Federal Reserve Chairman Ben S. Bernanke said the U.S. economy remains hampered by high unemployment and government spending cuts, and tightening policy too soon would endanger the recovery.
“A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further,” Bernanke said today in testimony prepared for a hearing at the Joint Economic Committee of Congress in Washington. Monetary policy is providing “significant benefits,” he said.
Bernanke is leading the most aggressive economic stimulus in the Fed’s 100-year history in an effort to spur growth and reduce an unemployment rate that stands at 7.5% almost four years into a recovery from the longest and deepest recession since the Great Depression.
While the labor market has shown “some improvement,” the Fed chairman said “high rates of unemployment and underemployment are extraordinarily costly.”
“Not only do they impose hardships on the affected individuals and their families, they also damage the productive potential of the economy as a whole by eroding workers’ skills and -- particularly relevant during this commencement season -- by preventing many young people from gaining workplace skills and experience in the first place,” he said.
William Dudley, president of the Federal Reserve Bank of New York, also signaled that it’s too soon to tighten policy.
“Three or four months from now I think you’re going to have a much better sense of, is the economy healthy enough to overcome the fiscal drag or not,” Dudley said in an interview with Michael McKee on Bloomberg Television that aired today.
Fed officials started a third round of asset purchases known as quantitative easing in September and increased them in December to $85 billion a month of Treasuries and mortgage- backed securities.
The Fed aims to drive down interest rates and encourage investors to seek higher returns in riskier assets, broadening the impact of the central bank’s stimulus. Lower borrowing costs for households and businesses allow them to refinance and pare debt, freeing up more cash for spending or dividends.
“With unemployment well above normal levels and inflation subdued, fostering our congressionally mandated objectives of maximum employment and price stability requires a highly accommodative monetary policy,” Bernanke said.
The personal consumption expenditures price index rose 1% for the year ending March, below the central bank’s 2% goal. At the same time, “measures of longer-term inflation expectations have remained stable and continue to run in the narrow ranges seen over the past several years,” Bernanke said.
Bernanke’s strategy, combined with expectations of faster growth in coming years, has helped support a 17% rise in the Standard and Poor’s 500 Index this year.
Returns on riskier assets have become more attractive with U.S. 10-year notes yielding as little as 1.63% May 2. The 10-year note yielded 1.93% yesterday. An index of high- risk, high-yield junk bonds tracked by Bank of America has a total return of 5.4% this year versus minus 0.3% for an index of Treasury and agency securities.
The Fed chairman said the central bank is on the watch for financial imbalances that may result from its low interest-rate policy. He also said another cost of the policy is that savers are receiving low returns.
“Recognizing the drawbacks of persistently low rates, the FOMC actively seeks economic conditions consistent with sustainably higher interest rates,” the Fed chairman said. “Unfortunately, withdrawing policy accommodation at this juncture would be highly unlikely to produce such conditions.”
“In considering whether a recalibration of the pace of its purchases is warranted, the committee will continue to assess the degree of progress made toward its objectives in light of incoming information,” Bernanke said, referring to the Federal Open Market Committee, the Fed panel that sets monetary policy.
Rising stock prices, consumer confidence, and housing values may be creating a foundation for self-sustaining growth this year. U.S. gross domestic product expanded at a 2.5% annual rate in the first quarter, helped by gains in consumer spending, after increasing at a rate of just 0.4% in the prior quarter.
“Compared to two years ago, three years ago, there are bright spots in this economy in housing, energy and automotive that would say this tepid recovery is moving into a phase where it can stand on its two legs,” Michael Jackson, chairman and chief executive of AutoNation Inc. told investors on an earnings call April 18.
Fed officials said in their statement May 1 that the Federal Open Market Committee “is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.”
Since then, some regional Fed bank presidents have indicated that they may be inclined to pare back the purchases if economic data continues to show the expansion gaining strength, while others said continued stimulus is necessary.
Philadelphia Fed President Charles Plosser last week called for shrinking purchases at the Fed’s next meeting; San Francisco’s John Williams said the central bank “could reduce somewhat” the pace of purchases as early as this summer “if all goes as hoped,” and Boston’s Eric Rosengren said low inflation and high unemployment suggest there may be a need for more stimulus, not less.
Charles Evans of Chicago said May 20 that he’d like to see monthly employment growth of 200,000 or more for at least six months before judging the labor market substantially improved. Payrolls have increased an average 208,000 a month over the last six monthly reports through April.
“If I had high confidence that this was going to be maintained over the next six months and beyond, I would be quite amenable to discussions about adjusting the flow of purchases downward,” Evans told reporters after his speech. “I’d like to see a few more months of data.”
Fed officials have left the benchmark lending rate near zero since December 2008 and have expanded the balance sheet to $3.35 trillion compared with $879 billion on May 9, 2007, with quantitative easing.