetary stimulus will be needed if the outlook for economic growth remains weak.
A few Fed members thought the committee “might have to consider providing additional monetary stimulus, especially if economic growth remained too slow to meaningfully reduce the unemployment rate in the medium run,” the minutes said. A few voiced concern inflation may accelerate and warrant the FOMC “taking steps to begin removing policy accommodation sooner than currently anticipated.”
Economic growth slowed to a 1.9 percent annual pace in the first three months of this year from a 3.1 percent rate in the final quarter of 2010. Fed policy makers blamed bad weather and energy prices for sapping consumer spending.
The economy’s growth probably accelerated to a 2 percent pace in the second quarter, according to the median forecast of 62 economists surveyed by Bloomberg from June 28 to July 7. Shortages of parts for manufacturers caused by the earthquakes and tsunami in Japan forced factories to slow production.
Parts supplies are now rising, along with measures of production. The Institute for Supply Management reported on July 1 that manufacturing expanded at a faster pace in June than the prior month. Orders to U.S. factories also have picked up.
Economic growth will accelerate to a 3.2 percent pace during the second half of this year, according to economists surveyed by Bloomberg News.
The slowdown in the first six months of 2011 prompted Fed officials to mark down their growth projections for the entire year. They forecast that the rate of expansion won’t exceed 2.9 percent this year, down from April’s top-end forecast of 3.3 percent.
Outlook for Unemployment
Unemployment by the end of the year will decline to between 8.6 percent and 8.9 percent. That’s higher than the range of 8.4 percent to 8.7 percent under the previous forecast.
Lockheed Martin Corp., the world’s largest defense contractor, and Cisco Systems Inc., the largest networking equipment company, are among firms reducing employment.
Cisco, based in San Jose, California, may cut as many as 10,000 jobs, including 7,000 by the end of August in a bid to revive profit growth. Lockheed Martin, based in Bethesda, Maryland, said late last month that it plans to eliminate about 1,500 employees from its Aeronautics business unit that makes F-35 jet fighters.
Inflation, excluding food and energy, also will be slightly higher this year, between 1.5 percent and 1.8 percent, Fed officials predict. That’s up from a range of 1.3 percent to 1.6 percent under the old forecast.