WASHINGTON (Thomson Financial) - Federal Reserve Board Chairman Ben Bernanke laid out an economic scenario without a recession, but with significant risks that the slowing economy he is predicting could get worse, and with a promise that the Fed would insure against those risks.
"My baseline outlook involves a period of sluggish growth, followed by a somewhat stronger pace of growth starting later this year as the effects of monetary and fiscal policy stimulus begin to be felt," he said.
The Fed has already acted to promote growth and mitigate risks, he told the Senate Banking Committee in prepared testimony. Now, its job is "to assess whether the stance of monetary policy is properly calibrated" and especially to decide "whether the policy actions taken thus far are having their intended effects."
If they are not, Bernanke promised the Fed "will act in a timely manner as needed to support growth and provide adequate insurance against downside risks."
He warned that the downside risks remaining include "the possibilities that the housing market or the labor market may deteriorate to an extent beyond that currently anticipated or that credit conditions may tighten substantially further."
In his inflation outlook, the Fed Chairman mentioned threats from the steep run-up in the price of oil, exceptionally rapid rises in food prices and the falling dollar.
Referring to an overall PCE price index increase of 3.4% in 2007, up from 1.9% in 2006, Bernanke began to raise the level of qualification and concern in his statements about inflation expectations.
"To date," he said, they "appear to have remained reasonably well anchored, but any tendency of inflation expectations to become unmoored or for the Fed's inflation-fighting credibility to be eroded" would make it far more difficult for the Fed to counter threats to growth in the future.
On the banking system, Bernanke said that while banks entered the current episode of distress with high profits and strong balance sheets, they've had to take large losses and pull back onto their balance sheets many of the investment vehicles they had created.
Many have become more restrictive in their lending to businesses and consumers. As a result, "more-expensive and less-available credit seems likely to continue to be a source of restraint on economic growth."
The financial markets' problems, so far, have had their "largest effects" on housing but conditions in the labor market have also "softened" more generally.
That softening, along with higher energy prices, lower stock prices and falling house prices "seem likely to weigh on consumer spending in the near term."
"On the other hand," Bernanke said in classic economist fashion, "growth in exports should continue to provide some offset" to weakening domestic demand.
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