By Steven K. Beckner

(MNI) – Federal Reserve Chairman Ban Bernanke cited a “weak”
housing market, credit strains for small business and the “important
drag” on spending caused by the “slow recovery in the labor market.”
Nevertheless, he said, “My colleagues … and I expect continued
moderate growth, a gradual decline in the unemployment rate, and subdued
inflation over the next several years.”

He anticipated the economy would benefit from “rising demand from
households and business.”

Bernanke said the Fed would need to tighten policy “at some point”
and outlined the way it is apt to proceed “when that time comes.” He
said the Fed “will act to increase short-term interest rates by raising
the interest rate it pays on reserve balances that depository
institutions hold at Federal Reserve Banks” and “may also drain reserves
from the banking system.”

Bernanke said the FOMC has been “discussing alternatives” for
getting the balance sheet back to a normal size and composition
eventually.

“Currently, repayments of principal from agency debt and MBS are
not being reinvested, allowing the holdings of those securities to run
off as the repayments are received,” he said. “By contrast, the proceeds
from maturing Treasury securities are being reinvested in new issues of
Treasury securities with similar maturities.”

“At some point, the Committee may want to shift its reinvestment of
the proceeds from maturing Treasury securities to shorter-term issues,
so as to gradually reduce the average maturity of our Treasury holdings
toward pre-crisis levels, while leaving the aggregate value of those
holdings unchanged,” he said.

While Bernanke’s main focus was on eventual contraction and
normalization of the SOMA, he added an important caveat: “Of course,
even as the Federal Reserve continues prudent planning for the ultimate
withdrawal of extraordinary monetary policy accommodation, we also
recognize that the economic outlook remains unusually uncertain.”

“We will continue to carefully assess ongoing financial and
economic developments, and we remain prepared to take further policy
actions as needed to foster a return to full utilization of our nation’s
productive potential in a context of price stability,” he added.

Bernanke elaborated in response to questions from the Senate
Banking Committee about what further monetary stimulus the Fed could
provide if necessary.

Before answering, Bernanke observed that “monetary policy is
currently very stimulative.”

“We have brought interest rates down close to zero, we have had a
number of programs to stabilize financial markets, we have language
which says we plan to keep rates low for an extended period,” he said.
“And we have purchased more than a trillion dollars in securities. “So
certainly no one can accuse the Fed of not having been aggressive in
trying to support the recovery.”

Nonetheless, Bernanke didn’t rule out additional stimulus measures,
but he set a high bar, just as the FOMC had done.

“That being said, if the recovery seems to be faltering then we
will at least need to review our options,” he said.

“We have not fully done that review and we need to think about
possibilities,” he said. “But broadly speaking, there are a number of
things we could consider and look at.”

“One would be further changes or modifications of our language or
our framework describing how we intend to change interest rates over
time — giving more information about that, that’s certainly one
approach,” he said in an obvious reference to the FOMC’s oft-repeated
declaration that “the federal funds rate is apt to stay “exceptionally
low…for an extended period,” depending on “economic conditions,
including low rates of resource utilization, subdued inflation trends,
and stable inflation expectations.”

Secondly, Bernanke said, “We could lower the interest rate we pay
on reserves, which is currently one-fourth of 1%.”

“The third class of things has to do with changes in our balance
sheet and that would involve either not letting securities run off — as
they are currently running off — or even making additional purchases,”
he said.

“We have not come to the point where we can tell you precisely what
the leading options are,” Bernanke said. “Clearly each of these options
has got drawbacks, potential costs, so we are going to continue to
monitor the economy closely and continue to evaluate the alternatives
that we have, recognizing that — as I said — policy is already quite
stimulative.”

He said the Fed is “not prepared to take” any of the forementioned
steps “in the near-term.” But he added there is “the potential for some
of these (three steps) to be effective.” And he said the FOMC will
continue to “evaluate” those options.

By the time Bernanke spoke on Monday, Aug. 2, there had been some
confirmation that the recovery was slowing. The previous Friday, the
Commerce Department’s advance estimate for the second quarter showed a
real GDP growth of 2.4% — down sharply from the upwardly revised 3.7%
first quarter pace. And that morning the Institute for Supply
Management’s survey of corporate purchasing managers showed
manufacturing activity slowing for the third straight month.

But it is arguable whether Bernanke significantly altered his view
of the economy.

Gone was his comment about the economic outlook being “unusually
uncertain.” The grabber in his latest speech was that “we have a
considerable way to go to achieve a full recovery,” but that shouldn’t
be taken out of context.

What he said in full was: “Today, the financial crisis appears to
be mostly behind us, and the economy seems to have stabilized and is
expanding again. But we have a considerable way to go to achieve a full
recovery in our economy, and many Americans are still grappling with
unemployment, foreclosure, and lost savings.”

Much of what he said otherwise was nearly word for word what he had
said a couple of weeks earlier.

“While the support to economic activity from stimulative fiscal
policies and firms’ restocking of their inventories will diminish over
time, rising demand from households and businesses should help sustain
growth,” he said. “In particular, in the household sector, growth in
real consumer spending seems likely to pick up in coming quarters from
its recent modest pace, supported by gains in income and improving
credit conditions.” He was upbeat about business investment and exports.

Echoing what he had told Congress, Bernanke cautioned that “Notable
restraints on the recovery persist,” again noting that the housing
market is still “weak;” credit remains “tight,” especially for small
business, and “the slow recovery in the labor market” and people’s
uncertainty about their job prospects is “weighing on household
confidence and spending.”

Responding to audience questions, Bernanke said, “Technically,
we’re not in a recession any more, the economy’s growing, but obviously
the economy’s still in quite weak condition and unemployment is
unacceptably high.” And he added, “clearly we’re far from being in a
normal situation and we want to continue to support the economy to get
us back to something where people can find work, earn the incomes they
need to support their families.”

But the Chairman did not take the opportunity to hint at further
monetary stimulus or even at more passive efforts to avoid a natural
shrinkage of the balance sheet.

Rather than easing further, his emphasis was elsewhere: “We need to
be careful about tightening too quickly.”

One has to conclude that, as things now stand, the FOMC is sure to
discuss its portfolio management alternatives and its options for
providing additional “support” to the economy. But, unless the economy
“falters” or “worsens appreciably” more than it has thus far, it’s
premature to expect the Fed to implement such measures.

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** Market News International Washington Bureau **

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