Highlights of Bernanke’s remarks to the House today

Here you’ll find a few highlights from today’s prepared remarks by Ben Bernanke before the U.S. House Committee on Financial Services. It seems pretty clear the Fed is standing pat, despite fears from many of us that the current weakness in the economy could lead us into a new recession, and fears from others that higher inflation is right around the corner (there seems little evidence of this, but the concern is still there).

In short, there’s very little new here, other than perhaps a slight opening of the door to the possibility of a third round of so-called quantitative easing.

On “The Economic Outlook”:

The U.S. economy has continued to recover, but the pace of the expansion so far this year has been modest. After increasing at an annual rate of 2-3/4 percent in the second half of 2010, real gross domestic product (GDP) rose at about a 2 percent rate in the first quarter of this year, and incoming data suggest that the pace of recovery remained soft in the spring. At the same time, the unemployment rate, which had appeared to be on a downward trajectory at the turn of the year, has moved back above 9 percent.

In part, the recent weaker-than-expected economic performance appears to have been the result of several factors that are likely to be temporary. Notably, the run-up in prices of energy, especially gasoline, and food has reduced consumer purchasing power. In addition, the supply chain disruptions that occurred following the earthquake in Japan caused U.S. motor vehicle producers to sharply curtail assemblies and limited the availability of some models.

[. . .]Among the headwinds facing the economy are the slow growth in consumer spending, even after accounting for the effects of higher food and energy prices; the continuing depressed condition of the housing sector; still-limited access to credit for some households and small businesses; and fiscal tightening at all levels of government.

[. . .] Most of the recent rise in inflation appears likely to be transitory, and FOMC participants expected inflation to subside in coming quarters to rates at or below the level of 2 percent or a bit less that participants view as consistent with our dual mandate of maximum employment and price stability. The central tendency of participants’ forecasts for the rate of increase in the PCE price index was 2.3 to 2.5 percent for 2011 as a whole, which implies a significant slowing of inflation in the second half of the year. In 2012 and 2013, the central tendency of the inflation forecasts was 1.5 to 2.0 percent. Reasons to expect inflation to moderate include the apparent stabilization in the prices of oil and other commodities, which is already showing through to retail gasoline and food prices; the still-substantial slack in U.S. labor and product markets, which has made it difficult for workers to obtain wage gains and for firms to pass through their higher costs; and the stability of longer-term inflation expectations, as measured by surveys of households, the forecasts of professional private-sector economists, and financial market indicators.

On the just-completed second round of quantitative easing:

[. . .] the Fed’s asset purchase program–like more conventional monetary policy–has served to reduce the yields and increase the prices of those other assets as well. The net result of these actions is lower borrowing costs and easier financial conditions throughout the economy.2 We know from many decades of experience with monetary policy that, when the economy is operating below its potential, easier financial conditions tend to promote more rapid economic growth. Estimates based on a number of recent studies as well as Federal Reserve analyses suggest that, all else being equal, the second round of asset purchases probably lowered longer-term interest rates approximately 10 to 30 basis points.3 Our analysis further indicates that a reduction in longer-term interest rates of this magnitude would be roughly equivalent in terms of its effect on the economy to a 40 to 120 basis point reduction in the federal funds rate.

[. . .]even with the end of net new purchases, maintaining our holdings of these securities should continue to put downward pressure on market interest rates and foster more accommodative financial conditions than would otherwise be the case. It is worth emphasizing that our program involved purchases of securities, not government spending, and, as I will discuss later, when the macroeconomic circumstances call for it, we will unwind those purchases. In the meantime, interest on those securities is remitted to the U.S. Treasury.

On future fiscal policy and the possibility of stronger Fed action:

Once the temporary shocks that have been holding down economic activity pass, we expect to again see the effects of policy accommodation reflected in stronger economic activity and job creation. However, given the range of uncertainties about the strength of the recovery and prospects for inflation over the medium term, the Federal Reserve remains prepared to respond should economic developments indicate that an adjustment in the stance of monetary policy would be appropriate.

On the one hand, the possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support. [. . .]

On the other hand, the economy could evolve in a way that would warrant a move toward less-accommodative policy. Accordingly, the Committee has been giving careful consideration to the elements of its exit strategy, and, as reported in the minutes of the June FOMC meeting, it has reached a broad consensus about the sequence of steps that it expects to follow when the normalization of policy becomes appropriate. In brief, when economic conditions warrant, the Committee would begin the normalization process by ceasing the reinvestment of principal payments on its securities, thereby allowing the Federal Reserve’s balance sheet to begin shrinking.