Bernanke Outlines Range of Options for Additional Easing

Federal Reserve Chairman Ben S. Bernanke outlined options to ease policy further in case the flagging economic recovery fails to lower unemployment.

Easing tools include further purchases of Treasuries and mortgage-backed securities, and altering the Fed’s language on the outlook for interest rates, Bernanke told the Senate Banking Committee in Washington yesterday. Another option is to use the so-called discount window for direct lending to banks.

“That’s a range of things that we could do,” Bernanke said. “Each one of them has costs and benefits, and that’s an important part of the calculation.”

Bernanke and his colleagues on the Federal Open Market Committee meet in two weeks to continue debating whether further action is needed to reduce joblessness stuck above 8 percent since February 2009. Recent economic data shows the recovery is cooling, with consumer retail sales in June falling for a third consecutive month when economists had forecast an increase.

“We haven’t really come to a specific choice at this point, but we are looking for ways to address the weakness in the economy should more action be needed to promote a sustained recovery in the labor market,” Bernanke said. He resumes his semi-annual testimony before the House Financial Services Committee at 10 a.m. today.

Stocks rallied, with the Standard & Poor’s 500 Index adding 0.7 percent to 1,363.67 at the close of trading in New York. Equities initially fell as Bernanke’s prepared testimony provided no specific plans for boosting growth, then recovered as he signaled in answering questions that he’s concerned about the economic recovery. The yield on the 10-year Treasury note rose to 1.5 percent from 1.47 percent late on July 16.

Action Triggers

Policy makers are “concerned about the economy, but haven’t yet reached a decisive conclusion as to whether the weakness we’re seeing now will persist,” said Michael Feroli, chief economist at JPMorgan Chase & Co. in New York and a former Fed economist. “Everything Bernanke said made it seem like either a failure in the unemployment rate to decline or an increase in deflation risk is going to be what triggers action.”

Bernanke’s remarks yesterday were his first since the Labor Department reported on July 6 that employers added 80,000 jobs to payrolls in June, fewer than economists forecast, while the jobless rate was unchanged at 8.2 percent.

“It’s very important that we see sustained progress in the labor market and avoid deflation risk,” Bernanke said. “Those are the things we’ll be looking at as the committee meets later this month and later this summer.”

Bernanke came under pressure from Senators of both parties, with Republican Jim DeMint of South Carolina saying the Fed’s low-rate policies had deprived savers and retirees of $1 trillion in interest income, and New York Democrat Charles Schumer urging him to do more to reduce unemployment.

Budget Deficits

Schumer said there’s little prospect of a further fiscal boost for the economy as lawmakers seek to reduce budget deficits.

“I’m afraid the Fed is the only game in town,” he said. “And I would urge you to take whatever actions you think would be most helpful in supporting a stronger economic recovery.”

“We will act in an apolitical, nonpartisan manner to do what’s necessary for the economy,” Bernanke said. “We have said we’re prepared to take further action. The complication, of course, is that we are dealing with less conventional tools and we have to make assessments about their efficacy and whatever costs and risks may be associated with them.”

One risk is that Fed policy makers may open themselves to charges that they are making decisions normally reserved for fiscal policy with purchases of housing debt, a step that could be seen as favoring one sector of the economy over others.

Credit Programs

“When the Fed engages in targeted credit programs that seek to alter the allocation of credit across markets, I believe it is engaging in fiscal policy and has breached the traditional boundaries established between the fiscal authorities and the central bank,” Philadelphia Fed President Charles Plosser said in a Feb. 24 speech.

The Fed lowered interest rates to zero in December of 2008 and initiated two rounds of large-scale asset purchases totaling $2.3 trillion. In the first round the central bank purchased Treasuries and housing debt, while it limited purchases to Treasuries in the second round.

Bernanke’s reference yesterday to the discount window may show he is considering a plan to finance new mortgage loans with direct credits from the Fed, said Roberto Perli, managing director in charge of policy research at International Strategy & Investment Group Inc. in Washington and a former senior staff economist in the Fed’s Division of Monetary Affairs.

Stirring Opposition

Such a move would also stir opposition, said Sarah Binder, a senior fellow at the Brookings Institution in Washington.

“My sense is that Republicans will be highly critical of the Fed if it pursues additional stimulus in any form,” she said. “Venturing into mortgage markets beyond buying mortgage-backed securities seems to be a step too far into fiscal policy for Fed critics.”

Last month, the FOMC decided to extend to the end of the year its program, known as Operation Twist, to lengthen maturities of Treasury assets on the Fed’s balance sheet.

The Fed’s actions have helped keep the yield on 10-year Treasuries near record lows. The rate on a 30-year fixed mortgage fell to a record 3.56 percent on July 12.

“It is a very slow track of recovery with therefore slow growth in employment,” former Fed chairman Paul Volcker said in an interview on Bloomberg Television. The Fed “hasn’t got any magic bullets to solve all of these real problems.”