Bernanke: Early Tightening Could Choke Recovery

Removing monetary policy accommodation now would not create conditions that would sustain higher interest rates and could halt the economic recovery, Federal Reserve Board Chairman Ben S. Bernanke told the Congressional Joint Economic Committee Wednesday.

"Unfortunately, withdrawing policy accommodation at this juncture would be highly unlikely to produce such conditions," Bernanke said, according to prepared text of his remarks, released by the Fed. "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."

Accommodation is offering "significant benefits" to the economy, including boosting sales of durable goods, such as automobiles, as well as propping up the housing market. "Higher prices of houses and other assets, in turn, have increased household wealth and consumer confidence, spurring consumer spending and contributing to gains in production and employment," he said. "Importantly, accommodative monetary policy has also helped to offset incipient deflationary pressures and kept inflation from falling even further below the Committee's 2% longer-run objective."

But, he noted, officials know that the extended period of low-interest rates carries "costs and risks." He mentioned those who rely on interest income "are receiving very low returns." Also, low rates "could undermine financial stability" as "investors or portfolio managers dissatisfied with low returns may 'reach for yield' by taking on more credit risk, duration risk, or leverage."

But, the Fed is attempting to stave off financial stability concerns using "monitoring, a more systemic approach to supervising financial firms, and the ongoing implementation of reforms to make the financial system more resilient."

While some of the headwinds holding back economic growth have subsides, Bernanke warned, "fiscal policy at the federal level has become significantly more restrictive" and "the Congressional Budget Office estimates that the deficit reduction policies in current law will slow the pace of real GDP growth by about 1-1/2 percentage points during 2013."

With short-term interest rates near zero, Bernanke said, "monetary policy does not have the capacity to fully offset an economic headwind of this magnitude."

Economic growth and stability in the long-term depends upon a federal budget being on a sustainable long-run path. "Importantly, the objectives of effectively addressing longer-term fiscal imbalances and of minimizing the near-term fiscal headwinds facing the economic recovery are not incompatible. To achieve both goals simultaneously, the Congress and the administration could consider replacing some of the near-term fiscal restraint now in law with policies that reduce the federal deficit more gradually in the near term but more substantially in the longer run."

Current conditions are better, with economic growth "at a moderate pace." Real gross domestic product is growing somewhat faster this year (a 2.5% annual rate this year compared with 1.75% in 2012), and the job market has improved, with the jobless rate at 7.5%, down from more than 8% last summer.

"Despite this improvement, the job market remains weak overall: The unemployment rate is still well above its longer-run normal level, rates of long-term unemployment are historically high, and the labor force participation rate has continued to move down," Bernanke said.

Consumer price inflation remains low, with the price index for personal consumption expenditures up 1% for the 12 months ending in March, after a 2.25% rate in the previous 12 months. "This slow rate of inflation partly reflects recent declines in consumer energy prices, but price inflation for other consumer goods and services has also been subdued," he said. Projections are for inflation to stay at or below the Fed's 2% target for "the next few years."

For reprint and licensing requests for this article, click here.
MORE FROM BOND BUYER