WASHINGTON — Federal Reserve Chair Ben Bernanke reasserted his belief that the economic benefits of the Fed's easy money policies outweigh their financial risks and denied he is too much of a monetary "dove" as he responded to legislators' questions Tuesday.
Bernanke also defended the Fed against charges it started a "currency war" with its "quantitative easing" policies as he presented the Fed's semi-annual Monetary Policy Report to Congress before the Senate Banking Committee. He said Fed monetary stimulus measures are aimed at domestic objectives, not exchange rates.
Although recession in Europe poses downside risks to the U.S. economy, financial risks have lessened, said Bernanke, who suggested it is too soon to judge the impact of the Italian election results.
The Fed chief also downplayed concerns about the Fed's ability to "exit" from its "highly accommodative" monetary policy stance and large balance sheet.
Bernanke seemed much more concerned about what is going on with fiscal policy, which he said is operating "at cross purposes" with monetary policy.
As he did in prepared testimony, Bernanke acknowledged that holding short-term interest rates near zero for more than four years and pushing long-term rates down through bond buying run the risk of incentivizing too much risk-taking in a "reach for yield" by financial market participants.
However, while there are areas of risk to which the Fed needs to "pay attention," Bernanke said that "to this point ... they are not of sufficient concern that they outweigh the important benefits of supporting recovery."
At the recent Group of 20 meeting in Moscow, which Bernanke attended, the Fed and other major central banks were accused by some of using low interest rate policies to weaken their currencies to gain a trade advantage. He fiercely denied this.
After Sen. Bob Corker, R-Tennessee, flatly accused the Fed of "starting a currency war" by using quantitative easing to weaken the dollar and boost economic growth, Bernanke retorted, "We're not engaged in a currency war. We're not targeting our currency."
Bernanke said it was agreed by G20 finance ministers and central bank governors that "it is entirely appropriate to use monetary policy to attain domestic objectives."
Noting that the Bank of Japan is on the verge of expanding its quantitative easing program at the behest of Japan's new prime minister, Bernanke said the Fed's expansionary monetary policy is "replicated" by other major central banks. He said that collectively such policies are "increasing demand globally - not just in our country ... but other countries."
"It's a policy that helps our trading partners," he said, adding, "it's a positive sum game."
Bernanke said there was "certainly some discussion of the issue" of easy U.S. monetary policy affects dollar exchange rates with other currencies. And he acknowledged some "emerging market" nations "are not happy because low interest rates in advanced countries give them a choice they don't like." They either have to "let their exchange rate appreciate" or lower their own interest rates.
Bank of Mexico Gov. Agustin Carstens said in Moscow that the monetary policies of "advanced countries" are causing the creation of new asset price "bubbles" around the world, and Bernanke was asked specifically whether he sees an equity price bubble emerging.
"I don't see much evidence of an equity bubble.," he said, citing relatively high equity premiums and saying "equity investors are still being somewhat risk averse in their behavior."
Bernanke reassured senators the Fed is "monitoring" potential financial imbalances and said, if they "become sufficiently worrisome they will be taken into account in our monetary policy." He said the Fed is watching such things as whether market players are "taking on too much leverage; asset valuations out of line; is interest rate risk too concentrated?"
He said the Fed's bank supervisors are "spending a lot of time looking at our banks to make sure they have appropriate capital, appropriate liquidity. We're watching this very carefully."
Again and again, Bernanke was forced to defend the Fed's policies.
Called a "dove" by one senator, who accused the Fed of hurting elderly savers with low interest rates, Bernanke responded that he is most concerned about those who remain unemployed "for years, who never acquire skills and do not become productive part of the labor market."
"You call me a dove, and maybe in some respects I am," he went on, but he noted he has a record of keeping inflation very low.
"We're working on both sides of our mandate" and "trying to create a stronger economy for everyone," he added.
Bernanke said the low rate of return for savers "is an important issue," but "if we try to raise interest rates (on 10-year Treasury notes) to 3 or 4 or 5% while the economy is still weak it could not be sustained ... the economy is not strong enough."
Trying to raise rates to help savers "would throw the economy back into recession and we'd have low interest rates like the Japanese do," he continued. "The only way to get interest rates up is to have a stronger economy."
Bernanke said the Fed's policies are aimed not only at decreasing unemployment, but also avoiding a Japan-style deflation, and he said the Fed has been successful in doing the latter.
"We're not really trading one against the other," he said of unemployment and inflation. "We've supported both employment and keeping inflation close to our target."
Bernanke reiterated that the Fed's asset purchases - currently proceeding at an $85 billion a month pace - are boosting housing, autos and other durables good spending.
The Fed's policymaking Federal Open Market Committee has said it will continue buying bonds until it sees "substantial improvement" in the outlook for the labor market, then remain "highly accommodative" even after asset purchases end and the recovery strengthens.
Asked what the FOMC means by "substantial improvement" and when the Fed might end quantitative easing, Bernanke was necessarily vague.
"We're going to be looking at a variety of variables," he said. "Payroll employment, is it strengthening, is it sustainably strengthening? Is unemployment coming down?"
But Bernanke said "we do not have a specific target" for what constitutes "substantial" labor market improvement, although he noted "we do have thresholds" for considering hikes in the federal funds rate. He was referring to the FOMC's 6.5% unemployment condition.
Bernanke said he could not give an exact timeframe for ending QE because, aside from the various labor market indicators, the FOMC would need to weigh the impact of fiscal policy and pay "very close attention to the efficacy and costs of these policies."
"That makes it very difficult to say this is the number we're going to achieve," he said. "We're doing our best to estimate the criteria for action but have not been able to come to a specific number that encapsulates" all the policy considerations.
In response to concerns the Fed will have trouble exiting from its easy money policies and reducing its ever-growing balance sheet, Bernanke repeated earlier comments that the Fed has "the tools" it needs to tighten monetary policy when necessary.
He said the Fed has a "belts and suspenders" approach and a set of tools that "will allow us to normalize policy either by selling assets or by retaining assets and doing other things, like raising interest rates."
The Fed can also shrink its balance sheet without selling assets by allowing securities to mature and run off, he noted.
Bernanke said the Fed "wants to withdraw support at the right time: not too early, not too late."
Asked about the situation in Europe, he said the European Central Bank's policies, including its offer to buy sovereign debt of nations that meet certain conditions, "have helped" lower interest rates in the euro-zone and diminished risks to financial stability. But he said the European recession is hurting U.S. exports.
Asked about the Italian election, the results of which have raised fears the country might not stay in the euro-zone, Bernanke said financial markets have reacted to the uncertainty of the political landscape, but observed, "I don't think any of the candidates have outright rejected staying in the euro."
He said direct U.S. exposure to Italian debt is "moderate."
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