Ben Bernanke sought to reassure financial markets Friday on two fronts: that the Federal Reserve sees growth ahead for the US economy and, at the same time, that the Fed stands ready to provide more economic support if needed.
The Fed chairman, in a major speech, spelled out what he sees as the central bank's policy options to help lift an economy burdened by high unemployment and low consumer and business confidence. He spoke at an annual late-summer conference for central bankers in Jackson Hole, Wyo.
His words didn't spark either a major rally or a rout on Wall Street. Stock indexes rose modestly by mid-day as investors digested Mr. Bernanke's comments.
"I expect the economy to continue to expand in the second half of this year, albeit at a relatively modest pace," Bernanke told the conference, according to a text released by the Fed. That slow pace, he added, means that "the prospect of high unemployment for a long period of time remains a central concern of [Fed] policy."
The speech came just after the Commerce Department released a revised estimate of US growth in the second quarter, showing gross domestic product (GDP) expanding at an annualized pace of just 1.6 percent. Also Friday, a Reuters/University of Michigan index of consumer sentiment ticked upward by 1.1 points for the month of August, after a large decline the previous month.
Bernanke warned that central bankers "alone cannot solve the world's economic problems." But he said the Fed "retains a number of tools and strategies for providing additional stimulus" if needed.
Some critics of the Fed say more support for the economy is already needed, with a new recession dangerously close as a possibility. That would not only boost unemployment, but also could make it harder for the Fed to maintain stability in consumer prices. The great risk would lie in a Japan-style collapse into a cycle of deflation, with falling prices and wages damaging economic confidence and the profits companies need in order to hire.
Bernanke acknowledged the risk of deflation but played it down. He said inflation was running slower than the Fed's policymaking committee would like to see. But he said "the risk of either an undesirable rise in inflation or of significant further disinflation seems low."
One possible factor behind his cautious words is that Fed policymakers don't all agree on what's needed next. Some believe the economy needs little new support, and that the primary concern should be moving toward an "exit strategy" from the emergency measures the central bank has taken since 2007. Another camp is more inclined to consider expanded monetary stimulus.
Bernanke highlighted three ways the Fed could act to spur US growth:
- Expanding the Fed's holdings of longer-term securities. He said that moves to buy Treasury or mortgage bonds since 2008 were "effective in bringing down term premiums and lowering the costs of borrowing in a number of private credit markets."
- Using the power of the pen. The Fed could modify the language used in its recent post-meeting statements, for example, to communicate that its short-term interest rate will remain near zero percent "for a longer period than is currently priced in markets."
- Lowering the rate of interest that the Fed pays to private banks on the reserves they hold with the Federal Reserve System. Bernanke explained that "on the margin, [this] would provide banks with an incentive to increase their lending to nonfinancial borrowers ... possibly leading to some expansion in money and credit."
This list doesn't include all the Fed's options.
The central bank could, to give one example, create new programs to encourage bank lending, essentially by becoming a partner of commercial banks. By taking more private-sector loans onto its own balance sheet, the Fed could push private banks to lend more.
Even though his speech focused on policy options, Bernanke's overall tone was of tempered optimism.
"Despite the weaker data seen recently, the preconditions for a pickup in growth in 2011 appear to remain in place," he said. "Financial conditions have become more supportive of growth, in part because a concerted effort by policymakers in Europe has reduced fears related to sovereign debts and the banking system there."
He said banks are slowly becoming more willing to lend, consumers are repairing their finances, and businesses appear likely to invest "at a healthy pace in the coming year."