by Asha Bangalore, Northern Trust
Chairman Bernanke's prepared testimony largely echoed the message of the minutes of June 22-23 FOMC meeting. He reiterated that the FOMC expects "continued moderate growth, a gradual decline in the unemployment rate, and subdued inflation over the next several years." He also noted that the "majority saw risks to growth as weighted to the downside." He concluded with the caveat that "the economic outlook remains unusually uncertain." In addition, the customary note of reassurance was the last sentence of the testimony: "We will continue to carefully assess ongoing financial and economic developments, and we remain prepared to take further policy actions as needed to foster a return to full utilization of our nation's productive potential in a context of price stability."
Although the above citations suggest that the outlook is uncertain with the probability of weakening economic conditions much higher than the last time Mr. Bernanke testified about the economy, the following remarks from the Q&A session imply that the Fed is more willing to wait-and-see and weigh options before undertaking unconventional measures: (the emphasis is our own)
"Monetary policy is currently very stimulative. If the recovery seems to be faltering, then we at least need to review our options. We have not fully done that review and we need to think about possibilities. But broadly speaking, there are a number of things we can consider and look at. One would be further changes or modifications to our language or framework, describing how we intend to change interest rates over time, giving more information about that. We could lower the interest rate we pay on reserves, which is currently one fourth of one percent. The third will have to do with changes in our balance sheet and that would involve not either letting securities run off as they are currently or even making additional purchases. We have not come to the point where we can tell you precisely what the leading options are. Clearly each of these options has got drawbacks, potential costs. So we are going to continue to monitor the economy closely and continue to evaluate the alternatives that we have, recognizing that the policy is already stimulative. We still have options, but they are not going to be conventional options, so we need to look at them carefully and make sure we are comfortable with any step that we take."
The guarded approach is justified on the grounds that the U.S. economy is indeed on the recovery path compared with the situation a year ago when the economic outlook was significantly grimmer. Nonetheless, he noted early in the testimony that the pace of private sector job creation (+100,000) in the last six months is "insufficient to reduce the unemployment rate materially"
Deflation and credit crunch did not feature in the testimony. Bernanke's views about other hot issues circulating in financial market media:
Double Dip: Low Probability Event
Small Business: Sales not credit is the main problem.
Fiscal Stimulus: "Bernanke said some people want more government support for the economy, while others are concerned about the federal deficit and the possible negative impact of increasing it."
"There's some truth to both of those arguments."
"The best approach, in my view, is to maintain some fiscal support in the economy, but to combine that" with steps to address the fiscal issue.
