Bernanke: Economic outlook has worsened
In testimony, Fed chairman says central bank is ready to cut rates
WASHINGTON - Federal Reserve Chairman Ben Bernanke told Congress Thursday that the country’s economic outlook has deteriorated and signaled that the central bank is ready to keep on lowering a key interest rate — as needed — to shore things up.
In remarks to the Senate Banking Committee, Bernanke said the one-two punch of the housing and credit crises has greatly strained the economy. Hiring has slowed and people are likely to tighten their belts further, as they are pinched by high energy prices and watch the value of their single biggest asset — their homes — weaken, he warned.
The Bush administration and the Fed anticipate lowering their economic projections for 2008. Appearing on Capitol Hill, Bernanke and Treasury Secretary Henry Paulson said their forecasts still call for growth, although slow growth. Neither Bernanke nor Paulson made any mention of the possibility of recession, although many economists think the economy could slip into one.
“The outlook for the economy has worsened in recent months, and the downside risks to growth have increased,” Bernanke told the committee. “To date, the largest economic effects of the financial turmoil appear to have been on the housing market, which, as you know, has deteriorated significantly over the past two years or so.” Bernanke also said that the “virtual shutdown” of the market for subprime mortgages — given to people with blemished credit histories or low incomes — and a reluctance by skittish lenders to make “jumbo” home loans exceeding $417,000 have aggravated problems in the housing market.
Unsold homes have piled up and foreclosures have climbed to record highs.
“Further cuts in homebuilding and in related activities are likely,” Bernanke cautioned.
Given all the dangers facing the economy, the Fed “will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks,” he said, indicating additional rate cuts were likely.
Bernanke appeared with Treasury Secretary Henry Paulson and Christopher Cox, chairman of the Security and Exchange Commission, amid increasing concerns that the economy may be drifting into recession.
The troubles in the housing and credit markets threaten to push the economy into its first recession since 2001 — if it hasn’t fallen into one already.
Bernanke and Paulson didn’t speak of a recession, noting that their forecasts still call for growth, albeit slow growth. However, the Fed and the Bush administration are expected to downgrade their economic forecasts for this year, given all the troubles, Bernanke and Paulson said.
“It would be less, but I do believe we’ll keep growing,” Paulson told the panel. Bernanke said the Fed’s new forecast out next week will “show lower projections of growth ....growth looks to be weak, but still positive.”
On Wall Street, Bernanke’s bearish assessment of the economy pulled stocks lower. The Dow Jones industrials lost nearly 100 points in morning trading.
The Federal Reserve, which started lowering a key interest rate in September, recently turned much more aggressive. Over the span of just eight days in January, it slashed rates by 1.25 percentage points — the biggest one-month rate reduction in a quarter-century. Economists and Wall Street investors believe the Fed will cut rates even more at its next meeting in March and probably again in April.
“Our economy is clearly in trouble,” said the committee’s chairman, Sen. Christopher Dodd, D-Conn. Restoring investor and consumer confidence, he said, is critical “if we are going to get back on our feet again.”
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Bernanke said his forecast is for the economy to continue to endure a “period of sluggish growth.” That would be “followed by a somewhat stronger pace of growth starting later this year” as the effects of the Fed’s rate cuts and a newly enacted stimulus package begin to be felt. The $168 billion package, which includes rebates for people and tax breaks for businesses, was speedily passed by Congress last week and signed into law on Wednesday by President Bush.
Sen. Richard Shelby, R-Ala., though, believed the energizing impact of the rebates would be “negligible” and likened it to “pouring a glass of water into the ocean.”
Even though Bernanke’s forecast envisions an improving economic picture later this year, the Fed chief said it was nonetheless “important to recognize that downside risks to growth remain, including the possibilities that the housing market or the labor market may deteriorate to an extent beyond that currently anticipated” or that credit will become even harder to secure.
That’s why, for now, Bernanke indicated the Fed is still inclined to lower interest rates. Yet, that could change, depending on how the economy and inflation unfold.
“A critical task for the Federal Reserve over the course of this year will be to assess whether the stance of monetary policy is properly calibrated to foster our mandated objectives” of promoting healthy employment and economic growth while keeping inflation under control.
Inflation should moderate, Bernanke said. Yet last year’s steep run-up in oil prices is a reminder that the Fed can’t let down its inflation guard and must keep close tabs on the inflation expectations of investors, consumers and businesses. Those expectations can affect their behavior, which can affect the economy.
“Any tendency of inflation expectations to become unmoored or for the Fed’s inflation-fighting credibility to be eroded could greatly complicate” the Fed’s job, he said.
Stimulus from the new rescue package also should help the faltering jobs market, Paulson said. He estimated that it would create “more than half a million jobs by the end of this year.”
Meanwhile, the Bush administration’s efforts to help homeowners at risk of losing their homes is paying off.
In the final three months of last year, more than 470,000 received help from the company servicing their mortgages and almost 30 percent of those received a loan modification, Paulson said.
Still, the secretary said more needs to be done. He called on Congress to revamp mortgage giants Fannie Mae and Freddie Mac and modernize the Depression-era Federal Housing Administration. He also asked Congress to pass legislation that will allow states to issue tax-exempt bonds and use the proceeds to help struggling homeowners refinance into more affordable mortgages.
The SEC is exploring the role of ratings agencies in the meltdown of subprime mortgages, Cox said. Critics allege ratings agencies didn’t adequately assess risk when assigning ratings to certain complex mortgage securities.
Cox said he expects to receive preliminary reports from the agency’s examinations in the coming months and a final report in the early summer.
Bernanke and Paulson have been fighting to keep the economy afloat. Foreclosures have climbed to record highs, financial companies have racked up multibillion-dollar losses from soured mortgage investments, Wall Street has convulsed, and employers have turned cautious in their hiring. Payrolls in January fell by 17,000, the first nationwide job loss in more than four years.
Economic growth practically stalled in the final three months of last year, and some economists believe it may actually be contracting now. By one rough rule of thumb, a recession occurs when there are two consecutive quarters — six straight months — when the economy shrinks.
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