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Bernanke looking ahead to bailout 'exit strategy' as fears lessen

The Fed chief said he sees the economy beginning to revive by year-end.

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Bernanke can’t promise that the financial panic is over. But for now at least, he and the nation are starting to focus on different problems ahead.

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Lawmakers pressed the Fed chief on whether he has an exit strategy. How, they asked, will he pull back from all the stimulus and rescue efforts before they result in inflation or in costly burdens for taxpayers?

“We are spending an enormous amount of time” developing an exit strategy, Bernanke said. “We are very committed to price stability.”

He said many of the Fed’s emergency lending programs can be wound down fairly easily as private credit markets get back to business.

Since the financial crisis reached its peak last fall, the Fed has been stepping in as a “lender of last resort” to banks and private-sector firms that suddenly found themselves less able to find financing.

Bernanke said the programs, while not the Fed’s business during normal times, amount to profitable and safe lending. Thus, while economic rescue efforts at the US Treasury are costing taxpayers lots of money, the central bank doesn’t expect to turn to taxpayers.

Balancing concerns

Still, Bernanke acknowledged that the exit-ramp issue is a tricky one, taking up as much as half the discussion time at two-day policy meetings that top Fed officials hold every few weeks.

“How do we make sure that the monetary base contracts at the appropriate time?” Bernanke asked. “There’s risk on both sides, and we’re trying to manage,” he said.

He cautioned against worrying too soon about inflation at a time when unemployment is rising and US factories have a lot of spare capacity. “We don’t expect to see much inflation” in that environment, he said.

In fact, he said an economic recovery should not be taken for granted. The Fed forecast of growth reviving later this year hinges on the assumption of a continued healing in credit markets, he said.

Rep. Ron Paul (R) of Texas pushed Bernanke to comment on what the Fed would do in a scenario where inflation heats up without an economic recovery.

Bernanke said he viewed that as unlikely but in that case, he would focus on price stability, because of the damage that out-of-control inflation can have on an economy.

He tried to counter concern that, with federal budget deficits shooting above $1 trillion a year, the Fed would face political pressure if the Treasury has trouble finding buyers for all the bonds it has to issue.

They will not “monetize the deficits” by allowing higher inflation (in a bid to lower the government’s real debt burden), Bernanke insisted.

Still, the questions point to a challenge for the government. The government's total outstanding debt could roughly double between 2008 and 2012, according to some forecasts.

If bond buyers grow more cautious about the prospects of being paid back in un-inflated dollars, the Treasury’s cost of borrowing could rise while the government is still trying to put the economy back on track.