Federal Reserve Chairman Ben S. Bernanke defended the central bank’s record stimulus program under questioning from lawmakers, telling them that ending it prematurely would endanger a recovery hampered by high unemployment and government spending cuts.
“A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further,” Bernanke said today in testimony to the Joint Economic Committee of Congress in Washington.
Bernanke lamented the human and economic costs of an unemployment rate at 7.5 percent nearly four years into the recovery from the deepest recession since the Great Depression, and said the Fed’s easing is providing “significant benefits.” His comments echoed remarks by William C. Dudley, president of the Federal Reserve Bank of New York, who said in an interview that it would take three to four months before policy makers will know whether a sustainable recovery is in place.
Fed officials “need to see inflation expectations remain in a desired range, they need to see that the peak home-buying season goes as well as it can, and they need to see that we have absorbed the bulk of the huge fiscal consolidation” before they reduce the pace of purchases from $85 billion a month, said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey.
Stocks erased an early rally and Treasuries fell after Bernanke said the Fed could “take a step down in our pace of purchases” in the “next few meetings.”
“We’re trying to make an assessment of whether or not we have seen real and sustainable progress in the labor market outlook,” Bernanke said in response to a question from Representative Kevin Brady, the Texas Republican who chairs the committee. “If we see continued improvement and we have confidence that that is going to be sustained, then we could in -- in the next few meetings -- we could take a step down in our pace of purchases.”
Bernanke’s caution was underscored by minutes of the Fed’s last meeting, released after his testimony, which showed many Fed officials said more progress in the labor market is needed before deciding to slow the pace of asset purchases.
“Most observed that the outlook for the labor market had shown progress” since the bond-buying program began in September, according to the record of the April 30-May 1 gathering. “But many of these participants indicated that continued progress, more confidence in the outlook, or diminished downside risks would be required before slowing the pace of purchases would become appropriate.”
The minutes also said that a “number” of officials were willing to taper bond buying as early as the next meeting in June if economic reports show “evidence of sufficiently strong and sustained growth.”
The Standard & Poor’s 500 Index fell 0.8 percent to 1,655.35 at the close in New York. Yields on the U.S. 10-year note climbed 11 basis points, or 0.11 percent, to 2.04 percent, rising above 2 percent for the first time since March.
“The market reacts pretty wildly to any hint of exit,” said Michael Hanson, senior economist at Bank of America Corp. in New York. “It’s a small exit and a lot of people are trying to get out of it -- like a rock concert.”
“The Fed is not looking to very quickly get out of this,” said Hanson, a former Fed economist. “There’s obviously a few members who want to wrap this up sooner than later, but Bernanke doesn’t seem eager to pull back on QE very soon. He wants to see more evidence that the economy really is moving on a forward path.”
Bernanke drew pointed questions from Brady and Representative John Campbell, a Republican from California, as well as Senator Pat Toomey, a Republican from Pennsylvania. Bernanke said the central bank may refrain from selling its holdings of mortgages, as envisioned in its 2011 “exit strategy,” prompting Campbell to ask if the Fed was engaging in “outright monetization” of debt.
While the labor market has shown “some improvement,” the Fed chairman said “high rates of unemployment and underemployment are extraordinarily costly.”
“Not only do they impose hardships on the affected individuals and their families, they also damage the productive potential of the economy as a whole by eroding workers’ skills and -- particularly relevant during this commencement season -- by preventing many young people from gaining workplace skills and experience in the first place,” he said.
Dudley also signaled that it’s too soon to tighten policy.
“Three or four months from now I think you’re going to have a much better sense of, is the economy healthy enough to overcome the fiscal drag or not,” the New York Fed chief said in an interview with Michael McKee on Bloomberg Television that aired today.
Fed officials started a third round of asset purchases known as quantitative easing in September and increased them in December to $85 billion a month of Treasuries and mortgage-backed securities.
The Fed aims to drive down interest rates and encourage investors to seek higher returns in riskier assets, broadening the impact of the central bank’s stimulus. Lower borrowing costs for households and businesses allow them to refinance and pare debt, freeing up more cash for spending or dividends.
Bernanke’s strategy, combined with expectations of faster growth in coming years, has helped support a 16 percent rise in the S&P 500 this year.
Returns on riskier assets have become more attractive with U.S. 10-year notes yielding as little as 1.63 percent May 2. An index of high-risk, high-yield junk bonds tracked by Bank of America has a total return of 5.5 percent this year through today versus minus 0.2 percent for an index of Treasury and agency securities through yesterday.
The Fed chairman said the central bank is on the watch for financial imbalances that may result from its low interest-rate policy. “Our sense is that major asset prices like stock prices and corporate bond prices are not inconsistent with the fundamentals,” Bernanke said in the question-and-answer period following his remarks.
In his prepared text, Bernanke recognized a persistent complaint from congressional constituents -- the low returns savers are earning as a result of the Fed’s policies.
“Recognizing the drawbacks of persistently low rates, the FOMC actively seeks economic conditions consistent with sustainably higher interest rates,” the Fed chairman said. “Unfortunately, withdrawing policy accommodation at this juncture would be highly unlikely to produce such conditions.”
Degree of Progress
“In considering whether a recalibration of the pace of its purchases is warranted, the committee will continue to assess the degree of progress made toward its objectives in light of incoming information,” Bernanke said, referring to the Federal Open Market Committee, the Fed panel that sets monetary policy.
Rising stock prices, consumer confidence and housing values may be creating a foundation for self-sustaining growth this year. U.S. gross domestic product expanded at a 2.5 percent annual rate in the first quarter, helped by gains in consumer spending, after increasing at a rate of just 0.4 percent in the prior quarter.
“Compared to two years ago, three years ago, there are bright spots in this economy in housing, energy and automotive that would say this tepid recovery is moving into a phase where it can stand on its two legs,” Michael Jackson, chairman and chief executive of AutoNation Inc., told investors on an earnings call April 18.
Fed officials said in their statement May 1 that the FOMC “is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.”
Since then, some regional Fed bank presidents have indicated that they may be inclined to pare back the purchases if economic data continues to show the expansion gaining strength, while others said continued stimulus is necessary.
Philadelphia Fed President Charles Plosser last week called for shrinking purchases at the Fed’s next meeting; San Francisco’s John Williams said the central bank “could reduce somewhat” the pace of purchases as early as this summer “if all goes as hoped,” and Boston’s Eric Rosengren said low inflation and high unemployment suggest there may be a need for more stimulus, not less.
Fed officials have left the benchmark lending rate near zero since December 2008 and have expanded the balance sheet to $3.35 trillion compared with $879 billion on May 9, 2007, with quantitative easing.