Bernanke signals rate cut to help US economy

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February 28, 2008 10:30
4 minute read.
Bernanke signals rate cut to help US economy

Ben Bernanke 88 224. (photo credit: )

Federal Reserve Chairman Ben Bernanke warned Congress on Wednesday that the US is in for a period of sluggish business growth and sent a fresh signal that interest rates will again be lowered to steady the teetering economy. "The economic situation has become distinctly less favorable" since the summer, he told the House Financial Services Committee. Since Bernanke's last such comprehensive assessment over the summer, the housing slump has worsened, credit problems have intensified and the job market has deteriorated. He said the confluence of these factors had turned people and businesses alike toward a more cautious attitude regarding spending and investment. This, he said, had further weakened the US economy. Incoming barometers continue to "suggest sluggish economic activity in the near term," Bernanke told lawmakers. At the same time, he said, the Fed must keep a close eye on inflation, given the recent run-up in energy and other prices paid by consumers and businesses. Were energy prices to continue to rise at a sharp clip - which the Fed does not anticipate - it would "create a very difficult problem," Bernanke said. It would spread inflation and put another damper on growth, he said. For now though, the No. 1 battle is shoring up the economy, which many fear is on the verge of a recession - or possibly has already toppled into one. Bernanke pledged anew to slice a key interest rate. The Fed "will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks," he said, hewing closely to assurances he offered earlier this month. The central bank, which started lowering a key interest rate in September, has since become more aggressive. Over just eight days in January, it slashed rates by 1.25 percentage points - the biggest one-month reduction in a quarter century. Economists and Wall Street investors predict the Fed will cut rates again at its next meeting on March 18. There are dangers that the economy will weaken even further. "The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further," Bernanke cautioned. As Bernanke began his first day of back-to-back appearances on Capitol Hill to discuss the economy, there was more bad news on the housing and manufacturing fronts. Sales of new homes fell in January for a third straight month, pushing activity down to the slowest pace in nearly 13 years, the Commerce Department reported. The median price of a new home dropped to the lowest level in more than three years. And orders to US factories for big-ticket manufactured goods dropped in January by the largest amount in five months. The Fed chief was hopeful that previous rate reductions along with a $168 billion stimulus package of tax rebates for people and tax breaks for business will energize the economy in the second half of this year. Bernanke has come under some criticism for not acting sooner. The panel's chairman, Rep. Barney Frank, suggested the economy was not suffering a garden-variety slowdown. "I don't want to appeal to you to use the word recession, because I'm not going to be responsible for the nervous people at the stock market who overreact when you twitch your nose," he told Bernanke. "But the problems we now have are different." Much of the current problem can be traced to the housing meltdown. Bernanke said it was possible that by "later this year it will stop being such a big drag directly" on the economy. However, house prices probably will decline into next year, he said. "It is very difficult to know, and we've been wrong before," he said. Even as the Fed tries to shore up the economy, it must remain mindful of inflation pressures, Bernanke said. Record high oil prices - topping $100 a barrel - are pushing consumer prices upward. That's shrinking paychecks, and with people feeling less well off because the values of their homes have dropped, consumer spending "slowed significantly" toward the end of the year, he said. The Fed forecasts that inflation will moderate this year compared with last year. But the Fed's recently revised inflation projection of an increase between 2.1% and 2.4% is higher than its old forecast from the fall. Bernanke said there are "slightly greater upside risks" that inflation could be higher than the Fed currently anticipates, given the recent run-up in energy and food prices. "Should high rates of overall inflation persist, the possibility also exists that inflation expectations could become less well anchored," he warned. If people, companies and investors think inflation will move higher, they will act in ways that could turn inflation even worse, a sort of self-fulfilling prophecy. And, Bernanke said, that could complicate the Fed's job of trying to nurture economic growth while also keeping inflation under control. With the economy slowing and prices rising, fears are growing that the country could be headed for a bout of stagflation, a dangerous economic brew not seen since the 1970s. The Fed for now is focused on bolstering the economy through interest-rate reductions. To combat inflation, the Fed would raise rates. With home foreclosures at record highs, the Fed has proposed rules to crack down on shady lending practices that have burned many of the nation's riskiest "subprime" borrowers - those with spotty credit or low incomes - which have been hardest hit by the housing and credit debacles. The rules also would curtail misleading ads for many types of mortgages and bolster financial disclosures to borrowers. The effectiveness of the regulations will depend on strong enforcement, Bernanke said. To that end, the Fed is working with other federal and state regulators. Bernanke said consumers need to be financially savvy - understanding mortgages, credit cards and other financial products.


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