WASHINGTON - Federal Reserve Chairman Ben Bernanke Thursday defended the central bank's actions to support the recovery since it slashed interest rates to zero, telling a Senate panel the Fed is attempting to calibrate its policy to a setting that will support the economy.

In day No. 2 of his monetary policy testimony on Capitol Hill, Bernanke told the Senate Banking Committee that the continued problems in the housing sector, combined with financial conditions that are stressed by the crisis in Europe, has resulted in a slower economic recovery than anticipated.

"Total demand in the economy is not adequate to fully utilize the resources of the economy, and that is why we talk about the need for greater consumer spending and greater investment," he said.

The Fed's monetary policy is aimed at its dual mandate, Bernanke told the Committee. "We are trying to set monetary policy at a setting that will help the economy recover in a context of price stability," he said.

He argued that the Fed's efforts, on net, are raising household wealth. "A stronger economy produces higher returns in equity markets, real estate markets and the like," he said.

Since November 2010, when the Fed has introduced a second round of quantitative easing and its so-called 'Operation Twist' program, Bernanke argued that 2.5 million jobs have been created and stock prices have seen big gains.

"In November 2010 we had some concerns about deflation and I think have sort of gotten rid of those and brought ourselves back to a more stable inflation environment," he said. "I think that ... those actions played a constructive role."

As for the program's impact on the U.S. dollar, Bernanke said the greenback has been "pretty stable" since QE2 was introduced.

He called the uncertainty about the direction of the housing market "troubling," and said the weakness in the housing "is probably muting to some extent" the impact of the Fed's low interest rate policy.

So, "Growth is not as strong, and the improvement in the unemployment rate is not as quick as obviously we would like," Bernanke said.

For the recovery to become strong and sustainable will require declines in the unemployment rate and strong growth in demand and production, he said. 

Still, "We don't see at this point that the very severe recession has permanently affected the growth potential of the U.S. economy," he said.

Bernanke added that he remains concerned about the long-term unemployed in the United States, warning if this continues it will reduce the human capital "that is part of our growth process going forward."

Commodity prices also remain a risk, he continued, although Bernanke argued that most of the volatility is inevitable, especially when a growing world economy and the resulting demand drive up prices.

Oil is one commodity that has been "particularly troublesome," Bernanke said, with mostly supply fears contributing to price increases.

He said shocks due to geopolitical events "are unambiguously negative and are bad for both households and for the broader economy."

Pressed on the Fed's plans to wind down its massive balance sheet when the time comes, Bernanke repeated the steps the Fed has laid out in the past on how it would proceed. These include allowing securities to run-off in the short-term, and in the longer-term selling some of the securities in the Fed's portfolio.

"Eventually, at the appropriate time, our goal is to get back to a more normal size balance sheet consisting only of Treasury securities," he said.

Bernanke was again asked to comment on Europe, and he assured the Senate panel that the direct exposures of U.S. banks to European sovereign debt "is quite limited and is well hedged."

He went on to warn, however, that "if there is a major financial problem in Europe, there'll be so many different channels by which that will affect the stability of our financial system that I wouldn't want to take too much comfort from that."

The Fed chairman repeated his warning against Congress enacting drastic spending cuts in one fell swoop, with the recovery not yet complete and unemployment still high while the rate of growth is modest.

Still the U.S. is on an unsustainable fiscal path, Bernanke said, and -- if nothing is done -- it will face a fiscal and financial crisis "that will be very bad for growth and stability."

Asked what in his opinion a credible fiscal plan should aim to accomplish, Bernanke said the goal should be to eliminate the U.S. primary deficit -- leaving nothing but interest payments -- within the next 10 to 15 years.

Bernanke also sounded a note of warning about money market mutual funds, saying they still face some risks.

"In particular they still could be subject to runs," he said, adding that because of the Dodd-Frank Act, the Fed's ability to lend to MMMFs is greatly restricted and the U.S. Treasury can no longer provide ad hoc insurance.

Market News International is a real-time global news service for fixed-income and foreign exchange market professionals. See www.marketnews.com.


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