US Federal Reserve Chairman Ben Bernanke strongly defended the central bank’s monetary stimulus before the US Congress on Tuesday, easing financial market worries over a possible early retreat from bond purchases.
Bernanke said Fed policymakers are cognizant of the potential risks of their extraordinary support for the economy, including the possibility that it might fuel unwanted inflation or stoke asset bubbles.
However, in testimony on the central bank’s semi-annual report on monetary policy, he said the risks did not seem material at the moment, adding that the bank has all the tools it needs to retreat from its monetary support in a timely fashion.
“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,” Bernanke told the US Senate Committee on Banking, Housing and Urban Affairs.
The Fed chairman also urged lawmakers to avoid sharp spending cuts set to take effect tomorrow, warning that they could combine with earlier tax increases to create a “significant headwind” for the US’ modest economic recovery.
In response to the financial crisis and deep recession of 2007 to 2009, the Fed not only slashed official interest rates effectively to zero, but also bought more than US$2.5 trillion in mortgage and US Treasury debt in an effort to push down long-term interest rates and spur hiring.
The Fed is currently buying US$85 billion in bonds each month and has said it plans to keep purchasing assets until it sees a substantial improvement in the outlook for the labor market.
Bernanke’s testimony and stronger-than-expected data on housing and consumer confidence helped settle jitters in US stock markets over the EU’s debt crisis, with the Dow Jones industrial average closing up nearly 116 points, or 0.8 percent.
“What Bernanke is saying, bottom line, indicates that there will not be a reversal anytime soon in the stimulus program,” Rockwell Global Capital chief market economist Peter Cardillo said in New York.
When asked pointedly by Republican Senator Bob Corker whether the Fed’s easy policies were contributing to competitive currency devaluations globally and laying the groundwork for inflation, Bernanke was unequivocal.
“My inflation record is the best of any Federal Reserve chairman in the post-war period,” he retorted. “We are not engaged in a currency war.”
Democrats seized on Bernanke’s remarks to fuel their argument that looming budget cuts could have a dire economic impact, as they sought to gain political advantage over Republicans, who prefer spending cuts over higher taxes.
Committee newcomer Elizabeth Warren, a Democrat, pressed Bernanke on what she said is an implicit subsidy that large banks enjoy in the form of lower borrowing costs from being perceived as too big to fail.
Bernanke replied that the Dodd–Frank Wall Street Reform and Consumer Protection Act had given regulators more power to wind down failing financial institutions, making the issue less of a concern.
“The subsidy is coming because of market expectations that the government would bail out these firms if they fail. Those expectations are incorrect,” Bernanke said.
In unusually direct remarks on fiscal policy, Bernanke warned that the spending cuts known as the sequester that are set to take hold later this week would threaten an already challenged economic expansion.
“The Congress and the administration should consider replacing the sharp, frontloaded spending cuts required by the sequestration, with policies that reduce the federal deficit more gradually in the near term, but more substantially in the longer run,” Bernanke said.
The US economy braked sharply in the fourth quarter, but is forecast to grow about 2 percent or more this year. The unemployment rate has remained elevated and registered 7.9 percent last month.