WASHINGTON (MNI) – The following is Federal Reserve Chairman Ben
Bernanke’s testimony prepared Thursday for the Joint Economic Committee:

Chairman Casey, Vice Chairman Brady, and other members of the
Committee, I appreciate this opportunity to discuss the economic outlook
and economic policy. Economic growth has continued at a moderate rate so
far this year. Real gross domestic product (GDP) rose at an annual rate
of about 2 percent in the first quarter after increasing at a 3 percent
pace in the fourth quarter of 2011. Growth last quarter was supported by
further gains in private domestic demand, which more than offset a drag
from a decline in government spending.

Labor market conditions improved in the latter part of 2011 and
earlier this year. The unemployment rate has fallen about 1 percentage
point since last August; and payroll employment increased 225,000 per
month, on average, during the first three months of this year, up from
about 150,000 jobs added per month in 2011. In April and May, however,
the reported pace of job gains slowed to an average of 75,000 per month,
and the unemployment rate ticked up to 8.2 percent. This apparent
slowing in the labor market may have been exaggerated by issues related
to seasonal adjustment and the unusually warm weather this past winter.1
But it may also be the case that the larger gains seen late last year
and early this year were associated with some catch-up in hiring on the
part of employers who had pared their workforces aggressively during and
just after the recession.2 If so, the deceleration in employment in
recent months may indicate that this catch-up has largely been
completed, and, consequently, that more- 1 rapid gains in economic
activity will be required to achieve significant further improvement in
labor market conditions.

Economic growth appears poised to continue at a moderate pace over
coming quarters, supported in part by accommodative monetary policy. In
particular, increases in household spending have been relatively well
sustained. Income growth has remained quite modest, but the recent
declines in energy prices should provide some offsetting lift to real
purchasing power. While the most recent readings have been mixed,
consumer sentiment is nonetheless up noticeably from its levels late
last year. And, despite economic difficulties in Europe, the demand for
U.S. exports has held up well. The U.S. business sector is profitable
and has become more competitive in international markets.

However, some of the factors that have restrained the recovery
persist. Notably, households and businesses still appear quite cautious
about the economy. For example, according to surveys, households
continue to rate their income prospects as relatively poor and do not
expect economic conditions to improve significantly. Similarly, concerns
about developments in Europe, U.S. fiscal policy, and the strength and
sustainability of the recovery have left some firms hesitant to expand
capacity.

The depressed housing market has also been an important drag on the
recovery. Despite historically low mortgage rates and high levels of
affordability, many prospective homebuyers cannot obtain mortgages, as
lending standards have tightened and the creditworthiness of many
potential borrowers has been impaired. At the same time, a large stock
of vacant houses continues to limit incentives for the construction of
new homes, and a substantial backlog of foreclosures will likely add
further to the supply of vacant homes. However, a few encouraging signs
in housing have appeared recently, including some pickup in sales and
construction, improvements in homebuilder sentiment, and the apparent
stabilization of home prices in some areas.

Banking and financial conditions in the United States have improved
significantly since the depths of the crisis. Notably, recent stress
tests conducted by the Federal Reserve of the balance sheets of the 19
largest U.S. bank holding companies showed that those firms have added
about $300 billion to their capital since 2009; the tests also showed
that, even in an extremely adverse hypothetical economic scenario, most
of those firms would remain able to provide credit to U.S. households
and businesses. Lending terms and standards have generally become less
restrictive in recent quarters, although some borrowers, such as small
businesses and (as already noted) potential homebuyers with
less-than-perfect credit, still report difficulties in obtaining loans.

Concerns about sovereign debt and the health of banks in a number
of euro-area countries continue to create strains in global financial
markets. The crisis in Europe has affected the U.S. economy by acting as
a drag on our exports, weighing on business and consumer confidence, and
pressuring U.S. financial markets and institutions. European
policymakers have taken a number of actions to address the crisis, but
more will likely be needed to stabilize euro-area banks, calm market
fears about sovereign finances, achieve a workable fiscal framework for
the euro area, and lay the foundations for long-term economic growth.
U.S. banks have greatly improved their financial strength in recent
years, as I noted earlier. Nevertheless, the situation in Europe poses
significant risks to the U.S. financial system and economy and must be
monitored closely. As always, the Federal Reserve remains prepared to
take action as needed to protect the U.S. financial system and economy
in the event that financial stresses escalate.

Another factor likely to weigh on the U.S. recovery is the drag
being exerted by fiscal policy. Reflecting ongoing budgetary pressures,
real spending by state and local governments has continued to decline.
Real federal government spending has also declined, on net, since the
third quarter of last year, and the future course of federal fiscal
policies remains quite uncertain, as I will discuss shortly.

With regard to inflation, large increases in energy prices earlier
this year caused the price index for personal consumption expenditures
to rise at an annual rate of about 3 percent over the first three months
of this year. However, oil prices and retail gasoline prices have since
retraced those earlier increases. In any case, increases in the prices
of oil or other commodities are unlikely to result in persistent
increases in overall inflation so long as household and business
expectations of future price changes remain stable. Longer-term
inflation expectations have, indeed, been quite well anchored, according
to surveys of households and economic forecasters and as derived from
financial market information. For example, the five-year-forward measure
of inflation compensation derived from yields on nominal and
inflation-protected Treasury securities suggests that inflation
expectations among investors have changed little, on net, since last
fall and are lower than a year ago. Meanwhile, the substantial resource
slack in U.S. labor and product markets should continue to restrain
inflationary pressures. Given these conditions, inflation is expected to
remain at or slightly below the 2 percent rate that the Federal Open
Market Committee (FOMC) judges consistent with our statutory mandate to
foster maximum employment and stable prices.

With unemployment still quite high and the outlook for inflation
subdued, and in the presence of significant downside risks to the
outlook posed by strains in global financial markets, the FOMC has
continued to maintain a highly accommodative stance of monetary policy.
The target range for the federal funds rate remains at 0 to 1/4 percent,
and the Committee has indicated in its recent statements that it
anticipates that economic conditions are likely to warrant exceptionally
low levels of the federal funds rate at least through late 2014. In
addition, the Federal Reserve has been conducting a program, announced
last September, to lengthen the average maturity of its securities
holdings by purchasing $400 billion of longer-term Treasury securities
and selling an equal amount of shorter-term Treasury securities. The
Committee also continues to reinvest principal received from its
holdings of agency debt and agency mortgagebacked securities (MBS) in
agency MBS and to roll over its maturing Treasury holdings at auction.
These policies have supported the economic recovery by putting downward
pressure on longer-term interest rates, including mortgage rates, and by
making broader financial conditions more accommodative. The Committee
reviews the size and composition of its securities holdings regularly
and is prepared to adjust those holdings as appropriate to promote a
stronger economic recovery in a context of price stability.

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** MNI Washington Bureau: 202-371-2121 **

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