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Bernanke At Jackson Hole: Economic Outlook 'Inherently Uncertain,' But Fed May Act

JEANNINE AVERSA   08/27/10 05:24 PM ET   AP

Bernanke

JACKSON, Wyo. — Ben Bernanke is struggling to build consensus among Federal Reserve officials about what steps are needed – if any – to give the economy a boost.

It showed in a speech the Fed chairman delivered Friday that carried a mixed message: He sees the economy improving next year, but he stands ready to take bold action if it falters.

Bernanke acknowledged the economy is fragile, especially after the government just reported the weakest quarterly growth in a year. And he said high unemployment poses a serious threat. Still, Bernanke remained optimistic enough to repeat the Fed's forecast for some pickup in growth in 2011 and beyond.

The Fed chairman's colleagues have more latitude to speak their minds bluntly, and many have done so recently.

Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, says keeping interest rates at record lows is a "dangerous gamble" that could unleash inflation or new speculative bubbles in the prices of financial assets.

Fed governor Kevin Warsh has expressed concern that further stimulative efforts could alarm investors. Fed Governor Elizabeth Duke also is skeptical about more aid.

Charles Plosser, president of the Federal Reserve Bank of Philadelphia, has cautioned against taking further stimulative action while the economy is still growing.

But other Fed members are more concerned about high unemployment and more likely to embrace further stimulus aid.

All that helps explain why Bernanke stopped short Friday of pledging to take any specific new steps now to invigorate the economy, which some economists fear could tip into another recession.

But in speaking to an annual economic conference, Bernanke said the Fed was prepared to make a major new investment in government debt or mortgage securities if the economy worsened significantly or if the Fed detected deflation – a prolonged drop in prices of wages, goods and assets like homes and stocks.

The Fed's goal in buying more debt securities would be to further lower rates on mortgages and other loans, to get people and businesses to spend more.

"Bernanke is sending the signal that even though his Fed colleagues aren't fully on board and haven't agreed on what to do next, he will do all he can to avoid a 'double-dip' recession," said Diane Swonk, chief economist at Mesirow Financial.

On the one hand, Bernanke is trying to bolster Americans' shaky confidence that another recession can be avoided. On the other hand, he wants to reassure them that the Fed is prepared to act if the economy takes a turn for the worse. So he delivered a message that the Fed still has tools, however limited, to deliver relief if necessary.

"He's trying to manage Americans' anxiety," said Terry Connelly, dean of Golden Gate University's Ageno School of Business in San Francisco. "Bernanke can't be perceived as the skinny, weakling kid when people want Charles Atlas."

Bernanke outlined two other relief options:

_Disclosing more information in the Fed's post-meeting policy statements about how long Fed policymakers would continue to hold rates at record lows. For more than a year, the Fed has been pledging to hold rates at ultra-low levels for an "extended period."

_ Cutting to zero the interest the Fed pays for banks to keep money parked at the Fed. That rate is now 0.25 percent. The goal would be to induce banks to withdraw their money from the Fed and lend it instead.

"The issue at this stage is not whether we have the tools to help support economic activity and guard against disinflation," Bernanke said. "We do. The issue is instead whether, at any given juncture, the benefits of each tool, in terms of additional stimulus, outweigh the associated costs or risks of using each tool."

The Fed's strategy carries no guarantees. Short-term interest rates near zero have yet to rejuvenate the economy. The benefits of federal stimulus programs are fading, and Congress has declined to pass any major new economic aid. Bernanke is under intense pressure to provide relief yet has no easy options for fixing the economy.

Hoenig likened Bernanke's job to that of a horse whisperer: Both must watch their body language and avoid inciting any panic. "There is a lot in common with a horse whisperer and a good central banker, I think," he says.

At a Fed meeting earlier this month, Bernanke persuaded his colleagues to use a relatively small amount of money generated by its portfolio of mortgage securities to buy government debt. The goal is to further ease rates on mortgages and other loans.

The economy, which has been slowing all year, barely grew in the spring – it eked out a 1.6 percent annual growth rate in the April-to-June period. At such a tepid pace, the nation's 9.5 percent unemployment rate could climb and pass 10 percent later this year or early next year, some analysts say.

The gravest risk is that consumers could turn even more cautious about spending and businesses more nervous about hiring – causing the economy not just to stall but to slip into reverse.

Just a year ago, Bernanke and others attending the conference had been breathing a sign of relief that the worst of the financial crisis had passed. This year, they are holding their breath again.

Last year, Bernanke made time for a hike. Not so this year.

Yet despite the economy's recent slowing, Bernanke said he continues to believe there will be "some pickup" in growth in 2011, if not enough to substantially drive down unemployment and reduce the vast ranks of the unemployed.

"We have come a long way, but there is still some way to travel," Bernanke said.

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Filed by Ryan McCarthy  |