Bernanke lays out Fed's exit strategy before House committee

07/17/2013 9:28 AM

07/17/2013 9:29 AM

Federal Reserve Chairman Ben Bernanke said the central bank’s asset purchases “are by no means on a preset course” and can be reduced more quickly or expanded as conditions warrant.

“If the outlook for employment were to become relatively less favorable, if inflation did not appear to be moving back toward 2 percent, or if financial conditions — which have tightened recently — were judged to be insufficiently accommodative to allow us to attain our mandated objectives, the current pace of purchases could be maintained for longer,” Bernanke, 59, said Wednesday in prepared testimony before the House Financial Services Committee.

If the economy improved faster than expected, and inflation rose “decisively” back toward the central bank’s 2 percent target, “the pace of asset purchases could be reduced somewhat more quickly,” he said. The committee would also be prepared to increase the pace of purchases “for a time, to promote a return to maximum employment in a context of price stability.”

The Fed chairman’s remarks highlight the Federal Open Market Committee’s desire to assure that the economy and labor markets have sufficient momentum before reducing its $85 billion in monthly bond purchases. An increase in borrowing costs since the chairman first started discussing tapering purchases threatens to slow the four-year expansion.

The yield on the 10-year note rose as high as 2.74 percent this month from 1.93 percent on May 21, the day before Bernanke said the Federal Open Market Committee may trim its bond buying in its “next few meetings” if officials see signs of sustained improvement in the labor market.

Bernanke Wednesday also said that the Fed’s balance sheet would remain elevated after purchases of mortgage bonds and Treasuries end. The Fed “will be holding its stock of Treasury and agency securities off the market and reinvesting the proceeds from maturing securities,” Bernanke said. The strategy “will continue to put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.”

Policy makers, including Bernanke, have tried to assure investors that the Fed will hold down the benchmark interest rate after ending bond buying. Bernanke, in an appearance in Cambridge, Massachusetts on July 11, said “highly accommodative monetary policy for the foreseeable future is what’s needed in the U.S. economy,” a message he repeated Wednesday.

Even so, the average 30-year fixed rate mortgage has risen to 4.51 percent as of July 11 from 3.51 percent two months ago, according to Freddie Mac.

The FOMC said in a June 19 statement that keeping the federal funds rate between zero and 0.25 percent “will be appropriate at least as long” as unemployment remains above 6.5 percent and the forecast for inflation in one to two years doesn’t exceed 2.5 percent. The chairman again took pains Wednesday to explain that the Fed will look beyond the unemployment rate to assure that labor markets are improving before deciding on interest rates.

“For example, if a substantial part of the reductions in measured unemployment were judged to reflect cyclical declines in labor force participation rather than gains in employment, the committee would be unlikely to view a decline in unemployment to 6.5 percent as a sufficient reason to raise its target for the federal funds rate,” he said. Increases in the benchmark lending rate “are likely to be gradual” when they happen, he said.

Bernanke, seeking to help unemployed Americans find work, has orchestrated the most aggressive easing in the central bank’s 100-year history, expanding its balance sheet to $3.5 trillion from $869 billion since August 2007. He said last month the FOMC may begin tapering bond purchases “later this year” and halt the program around mid-2014 if the economy performs in line with the Fed’s forecasts.

In Wednesday’s testimony, he described labor markets as “far from satisfactory, as the unemployment rate remains well above its longer-run normal level, and rates of underemployment and long-term unemployment are still much too high.”

While risks to the economy have diminished since late last year, Bernanke said, “the risks remain that tight federal fiscal policy will restrain economic growth over the next few quarters by more than we currently expect, or that the debate concerning other fiscal policy issues, such as the status of the debt ceiling, will evolve in a way that could hamper the recovery.”

The slow pace of the recovery means that it remains “vulnerable to unanticipated shocks, including the possibility that global economic growth may be slower than currently anticipated.”

Fed officials estimate the 6.5 percent unemployment threshold could be reached by the end of next year. That outlook is based on estimated growth of 3 percent to 3.5 percent for the economy in 2014, according to the committee’s June central tendency estimates, which are higher than the 2.9 percent estimate of private forecasters in a Bloomberg survey.

Bernanke and policy makers have had to gauge how much government spending cuts and higher tax rates are sapping consumer confidence and growth. JPMorgan Chase & Co. economists estimate that an expiration of tax breaks could reduce take-home pay this year by more than $100 billion.

Retail sales climbed 0.4 percent last month, about half of what economists forecast, and the figures showed households are replacing outdated vehicles and furnishing new homes while cutting back on electronics and meals outside the home.

“The consumer is under pressure,” said Bob Sasser, chief executive officer of Chesapeake, Va.-based discount retailer Dollar Tree. “They’re now facing higher taxes,” a weak job market, “and the uncertainty around the economy,” Sasser told analysts and investors on a conference call in May.

The U.S. faces a “very troublesome and challenging recovery,” Kendall Powell, chairman and chief executive officer of Minneapolis-based General Mills, said in a June 26 conference call with shareholders and analysts.

Still, Fed stimulus has helped fuel a housing-market rebound and this year’s 17.5 percent surge in the Standard and Poor’s 500 Index of stocks.

The job market has also shown some signs of recovery. Non- farm payrolls have expanded on average by around 200,000 jobs per month from January through June. The proportion of unemployed workers who have been without a job for six months or more has fallen to less than 37 percent from about 40 percent when Bernanke launched the third round of quantitative easing in September.

“We are seeing steady improvement” in the economy, Powell of General Mills said.

Slack in the labor market, including 7.6 percent unemployment last month, helped keep inflation for the 12 months ending May a full point below the Fed’s 2 percent goal, reducing the odds of any tightening based on that measure. the participants on the FOMC. In December, when the committee expanded the program of $40 billion in monthly buying of mortgage bonds with purchases of $45 billion of Treasuries, about half of FOMC participants wanted to halt the stimulus around the middle of this year, according to minutes from the meeting.

After a March staff presentation on the costs and benefits of the program, “many” participants called for slowing the pace of purchases over the next several meetings if labor markets continued to improve. By the June 18-19 meeting, “about half” of the participants “indicated that it likely would be appropriate to end asset purchases late this year,” according to meeting minutes.

The language suggests that concern over the risks from the program extends beyond the four Fed regional bank presidents who have publicly spoken out against it: Esther George of Kansas City, Jeffrey Lacker of Richmond, Va., Richard Fisher of Dallas and Charles Plosser of Phildelphia.

George, the only one of the four presidents with an FOMC vote this year, has dissented against additional stimulus at all four meetings this year. In June she cited the “risks of future economic and financial imbalances” and the possibility long- term inflation expectations may rise.

Bernanke’s comments to the House Wednesday and the Senate Thursday may be his final semi-annual testimony. His second four-year term expires in January. While Bernanke has declined to describe his plans, President Obama said last month the Fed chairman has stayed in his post “longer than he wanted.”


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