By Steven K. Beckner

Bernanke also cited FOMC participants’ projections that inflation
will stay “at historically low levels for some time.” And he said “very
low rates of inflation raise several concerns.”

“First, very low inflation increases the risk that new adverse
shocks could push the economy into deflation, that is, a situation
involving ongoing declines in prices,” he said. “Experience shows that
deflation induced by economic slack can lead to extended periods of poor
economic performance; indeed, even a significant perceived risk of
deflation may lead firms to be more cautious about investment and

“Second, with short-term nominal interest rates already close to
zero, declines in actual and expected inflation increase, respectively,
both the real cost of servicing existing debt and the expected real cost
of new borrowing,” he continued. “By raising effective debt burdens and
by inhibiting new household spending and business investment, higher
real borrowing costs create a further drag on growth.”

“Finally, it is important to recognize that periods of very low
inflation generally involve very slow growth in nominal wages and
incomes as well as in prices,” he went on. “Thus, in circumstances like
those we face now, very low inflation or deflation does not necessarily
imply any increase in household purchasing power. Rather, because of the
associated deterioration in economic performance, very low inflation or
deflation arising from economic slack is generally linked with
reductions rather than gains in living standards.”

Bernanke said the Fed would normally be cutting the funds rate “in
a situation in which unemployment is high and expected to remain so and
inflation is unusually low,” but that since it has run out of room to
cut the funds rate, the Fed has resorted to quantitative easing. And he
defended that approach.

“(S)ecurities purchases by the Federal Reserve put downward
pressure directly on longer-term interest rates by reducing the stock of
longer-term securities held by private investors,” he said. “These
actions affect private-sector spending through the same channels as
conventional monetary policy.”

Bernanke, in his prepared testimony did not justify the spike in
yields that has occurred since the FOMC launched its second round of
quantitative easing, but he said “the Federal Reserve’s earlier program
of asset purchases appeared to be successful in influencing longer-term
interest rates, raising the prices of equities and other assets, and
improving credit conditions more broadly, thereby helping stabilize the
economy and support the recovery.” And so the FOMC decided on a second

Echoing the Nov. 3 and Dec. 14 FOMC statements, Bernanke said the
FOMC “will review its asset purchase program regularly in light of
incoming information and will adjust the program as needed to meet its

“Importantly, the Committee remains unwaveringly committed to price
stability and, in particular, to maintaining inflation at a level
consistent with the Federal Reserve’s mandate from the Congress,” he

Bernanke stressed once again that the Fed “has all the tools it
needs to ensure that it will be able to smoothly and effectively exit
from this program at the appropriate time.”

“Importantly, the Federal Reserve’s ability to pay interest on
reserve balances held at the Federal Reserve Banks will allow it to put
upward pressure on short-term market interest rates and thus to tighten
monetary policy when needed, even if bank reserves remain high,” he
said. “Moreover, the Fed has invested considerable effort in developing
methods to drain or immobilize bank reserves as needed to facilitate the
smooth withdrawal of policy accommodation when conditions warrant.”

“If necessary, the Committee could also tighten policy by redeeming
or selling securities on the open market,” he added.

But Bernanke gave no indication that the Fed is going to exit
anytime soon either in his text or in response to questions.

“Now it’s always the case that when you are reversing monetary
policy in a period of growth that as a matter of judgement you can be
too early or too late,” he said in response to a Senator’s question.
“But that’s true for normal monetary policy as well as for unusual
monetary policy.”

“So I’m not trying to claim omniscience, and of course it is always
possible that we will be either a little too slow or little too quick
and we’ll do our very, very best to move at the right time,” he said.

“As far as inflation is concerned, though, again the absolute
inflation rate is at essentially a post-war low and inflation
expectations look very stable,” he added.

Bernanke said “break-even” spreads between yields on conventional
and inflation indexed Treasury notes (TIPS) is “about where you think
they would want to be if people expect that over the next five to ten
years the Fed will keep inflation at about 2%, which is about where we
think we ought to be aiming.”

“We are going to pay very close attention to the inflation
situation and we take that very, very seriously,” he added.

Bernanke said the Fed is “in a situation similar to where we always
are — which is we need to find the right moment to begin tightening.”

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** Market News International **

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