By Greg Robb, MarketWatch
WASHINGTON (MarketWatch) — Just two weeks after completing a second extraordinary effort to juice the moribund U.S. economy, the Federal Reserve is contemplating more “untested” steps, the head of the central bank said Wednesday.
Federal Reserve Chairman Ben Bernanke says the central bank is examining several untested means to stimulate growth if conditions deteriorate, even though the central bank believes the temporary shocks holding down economic activity will pass. The Fed at the end of June completed a plan to buy $600 billion worth of Treasury bonds in what markets have dubbed “QE2.”
“The possibility remains that the recent weakness may prove more persistent than expected and that deflationary risks might reemerge, implying additional policy support,” Bernanke told the House Financial Services Committee, in the first of two days of testimony about the economy and monetary policy.
At the moment, Fed officials see a recovery that “will likely remain moderate,” Bernanke said, with the unemployment rate falling “only gradually.” Inflation is expected to subside in coming months, he said.
Fed officials have forecast that the economy will expand at around a 3.5% rate over the next 18 months and Bernanke said this remained the forecast.
“One the temporary shocks that have been holding down economic activity pass, we expect to again see the effects of policy accommodation reflected in stronger economic activity and job creation,” Bernanke said.
But there are a “range of uncertainties about the strength of the recovery and the Fed must engage in “prudent planning” to explore ways for stimulating demand, he said.
Bernanke discussed three approaches to further easing in his prepared remarks.
One option, Bernanke said, would be for the Fed to provide more “explicit guidance” to the pledge that rates will stay low for “an extended period.”
Another approach would be another round of asset purchases, or quantitative easing, or for the Fed to “increase the average maturity of our holdings.”
Finally, the Fed could also reduce the quarter percentage point rate of interest that it pays to banks on their reserves, “thereby putting downward pressure on short-term rates more generally.”
“Of course, our experience with these policies remains relatively limited, and employing them would entail potential risks and costs,” Bernanke said.
Bernanke was clear to stress that easing was not the only option under consideration and that the next Fed move could well be to tighten.
The broad consensus of Fed watchers has been for the Fed to hold rates steady until the middle of next year and then begin to exit from its ultra-low policy. Only a few economists had predicted an easing. But that was before the June unemployment report, which showed the labor market was just about dead in the water.
The Fed chairman detailed the “broad consensus” among Fed officials about how the Fed plans to exit. This agreement was unveiled in the minutes of the Fed’s June meeting released on Tuesday.
Bernanke defended the Fed’s controversial second round of asset purchases, or QE2, saying that it lowered long-term interest rates and boosted employment.
“When we began this program, we certainly did not expect it to be a panacea for the country’s economic problems,” he said.
Bernanke said Fed officials still believed the unemployment rate would decline to a range of 8.6%-8.9% by the fourth quarter. The jobless rate has moved up to 9.2% in June from 8.8% in March.
