With economy slowing, Bernanke still not ready to act

WASHINGTON — The U.S. economy grew at a slower pace during the second quarter of this year than first estimated, the government reported Friday, another indication that the recovery is losing steam and one that prompted Federal Reserve Chairman Ben Bernanke to pledge new action if the economy deteriorates further.

Although the Commerce Department's first estimate of growth from April through June had been 2.4 percent, the agency revised that number Friday to 1.6 percent. That suggests that the slowdown from strong 3.7 percent growth in the first three months of this year was more pronounced than had been thought. The agency attributed the revision to stronger-than-anticipated growth in imports, which partially reduce domestic growth.

The Commerce Department's revision came hours before a much-anticipated speech by Bernanke on his outlook amid darkening views of the economy.

Speaking at the Fed's annual gathering in the Wyoming town of Jackson Hole, Bernanke restated in a detailed 20-page speech that the Fed's rate-setting Federal Open Market Committee still anticipates growth. He also indicated that he isn't ready to take new aggressive actions until there are clearer signs of economic deterioration.

"We will continue to monitor economic developments closely and to evaluate whether additional monetary easing would be beneficial. In particular, the committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly," Bernanke said.

While the Fed thinks it has the tools to act, most steps that can be taken carry costs, and it isn't always clear that the actions will do more good than harm, he cautioned.

"The issue at this stage is not whether we have the tools to help support economic activity and guard against disinflation. We do. As I will discuss next, 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 the tool."

Bernanke cautioned that the benefits of his monetary policy are powerful but limited, and he made no recommendations on whether Congress should pass a new stimulus for the economy, new tax cuts or deficit reductions.

One Fed option is to resume purchasing mortgage bonds or Treasury bonds in an effort to lower long-term borrowing rates. This use of the Fed's balance sheet to boost the economy would spur consumers and businesses to borrow more and spend more. The Fed did this successfully last year. Seeing signs of recovery, it began reducing its debt holdings earlier this year. It then stopped this summer, amid the slowdown, and announced that it would reinvest the profits from its intervention in the bond market into Treasury bonds. This makes Treasury bonds less attractive.

"One risk of further balance sheet expansion arises from the fact that, lacking much experience with this option, we do not have very precise knowledge of the quantitative effect of changes in our holdings on financial conditions," Bernanke said.Translation: These purchases helped when the markets were nearing collapse, but it's not clear what effect they'd have when markets are less stressed and the economy is simply underperforming.

Another option is to change the language in its statements after rate-setting meetings to reflect that the Fed's benchmark lending rate — the federal funds rate — will remain low longer than the markets are expecting. This effort gets at the market psychology.

"A step the committee could consider, if conditions called for it, would be to modify the language in the statement to communicate to investors that it anticipates keeping the target for the federal funds rate low for a longer period than is currently priced in markets. Such a change would presumably lower longer-term rates by an amount related to the revision in policy expectations," the Fed chief said.

Adding a twist on this, Bernanke said the Fed could condition the long period of low interest rates on specific indicators, such as the unemployment rate falling below a certain threshold. This could signal that the Fed is supporting economic growth while being mindful of the threat of an eventual return of inflation.

A third tool that's available is lowering the interest rate that banks get for keeping their excess reserves at the Fed's district banks. This move would seek to push banks to lend and invest more, effectively taking more risks with their capital.

The Fed continues to have a more optimistic view on growth than mainstream forecasters do, projecting growth this year of 3 percent to 3.5 percent, and next year from 3.5 percent to 4.2 percent. At 1.6 percent growth from April through June and continued soft data, the Fed may be nearing the date for more steps to spark economic activity.

The conditions would come into place this year for the Fed to do something more. They've certainly laid the groundwork for action; they've laid out the options that are out there," said Nigel Gault, the chief U.S. economist for forecaster IHS Global Insight. "It's a question of does the incoming data continue to be bad."

Some economists, Bernanke said, have advocated that the Fed announce that it would tolerate inflation at rates higher than its traditional targets. Inflation, the rise of prices across the economy, usually accompanies strong growth and the Fed raises its benchmark-lending rate to slow growth and tame rising prices.

"Conceivably, such a step might make sense in a situation in which a prolonged period of deflation had greatly weakened the confidence of the public in the ability of the central bank to achieve price stability, so that drastic measures were required to shift expectations," he said. "However, such a strategy is inappropriate for the United States in current circumstances."

Bernanke feared that option puts at risk the Fed's hard-won credibility on fighting inflation over the past two decades. Although many economists are more afraid of deflation, or the destructive collapse in prices across the economy, Bernanke appeared less concerned.

"Falling into deflation is not a significant risk for the United States at this time, but that is true in part because the public understands that the Federal Reserve will be vigilant and proactive in addressing significant further disinflation. It is worthwhile to note that, if deflation risks were to increase, the benefit-cost tradeoffs of some of our policy tools could become significantly more favorable," he said, discounting critics who claim that the Fed has few bullets left in the chamber. "Second, regardless of the risks of deflation, the FOMC will do all that it can to ensure continuation of the economic recovery."


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