WASHINGTON - Federal Reserve Chair Ben Bernanke said Wednesday that if it was possible short-term interest rates should be even lower than they are given the state of the economy as he defended the Fed's extended zero rate policy.
Although that policy is limiting returns for savers, as well as pension funds, Bernanke maintained that by keeping rates "exceptionally low" the Fed will boost economic growth and eventually returns for savers and investors.
Because it has almost no room left to cut the federal funds rate, Bernanke said the Fed has had to seek other ways of stimulating the economy. And he defended the Fed's large-scale asset purchases ("quantitative easing"), maintaining that it is not inflationary.
Bernanke said the Fed's policymaking Federal Open Market Committee has considered lowering the rate of interest it pays on excess reserves (IOER) to reduce banks' incentive to hold reserves and increase incentives to lend, but it has been determined so far that the effect would be "trivial" and that there would be offsetting costs to doing so.
Bernanke also rebutted charges the Fed's "highly accommodative" monetary policy is undermining the value of the dollar as he answered questions on his semi-annual Monetary Policy Report to Congress before the House Financial Services Committee. He said the dollar is "doing okay" both in terms of its domestic purchasing power and in terms of exchange rates with other currencies.
Bernanke also downplayed fears that Fed policy is fuelling speculative asset price bubbles.
The FOMC has held the federal funds rate near zero since December 2008, and on Jan. 25, the FOMC said it expects to keep it there at least through late 2014. Meanwhile, it has held long-term interest rates down through massive bond purchases.
This has given rise to criticism, some of it from Fed officials, that the Fed is hurting savers. Some banks have also complained that the Fed is hurting their net interest margin.
But not only have low rates been justified, Bernanke said economic conditions are such that, if it was possible, rates should be even lower.
"It is arguable that the interest are too high that they are being constrained by the fact that interest rates cannot go below zero," he said. "We have an economy where demand falls far short of the capacity of the economy to produce, we have an economy where the amount of investment and durable goods spending is far less than the capacity of the economy to produce."
"That suggests that interest rates in some sense should be lower than higher," he said, adding that "we cannot make interest rates lower, of course, we only can go down to zero."
When challenged on how much good the Fed's policies have been given the continued high rate of unemployment, Bernanke said "monetary policy has been constructive" in "bringing unemployment back toward the maximum employment level."
Since the Fed launched a second, $600 billion round of quantitative easing in November 2010, 2.5 million jobs have been created, he noted, and while he was quick to add "I don't take credit for all those jobs," he reiterated that "monetary policy has been constructive."
Bernanke stipulated that "monetary policy is not a panacea" and that there are tax, regulatory and trade policies which could improve the prospects for employment.
Although the unemployment rate has fallen to 8.3%, Bernanke expressed concern that an historically high 40% of the unemployed have been out of work for at least six months and said "that's something we've been paying attention to."
One Congressman suggested that, by keeping rates near zero, the Fed is hurting Americans as much as helping them by depressing returns on their savings, while "subsidizing" banks.
Bernanke responded that the Fed is "certainly paying attention to the effect of low rates on savers." But he said most people depend not so much on savings, but on investments in stocks, mutual funds and 401K plans "whose returns depend very much on how strong the economy is."
By keeping rates very low, the Fed hopes to boost the economy and in turn net returns to investment, he said. "I would argue that a healthy economy with good returns is the best way to get returns to savers."
Bernanke said the Fed has had discussions with insurance companies, pension funds and others over the effect of zero rates on their customers' returns and said that, there again, the Fed's message has been that it is "trying to strengthen the economy to give a higher return" to investors.
Far from the Fed subsidizing banks, Bernanke said banks have been complaining that the zero federal funds rate reduces their net interest margin.
"When loan demand is weak, forcing banks to hold low-return safe assets instead of lending, net interest margins suffer," Bernanke acknowledged, but said "the purpose of the Federal Reserve's policy of low interest rates is to speed the economic recovery, which will increase loan demand and opportunities for profitable lending, among many other benefits, and thus, ultimately, lead to higher net interest margins.
"In short, it is necessary to set the negative effects on net interest margins against the positive effects of a strengthening economic and lending environment," he said.
"Moreover, the benefits of a stronger economy for the performance of existing assets should also be taken into account; as you know, delinquencies decline as the economy improves," he added. "Putting all these considerations together, in the longer term the overall effect on bank profitability of an appropriately accommodative monetary policy is almost certainly positive."
Bernanke repeated that credit, particularly mortgage credit, is too "tight" and said banks need to make creditworthy loans. But he doubted whether lowering the IOER from 25 basis points would incentivize banks to lend more and hold less reserves with the Fed.
Cutting the IOER is something the FOMC has considered, but the impact would be "trivial," he said. Noting that the effective federal funds rate is 10-12 basis points and that banks have to pay fees to the Federal Deposit Insurance Corporation, he said eliminating the IOER "would be a 10 basis point incentive," which he called "pretty small."
Bernanke disputed contentions that its quantitative easing and associated build-up in bank reserves amounts to an inflationary "printing of money."
"It is in fact the case that the amount of currency in circulation has not been affected by any of these policies," he said. "What has happened is that the amount of electronic reserves held by the banks at the Federal Reserve has gone up by a great deal but they're sitting there, they are not doing much ... So far we've not seen any indication that they've proved inflationary."
Asked how much more expansion the Fed and other Group of Eight central banks could do, Bernanke replied, "Each of these central banks is dealing in a similar way, and in this respect the Federal Reserve is not unusual. It's trying to find ways to provide more accommodation in a situation where interest rates are close to zero and so standard cutting the base of the federal funds rate by 25 basis points doesn't work."
"All of the central banks in question have similar tools to the ones we have," he said, "including; the ability to pay interest on reserves, the ability to sell assets and the ability to sterilize their balance sheets. So that I think we all have adequate tools to withdraw that accommodation and to shrink those balance sheets at the appropriate time.
"So I think this is currently where the best available approach is to provide additional financial accommodation in a world where rates are close to zero and we can't obviously go below zero."
In other comments, Bernanke reiterated multiple times that Congress and the administration need to put in place a "credible," long-term deficit reduction planned and warned of a possible "crisis of confidence" among investors in U.S. debt that could drive long-term interest rates higher if they do not. But he again warned of cutting the deficit too quickly.
Bernanke also reiterated his concern about the European debt crisis, but sounded hopeful that it will be defused.
"If there were a major financial accident in Europe," Bernanke said he would be concerned "not so much the direct exposure" of U.S. firms but about general "contagion" effects and a "loss of confidence."
The impact on the U.S. would depend on the severity of the European problems, he said.
"If there is a European slowdown our companies will feel that," he said. "However we do think if Europe has a mild downturn ... and if the financial situation remains under control ... the effect on the U.S. might not be terribly serious; it would not the threaten recovery ... But it would have an effect certainly."
On the other hand, Bernanke said an "uncontrolled, disorderly default (by Greece) would create lot of problems."
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