NEW YORK – While the economy has gradually recovered over the past two and a half years, albeit at a “frustratingly slow” rate, such expansion leaves it vulnerable to shocks, and the outlook is still uncertain, and requires “close monitoring of economic developments,” Federal Reserve Board Chairman Ben Bernanke said Thursday.

“Indeed, last year, supply chain disruptions stemming from the earthquake in Japan, a surge in the prices of oil and other commodities, and spillovers from the European debt crisis risked derailing the recovery,” Bernanle noted according to prepared text of his testimony to the House Committee on the Budget, which was released by the Fed.

Going forward, consumer spending “will be an important determinant of the pace at which the economy expands in coming quarters.” Despite a moderate increase in consumption last quarter, “real household income and wealth stagnated in 2011, and access to credit remained tight for many potential borrowers. Consumer sentiment has improved from the summer's depressed levels but remains at levels that are still quite low by historical standards,” Bernanke said.

Consumers take their cues from the labor market, which, while improved, is still far normal operations. “Particularly troubling is the unusually high level of long-term unemployment: More than 40 percent of the unemployed have been jobless for more than six months, roughly double the fraction during the economic expansion of the previous decade.”

Weak labor markets and tight lending standards continue to restrain housing demand.

In the business sector, spending grew in the past two years, but that increase slowed, Bernanke said, “likely reflecting concerns about both the domestic outlook and developments in Europe. However, there are signs that these concerns are abating somewhat.”

An increase in business confidence could leave firms well-positioned for additional capital spending and hiring, he noted.

Inflation should remain subdued, according to Bernanke, as evidenced by the decline from a 3.5% pace of inflation in the first half of 2011, which dropped to a 1.5% rate in the last half of the year.

“Against that backdrop, the Federal Open Market Committee (FOMC) decided last week to maintain its highly accommodative stance of monetary policy,” Bernanke told Congress. “In particular, the Committee decided to continue its program to extend the average maturity of its securities holdings, to maintain its existing policy of reinvesting principal payments on its portfolio of securities, and to keep the target range for the federal funds rate at 0 to 1/4 percent. The Committee now anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate at least through late 2014.”

Bernanke repeated his concern about the widening budget deficit, which he expects will narrow when the economy rebounds and stimulus is phased out. “Unfortunately, even after economic conditions have returned to normal, the nation will still face a sizable structural budget gap if current budget policies continue,” he said.

He warned that previous predictions of the dangers of ignoring the aging of the population were unheeded and “the time when projections become reality is coming closer.”

He added, “Even as fiscal policymakers address the urgent issue of fiscal sustainability, they should take care not to unnecessarily impede the current economic recovery. Fortunately, the two goals of achieving long-term fiscal sustainability and avoiding additional fiscal headwinds for the current recovery are fully compatible--indeed, they are mutually reinforcing. On the one hand, a more robust recovery will lead to lower deficits and debt in coming years. On the other hand, a plan that clearly and credibly puts fiscal policy on a path to sustainability could help keep longer-term interest rates low and improve household and business confidence, thereby supporting improved economic performance today.

“Fiscal policymakers can also promote stronger economic performance in the medium term through the careful design of tax policies and spending programs. To the fullest extent possible, our nation's tax and spending policies should increase incentives to work and save, encourage investments in the skills of our workforce, stimulate private capital formation, promote research and development, and provide necessary public infrastructure. Although we cannot expect our economy to grow its way out of our fiscal imbalances, a more productive economy will ease the tradeoffs that we face and increase the likelihood that we leave a healthy economy to our children and grandchildren.”

 

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