WASHINGTON — Federal Reserve Chairman Ben Bernanke acknowledged Tuesday that the Fed's expansionary, super-low interest rate policy carries risks to financial stability, but said those risks are outweighed by the economic benefits of monetary stimulus.
With unemployment too high and inflation low, a "highly accommodative" monetary policy has been necessary, Bernanke said in presenting the Fed's semi-annual Monetary Policy Report to Congress.
Although the labor market has been "improving gradually," it "remains generally weak," Bernanke told the Senate Banking Committee, citing not just the high level but also the duration of unemployment.
Joblessness "has substantial costs," in economic, social and even fiscal terms, he said.
Meanwhile, inflation is not a threat, according to Bernanke. Despite higher gasoline prices which are "hitting family budgets," he said "overall inflation remains low" and is likely to continue to "run at or below" the Fed's 2% inflation target.
The Fed is attempting to boost employment both through $85 billion per month in asset purchases and through "forward guidance" on the future path of the federal funds rate. The Fed's policymaking Federal Open Market Committee has said it will remain "highly accommodative" even after asset purchases end and the recovery strengthens.
And the FOMC has said it will hold the funds rate near zero at least until the unemployment rate falls to 6.5%, so long as forecasted inflation does not exceed 2.5%, and inflation expectations are "well-anchored."
Bernanke reiterated the FOMC's intention to keep buying bonds until it sees "substantial" improvement in the labor market outlook. And he said the new forward guidance, which replaces the former use of a calendar date, "serves to underscore the Committee's intention to maintain accommodation as long as needed to promote a stronger economic recovery with stable prices."
He said the use of thresholds will allow markets to adjust their policy expectations "more accurately" as economic conditions change.
Recently Fed Board Gov. Jeremy Stein, Kansas City Federal Reserve Bank President Esther George and others have warned that the Fed's very low interest rate stance is encouraging a "reach for yield" that could lead to excessive risk-taking and financial instability.
But Bernanke strongly suggested that, at the present time, such behavior does not pose a threat sufficient to justify a backing off from the Fed's easy money policies.
He said the a "potential cost" that the FOMC "takes very seriously is the possibility that very low interest rates, if maintained for a considerable time, could impair financial stability." In a search for yield, portfolio managers may take on more credit risk, duration risk or leverage, he said.
However, some risk-taking is needed and he added that "although accommodative monetary policies may increase certain types of risk-taking, in the present circumstances they also serve in some ways to reduce risk in the system, most importantly by strengthening the overall economy, but also by encouraging firms to rely more on longer-term funding, and by reducing debt service costs for households and businesses."
Bernanke said the Fed has increased its efforts to monitor potential financial risks, but indicated he does not see any overriding concerns at this time. The needs of the economy, especially the labor market, remain paramount.
"Although a long period of low rates could encourage excessive risk-taking, and continued close attention to such developments is certainly warranted, to this point we do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more-rapid job creation," he said.
Some Fed officials have also warned that, by expanding its balance sheet at a $1 trillion annual pace, the Fed is making it more difficult to eventually exit from its "highly accommodative" monetary stance. Others have voiced their concern that, as the interest rates that the Fed has to pay on excess reserves rise, its annual remittances to Treasury could greatly diminish, potentially causing political pressure on the Fed.
But Bernanke repeated that he is "confident" that the Fed "has the tools necessary to tighten monetary policy when the time comes to do so."
As for remittances to Treasury, Bernanke said they will "likely decline in coming years" as the economy improves and policy accommodation is reduced. They "could be quite low for a time in some scenarios," he said.
However, Bernanke said "even in such scenarios, it is highly likely that average annual remittances over the period affected by the Federal Reserved's purchases will remain higher than the pre-crisis norm, perhaps substantially so."
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