Bernanke: Fed Will Focus on Preventing Downturn
WASHINGTON _ There are two economic beasts staring down Federal Reserve Chairman Ben Bernanke and, by extension, the U.S. economy: A debilitating recession and destructive inflation.
Backed into a corner from the spreading effects of a housing-triggered credit crunch, Bernanke indicated Wednesday that inflation is the lesser worry and he signaled the central bank will focus its attention on preventing a steep economic downturn.
In testimony before the House Financial Services Committee, the embattled Fed chairman signaled that another interest rate reduction is coming in March, perhaps as much as one-half percentage point, as he continues to try to get ahead of the curve on a financial market squeeze that many say he was late in anticipating.
“The economic situation has become distinctly less favorable” since last summer, he said. “The housing market is expected to continue to weigh on economic activity in coming quarters.”
He said a surge in oil prices and food prices is worrisome, but he shed his inflation-fighting rhetoric for the moment to address the economic weaknesses he now faces. Bernanke also suggested Congress might need to come up with more far-reaching alternatives to deal with the economic fallout from the housing sector, including direct and costly measures by the government.
Widely accused of waiting too long to attack the growing credit problems that began to strangle economic growth last fall, Bernanke indicated that he has gotten the message. He spoke of a sluggish economy, falling house prices that could impact consumer spending and financial markets that “continue to be under considerable stress.”
He made it clear that he is trying to balance the risks now confronting the economy, which many analysts say is already in a recession. And he made clear that he wants to avoid a widespread crisis of confidence that would be harder to contain.
“You fight the enemy in front of you, not the one over the hill,” said David Wyss, chief economist at Standard & Poor’s, the credit-rating firm. “Right now, the danger is recession, and inflation is just over the hill…. My general feeling is the Fed is worried about a meltdown in financial markets.”
Diane Swonk, chief economist at Mesirow Financial in Chicago, added, “The Fed is in full risk-management mode,” and added that Bernanke “has all the weight on his shoulders” and is showing his discomfort in trying to manage the situation.
“He’s playing catch-up,” said Joel Naroff, an economic consultant in Holland, Pa., saying that Bernanke was too slow to act when the credit crunch began to hit the economy last summer.
Bernanke came to the Fed as an advocate of “inflation targeting,” a concept meaning that the Fed would raise interest rates if inflation rose above a specified range. But he has backed away from that idea. Though inflation now appears to re-igniting, he is being forced by events to look the other way until financial markets regain stability.
The danger Bernanke faces is a miscalculation in which the Fed lowers interest rates more to spur growth only to find that it fans inflation. In recent weeks economists have begun to warn of the perils of “stagflation,” or economic stagnation combined with sharp inflation like that which prevailed in the 1970s.
If the central bank reduces interest rates by another half percentage point on March 18, its benchmark interest rate that banks charge each other for overnight lending would fall to 2.5 percent. Since last September, it has reduced interest rates by 2.25 percentage points.
The Fed chief declined to give his support to various proposals in Congress to use more government power and resources to deal with the housing crisis. One such proposal would expand the Federal Housing Administration’s ability to buy mortgage-backed securities from Wall Street banks at a discount. Another would provide $4 billion to state and local governments to redevelop foreclosed homes.
Sen. Dick Durbin (D-Ill.) is sponsoring a bill that would allow bankruptcy judges to cut interest rates on mortgages to a “reasonable” rate for homeowners who cannot afford their “sub-prime” mortgages now that their initial low teaser interest rates are expiring and higher rates _ and monthly payments _ are taking effect. But the White House vehemently opposes the Durbin plan, saying it favors a voluntary plan in which the banking industry can rework the loans.
Bernanke said that the bankruptcy relief plan causes “conflicting effects.” It could help some people to avoid foreclosure, he said, but it would “probably lead to higher interest rates. I think I’m going to leave this to Congress.”
But he told members of the panel that “we need to be flexible and address the (economic) situation as it arises. It’s worthwhile to be thinking of approaches one might take if the housing situation were to get worse…. At the moment, we are satisfied with the approaches we are taking.”
Congress has already approved a $168 billion economic stimulus package to boost the economy, but most taxpayers will not get their checks until late spring. Meantime, the Fed’s interest-rate reductions also will take time to have a real impact on the economy _ usually six to nine months.
Since the credit crunch hit, the economy has gone steadily downhill. It grew only slightly in the fourth quarter. The economy could currently be in a recession, many analysts said. Bernanke’s task is to contain the current weakness in business _ a job that most analysts said will be difficult.
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