By Steven K. Beckner

(MNI) – The nuances of Federal Reserve Chairman Ben Bernanke’s
congressional testimony Tuesday strongly suggest he is moving closer to
asking the Fed’s policymaking Federal Open Market Committee to approve
additional monetary stimulus.

It’s not just the fact that the Fed chief repeated the FOMC’s
readiness to take further action, but the way he characterized economic
activity and the risks thereto that seem to open the door wider to a
third round of large-scale asset purchases and/or other actions.

The tone and substance of his testimony before the Senate Banking
Committee, as he presented the Fed’s mid-year Monetary Policy Report to
Congress, indicate that in the nearly four weeks since his June 20
post-FOMC news conference Bernanke has become more concerned about the
economy’s condition and prospects.

Most of all, he is worried about high unemployment and meager job
gains.

New monetary stimulus could come before the early November
election, even though that is often thought of as a peremptory barrier
to Fed action. Bernanke made clear the FOMC will be taking a strong look
at the economy and its needs at its remaining summer meetings — July
31-Aug. 1 and Sept. 12-13.

Bernanke’s prospective comments about monetary policy were succinct
in his prepared testimony, which devoted more attention to avoiding the
so-called “fiscal cliff.”

“Reflecting its concerns about the slow pace of progress in
reducing unemployment and the downside risks to the economic outlook,
the Committee made clear at its June meeting that it is prepared to take
further action as appropriate to promote a stronger economic recovery
and sustained improvement in labor market conditions in a context of
price stability,” he said, echoing the June 20 FOMC statement.

Bernanke elaborated in response to questions from senators, but
largely reiterated the kinds of comments he made to reporters last
month.

Repeating that the FOMC is “prepared to take further action,” and
that the Fed still has effective tools at his disposal, he listed the
options: “The logical range includes different types of purchase
programs that can include Treasuries or can include Treasuries and
mortgage backed securities. Those are the two things we are allowed to
buy.”

“We could also use our discount window for lending purposes; that
is another possibility,” he continued. “We could use communication to
talk about our future plans regarding rates or our balance sheet.”

“And a possibility that we have discussed in the past is cutting
the interest rate we pay on excess reserves,” he went on. “That is a
range of things we can do. Each one of them has costs and benefits and
that is an important part of the calculation.”

What was more striking and ostensibly more pregnant with policy
implications was the dismay Bernanke conveyed as he talked about the
economy.

At the June FOMC meeting, the 19 Federal Reserve Governors and Bank
Presidents revised down their economic projections, collectively
presenting an even gloomier outlook than they had in January. The FOMC
said it “expects economic growth to remain moderate over coming quarters
and then to pick up very gradually.”

Now, Bernanke seemed to be suggesting not quite a month later that
the economy’s performance has been disappointing, even relative to the
FOMC’s downgraded expectations. Indeed, the gloom of his testimony was
almost unrelieved by bright spots. If anything, things could turn out
even worse than feared, he suggested.

Bernanke observed that “economic activity appears to have
decelerated somewhat during the first half of this year.” After slowing
from a 2.5% growth rate during the second half of last year to 2% in the
first quarter, he said “available indicators point to a still-smaller
gain in the second quarter.”

Given that GDP growth is barely enough to absorb new entrants to
the labor force, he predicted reductions in unemployment will be
“frustratingly slow.”

Not long ago, Bernanke and other Fed officials were postulating
that the swing from relatively strong to weaker monthly job gains might
be attributable to weather and other factors. Warm winter
weather may have brought hiring forward, leading to “give-backs” in the
Spring and Summer, it was theorized. Bernanke also warned that
higher payroll gains in January and February might reflect a “catch-up”
for heavy layoffs that might prove temporary unless economic growth
accelerated.

In his latest outing, Bernanke largely eschewed special factors in
wearily describing the labor market picture, after noting that non-farm
payroll gains averaged a substandard 75,000 per month during the second
quarter.

“Issues related to seasonal adjustment and the unusually warm
weather this past winter can account for a part, but only a part, of
this loss of momentum in job creation,” he said, adding that the
unemployment rate has “leveled out at just over 8%.”

Bernanke noted that consumer spending has slowed despite falling
gasoline prices because “households remain concerned about their
employment and income prospects and their overall level of confidence
remains relatively low.”

He also pointed to slowing in manufacturing output, partially
because foreign weakness is hurting U.S. exports. He noted business
investment is cooling and warned that forward-looking indicators
“suggest further weakness ahead.”

Even in the housing sector, where he acknowledged “modest signs of
improvement,” Bernanke surveyed a bleak landscape. “Still, a number of
factors continue to impede progress in the housing market.”

“On the demand side, many would-be buyers are deterred by worries
about their own finances or about the economy more generally,” he
elaborated. “Other prospective homebuyers cannot obtain mortgages due to
tight lending standards, impaired creditworthiness, or because their
current mortgages are underwater — that is, they owe more than their
homes are worth.”

“On the supply side, the large number of vacant homes, boosted by
the ongoing inflow of foreclosed properties, continues to divert demand
from new construction,” he added.

As bad as it looks already, the risks are to the downside, as far
as Bernanke is concerned. He cited two major ones: Europe and U.S.
fiscal policy.

Even with the recent European moves to recapitalize Spanish banks,
increase flexibility in the use of Euro-zone bail-out funds and
centralize bank supervision, Bernanke said “Europe’s financial markets
and economy remain under significant stress, with spillover effects on
financial and economic conditions in the rest of the world, including
the United States.”

“Moreover, the possibility that the situation in Europe will worsen
further remains a significant risk to the outlook,” he said.

The threat of automatic tax hikes and spending cuts next January in
the U.S. could push the U.S. economy back into recession, he warned.

In response to questions about what more the Fed is prepared to do,
Bernanke made no bones about weak labor market conditions being the main
criterion for additional monetary stimulus. And he was largely
dismissive of inflation concerns, even using the dreaded “D” word —
deflation — a couple of times.

“We are looking very carefully at the economy, trying to judge
whether or not the loss of momentum we have seen recently is enduring
and whether or not the economy is likely to progress towards lower
unemployment and more satisfactory labor market conditions,” he said.
“If that does not occur obviously we have to consider additional steps.”

Later, Bernanke said “we’re looking to see if we get sustainable
improvements in labor markets … . If we’re not getting sustained
improvement we will have to consider taking additional actions.”

Inflation risks are no obstacle to further easing, he strongly
suggested. Far from inflation being a problem, “there is a modest risk
of going in the other direction … to the deflation side,” he said in
response to a question from Sen. Chuck Schumer, D-N.Y.

“It is very important we make sustained progress in the labor
market and avoid deflation,” he said.

Nor is the dollar a worry, he implied, telling Sen. Jim DeMint,
R-S.C., that the dollar has strengthened, not weakened.

As for the timing of possible further action, Bernanke gave no
commitments, but also showed no aversion to acting before the election
if he and his colleagues don’t see progress against joblessness —
beyond uttering the requisite cautionary words about weighing costs and
risks of additional actions.

“We have looked at a range of possible tools, mostly involving the
balance sheet and communications,” he said. “The committee meets in a
couple of weeks and we will be discussing those tools.”

“We haven’t come to a specific choice at this point but we are
looking for ways to address the weakness in the economy should more
action be needed to promote a sustained recovery in the labor market,”
he added.

Clearly, employment reports for July, August and beyond will be
crucial to the policy choices made at coming FOMC meetings.

** MNI **

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