Bernanke tells Congress U.S. outlook to improve later this year

The Fed chief and Treasury Secretary Paulson note tightening credit markets but expect a return to normal.

The economy may be weak now, but it's going to improve later in the year as Congress's economic-stimulus package kicks in and prior interest-rate cuts start to help the nation.

That's the message from the government's top economic czars, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson, both testifying before the Senate Banking Committee on Thursday morning.

However, Mr. Bernanke warned that there remain risks to the economy, including a further deterioration of the housing market, softness in the labor market, and credit tightening by the banking industry. In addition, he says the Fed is continuing to monitor inflation, which Bernanke says will moderate. If inflation expectations were to rise, he said it would complicate the central bank's job.

So far, inflation has been mainly falling on household budgets, says Scott Brown, chief economist at Raymond James & Associates in St. Petersburg, Fla. "We're not seeing wage inflation and a rise in inflation expectations.... But it doesn't help that oil is closing in on $95 a barrel again."

The senators were particularly concerned about some of the cracks now appearing in the credit markets. For example, some college-loan programs are having trouble raising funding, and some short-term securities have become difficult to sell to investors. On Wednesday, the Port Authority of New York and New Jersey was forced to offer to pay interest as high as 20 percent to sell $100 million in short-term securities. That's up from 4.3 percent last week.

"Clearly, the Port Authority is not going to pay 20 percent, it will refinance," said Mr. Paulson, adding that the Treasury was monitoring the situation. Bernanke said if credit conditions were to continue to worsen, the Fed might have to take further action. But he was also somewhat upbeat, expecting the credit markets to return to normal. "I don't think this is a long-term situation," he said.

However, economist David Rosenberg of Merrill Lynch, in an e-mail to clients on Thursday, said the "debt crisis is escalating." He noted that UBS, a major Swiss bank, said there are now some short-term securities that it will no longer buy.

Economists described the testimony as an effort to reassure the nation but still honestly highlight the risks. "They want to make sure everyone knows there is no malfeasance on their part," says economist Bob Brusca of Fact & Opinion Economics in New York.

As the testimony moved through the morning, the stock market started to fall and closed down 175.58 points.

"The markets were hoping for a more direct indication the Fed was thinking of cutting rates right away," says Mr. Brown. "Plus, the tone was a bit somber."

In fact, both Bernanke and Paulson said they expected the housing slump to continue for a while. Paulson encouraged the banks to recognize their losses, raise new capital, and get back to making loans.

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