All eyes will be on Chairman this week, as he goes to Capitol Hill to deliver the Fedâs twice-yearly Monetary Policy Report to Congress. Bernanke is scheduled to testify before the House Financial Services Committee on Tuesday at 10 a.m. The usual repeat performance before the Senate Banking Committee on Wednesday is expected but not yet officially scheduled. The Fed chief's remarks will come at a crucial time for the , the Fed, and Bernanke himself, who is facing reappointment when his term as chairman expires on Jan. 31, 2010.
The economy is showing several signs that the recession is bottoming out, and the Fedâs latest forecast, which included an upward revision to growth prospects for 2009, is consistent with that notion. Private-sector economists believe the contraction in real GDP moderated substantially in the second quarter, and they expect growth to turn modestly positive in the third quarter. But amid hints of recovery, the markets are increasingly concerned about how the Fed will manage to wind down the greatest expansion in monetary policy in central bank history without fueling future .
In his testimony, Bernanke is expected to develop more fully the Fedâs so-called exit strategy from programs that already have pumped more than $1 trillion in funds into the financial system, with standing commitments to add another $1 trillion or so through purchases of mortgage-backed, Treasury, and other securities. Minutes of the policymakersâ June 23-24 meeting suggest the Fed would prefer not to drain excess funds from the system by selling the securities they have added to their balance sheet, especially mortgage-related securities. Given the Fedâs large footprint in the mortgage market, such sales could be disruptive and possibly push up interest rates.
Rather, the Fed believes it has the tools to control its target interest rate in a way that will neutralize the inflationary impact of the excess funds now in the system. So far, Bernanke & Co. have described some of the tools it has available to withdraw all this monetary fuel, including paying interest on reserves, reverse repurchase agreements, and other special operations. However, the markets increasingly want to hear how these tools will operate in what will be the Fedâs overall exit strategy. Only then can the Fed begin to gain the confidence of the markets that its current unconventional policies can revive the economy without generating inflation.
Bernanke is also likely to be grilled on the Fedâs proposed new role in financial market regulation. A current proposal would greatly expand the Fedâs regulatory powers by making the Fed the sole authority for managing risk in the financial system. The idea has split both Republicans and Democrats, even though the Fedâs leading role in the banking crisis clearly prevented a financial Armageddon that would have done even greater damage to the economy. The Fedâs emergency actions over the past two years have made Congress more aware than ever of the Fedâs vast influence over the economy and financial institutions, and lawmakers may want more say in the central bankâs operations.
Hereâs the weekly economic calendar, from Action Economics: