Bloomberg News

Bernanke Sees Range of Options for Additional Fed Easing

July 17, 2012

Federal Reserve Chairman Ben S. Bernanke said policy makers are studying options for further easing that could be deployed in case economic growth remains too feeble to produce a lasting decline in unemployment.

Bernanke, responding to questions during testimony today to the Senate Banking Committee in Washington, said easing tools include further purchases of assets, such as mortgage-backed securities, reducing the interest rate that the Fed pays on reserves banks keep with the Fed, and altering its communications on the outlook for interest rates.

“We haven’t really 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,” Bernanke said.

Bernanke and his colleagues on the Federal Open Market Committee meet in two weeks to continue debating whether further action is needed to reduce a jobless rate stuck above 8 percent since February 2009. Last month, they decided to extend to the end of the year their program, known as Operation Twist, to lengthen maturities of assets on the Fed’s balance sheet.

“They probably want to see more evidence that the labor market has stalled,” said Roberto Perli, a managing director at International Strategy and Investment Group Inc. in Washington and a former senior staff economist in the Fed’s division of monetary affairs. “If they do become convinced of that, then further easing is in the cards, but we’ll probably have to wait beyond the next meeting for that.”

Stocks Rally

The Standard & Poor’s 500 Index rose 0.7 percent to 1,363.67 at 4 p.m. in New York. The yield on the 10-year Treasury note rose to 1.51 percent at 4:59 p.m. from 1.47 percent late yesterday.

Bernanke’s remarks today are his first since the Labor Department reported on July 6 that employers added 80,000 jobs to payrolls in June, fewer than economists forecast, while the jobless rate was unchanged at 8.2 percent. Since then, other reports have shown retail sales unexpectedly declined in June and consumer confidence slumped this month.

“It’s very important that we see sustained progress in the labor market and avoid deflation risk,” Bernanke said. “Those are the things we’ll be looking at as the committee meets later this month and later this summer.”

Data from the Fed today showed industrial production increased in June, led by gains among automobile and machinery makers. A pickup in manufacturing may temper concerns of a slowdown in the industry that has led the three-year economic expansion.

June Minutes

Minutes of the June meeting of the FOMC indicated that a few participants believed the Fed will need to do more, while several others said new easing would be warranted if growth slows, risks intensify or inflation seems likely to fall persistently below the Fed’s 2 percent target.

The Fed last month sought to hold down borrowing costs and spur economic growth by extending Operation Twist, which swaps shorter-term Treasury securities with longer-term debt.

The Fed’s actions have helped keep the yield on 10-year Treasuries near record lows. The yield hit an all-time low of 1.44 percent on June 1. The rate on a 30-year fixed mortgage fell to a record 3.56 percent on July 12.

Operation Twist has been “effective in easing financial conditions and promoting strength in the economy,” Bernanke said today. The Fed’s two rounds of large-scale asset purchases totaling $2.3 trillion, known as quantitative easing, have “also contributed to economic growth,” he said.

Risks of Easing

At the same time, there are also “questions about side effects and risks that may be associated,” with those programs, Bernanke said. “Therefore they should be not be used lightly.”

Other Fed policy makers, including Chicago Fed President Charles Evans and San Francisco’s John Williams, have said the Fed should consider purchasing mortgage-backed securities in a third round of large scale asset purchases, or QE3.

The Fed has also previously considered reducing the interest rate it pays on excess reserves, to give banks an incentive to lend the money to companies and households.

Bernanke said in July 2010 testimony that reducing the rate could damage the functioning of short-term money markets like the Fed funds market for overnight loans among banks.

Policy makers last month lowered their outlook for economic growth and employment, with most foreseeing a jobless rate of at least 7.5 percent at the end of 2013.

‘Further Action’

“The U.S. economy has continued to recover, but economic activity appears to have decelerated somewhat during the first half of this year,” Bernanke said. The Fed is “prepared to take further action as appropriate to promote a stronger economic recovery.”

Bernanke said growth is slowing as business investment cools in response to the European crisis and the prospect of fiscal tightening in the U.S. At the same time, households are restraining spending as unemployment remains elevated and credit is hard to get.

“Given that growth is projected to be not much above the rate needed to absorb new entrants to the labor force, the reduction in the unemployment rate seems likely to be frustratingly slow,” Bernanke said.

Recent economic data have had a “generally disappointing tone,” Bernanke said in the first of two days testifying before Congress as part of the central bank’s semiannual monetary policy report. The economy probably expanded at less than a 2 percent annual rate in the second quarter, he said.

Still Elevated

“The bias continues to be toward easing,” although there was “no smoking gun” in Bernanke’s comments, said Jay Bryson, senior global economist at Wells Fargo Securities LLC in Charlotte, North Carolina. “Bernanke said the unemployment rate is still elevated, which other things being equal, would lead to easing.”

Retail sales unexpectedly declined in June for a third straight month, a sign that limited progress in job creation is holding back the biggest part of the economy. The 0.5 percent drop followed a 0.2 percent decrease in May, Commerce Department figures showed yesterday in Washington. The decline was worse than the most-pessimistic forecast in a Bloomberg News survey in which the median projection called for a 0.2 percent rise.

“The lower-income consumer continues to be very stressed” because of weak job growth, Howard Levine, chairman and chief executive of Family Dollar Stores Inc., told analysts on a June 28 conference call.

Purchase Programs

Discussing easing options in response to questions from Senator Bob Corker, a Tennessee Republican, Bernanke said there are “different types of purchase programs that could include Treasuries, or could include Treasuries and mortgage-backed securities.”

Bernanke also told lawmakers that U.S. fiscal policies are on an “unsustainable path” that must be corrected with a “credible” plan to control deficits, while avoiding damage to the recovery from spending cuts and tax increases that will take effect next year if Congress doesn’t act.

Unless Congress acts, $600 billion in tax increases and spending cuts are set to take effect automatically at the start of next year.

The so-called fiscal cliff would push the economy into a “shallow recession” early next year, Bernanke said, citing an estimate from the Congressional Budget Office. “Additional negative effects” would result from public uncertainty about spending plans, including the debt ceiling, he told lawmakers.

‘Significant Stress’

The Fed chairman said Europe’s financial markets and economy “remain under significant stress,” and that’s creating “spillover effects” in the rest of the world, including the U.S. “The possibility that the situation in Europe will worsen further remains a significant risk to the outlook.”

The Fed chief is scheduled to testimony tomorrow before the House Financial Services Committee.

Bernanke, responding to questions, said the Fed was concerned by the underreporting of London interbank offered rates and had a “substantial response” to address the problem.

The disclosures are “not only very troubling in themselves but they have the effect of undermining public confidence in financial markets,” Bernanke said. He said the Fed didn’t have information to suggest banks were manipulating rates “for profit,” only that some banks were “possibly submitting low rates to avoid appearing weak” during the financial crisis, he said.

The New York Fed knew “some banks” were potentially understating submissions for Libor as early as 2007, according to a statement posted on its website on July 13. A Barclays Plc employee told a New York Fed staff member in April 2008 that the U.K.’s second-largest lender was underreporting its rate to avoid a “stigma,” the Fed bank said.

To contact the reporters on this story: Joshua Zumbrun in Washington at jzumbrun@bloomberg.net;

Craig Torres in Washington at ctorres3@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net


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