Bernanke Says Raising Interest Rates Early Risks Stifling GrowthJoshua Zumbrun and Aki Ito
Federal Reserve Chairman Ben S. Bernanke signaled he will keep the Fed’s target interest rate low to support the economy, even as some colleagues warn the policy risks triggering financial market instability.
“Premature rate increases would carry a high risk of short-circuiting the recovery, possibly leading -- ironically enough -- to an even longer period of low long-term rates,” Bernanke said yesterday in a speech in San Francisco. “Only a strong economy can deliver persistently high real returns to savers and investors.”
Bernanke in congressional testimony this week defended the Fed’s $85 billion in monthly bond purchases, saying the benefits of reducing borrowing costs and fueling growth outweigh any potential costs. The Federal Open Market Committee is debating when to curtail the bond-buying amid concern the stimulus may encourage asset-price bubbles and complicate the Fed’s eventual reduction of its $3.09 trillion balance sheet.
The Fed chairman said in response to audience questions that “monetary policy can be a relatively blunt tool for addressing problems in a given market.” He cited the Fed’s attempt in the 1920s to raise rates to head off a stock market boom, and the subsequent Great Depression, to warn of the risks from using interest rates to restrain financial markets.
Bernanke said the central bank seeks to avoid causing disruptions by holding at 0.25 percent the interest rate it pays on reserves that banks keep at the Fed. He said he has “concerns on the effects of functioning of markets” if the Fed cut the rate to zero.
In his remarks, Bernanke expanded on his argument that the Fed’s accommodation remains warranted. By allowing the economy to regain its footing, long-term rates will gradually rise, providing a better return to savers than if the central bank raised rates now, Bernanke said.
“If, as the FOMC anticipates, the economic recovery continues at a moderate pace, with unemployment slowly declining and inflation expectations remaining near 2 percent, then long-term interest rates would be expected to rise gradually toward more normal levels over the next several years,” he said at a San Francisco Fed conference titled “The Past and Future of Monetary Policy.”
Bernanke devoted the bulk of his speech to an analysis of why longer-term interest rates in much of the world have fallen near record lows. The yield on the 10-year Treasury note hit a record 1.379 percent on July 25 and has since risen to 1.84 percent.
Bernanke’s remarks were also a response to an FOMC debate that has emerged publicly over how to confront financial instability that could be provoked by an extended period of very low rates.
Fed Governor Jeremy Stein said last month that some credit markets, including leveraged loans and junk bonds, show signs of too much risk taking. Kansas City Fed President Esther George has warned that prices of some farm land have hit “historically high levels.”
Bernanke said the Fed is “responding to financial stability concerns with the multipronged approach” that consists of monitoring risks, increased supervision and regulation of the financial system and communicating central bank policy well in advance to avoid surprising markets.
“While the recent crisis is vivid testament to the costs of ill-judged risk-taking, we must also be aware of constraints posed by the present state of the economy,” he said. “In light of the moderate pace of the recovery and the continued high level of economic slack, dialing back accommodation with the goal of deterring excessive risk-taking in some areas poses its own risks to growth, price stability, and, ultimately, financial stability.”
Bernanke noted that while too-low rates risk spurring asset bubbles, interest rates that rise too quickly threaten to impose losses on institutions that hold fixed-income assets.
The Fed has said it will start selling some of its assets as it withdraws stimulus. “Adjustments to the pace or timing of asset sales could be used, under some circumstances, to dampen excessively sharp adjustments in longer-term interest rates,” he said.
During his semi-annual testimony to Congress this week, Bernanke faced criticism from Senator Bob Corker, a Republican from Tennessee, who said the Fed’s low-rate policy is “basically punishing people who’ve done the right things and throwing seniors under the bus and others that have saved money.”
Representative John Campbell, a Republican from California, said that “savers and retirees are being forced into riskier assets in the search for some sort of yield. When this unwinds, that is going to be a problem for our savers and retirees.”
The FOMC reiterated in January it will keep its benchmark interest rate near zero as long as the unemployment rate is above 6.5 percent and inflation is projected to be no more than 2.5 percent. It also said it intends to keep buying bonds until there is a “substantial improvement” in the labor market.
Unemployment was 7.9 percent in January. Consumer prices, as measured by the Fed’s preferred gauge, rose 1.2 percent from a year earlier, the least since October 2009.
The Fed’s asset purchases are helping to maintain gains in the stock market as low rates encourage investors to seek higher returns. The Standard & Poor’s 500 Index rallied 13 percent last year and has climbed 6.5 percent this year amid data showing the economy is weathering a fiscal stalemate in Washington.
Bond purchases by the Fed are also pushing down borrowing costs on everything from mortgages to auto loans, spurring the consumer spending that accounts for 70 percent of the world’s largest economy.
Consumer spending rose in January even as incomes dropped by the most in 20 years, showing households were weathering an increase in payroll taxes by reducing savings.
Household purchases climbed 0.2 percent in January after a 0.1 percent gain the prior month, a Commerce Department report showed yesterday in Washington.
Manufacturers are expanding production as consumer demand grows and businesses boost investment. The Institute for Supply Management yesterday said its factory index rose to 54.2 in February, the highest reading since June 2011.
Applied Materials, the largest producer of chipmaking equipment, forecast fiscal second-quarter sales that beat most estimates, indicating that some customers are expanding output on brisk demand for mobile devices.
“The momentum in the business is strong,” Michael Splinter, chief executive officer at the Santa Clara, California-based company, said at a conference. “Our display business is starting to come back. Orders are picking up there as well.”
Bernanke and his FOMC colleagues will know more about the job market when the Department of Labor releases its monthly report on March 8. The unemployment rate last month was unchanged at 7.9 percent, with 160,000 jobs created, according to the median estimate of economists in a Bloomberg survey.