Fed Chairman: Recovery 'Far From Complete'

(Aug. 27) -- With lingering anxiety plaguing the economy, Federal Reserve Chairman Ben Bernanke today outlined an arsenal of tools that could still be applied to restore confidence amid a weak recovery and the sorry state of the job market.

"I think we would all agree that, for much of the world, the task of economic recovery and repair remains far from complete," Bernanke told an annual gathering of central bankers in Jackson Hole, Wyo., in a speech that was highly anticipated by financial players around the world. The Fed "is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly."

Bernanke spoke less than two hours after the Commerce Department announced that the economy grew much slower than previously thought during the second quarter.

Gross domestic product, the sum of output of goods and services produced in the U.S., grew at an annual rate of just 1.6 percent from April through June. That's down from a pace of 3.7 percent in the first three months of the year and considerably lower than the government's initial second-quarter estimate of 2.4 percent.

U.S. corporate profits in the period also plummeted, from $148.4 billion in the first quarter to just $72.7 billion in the second, the Commerce Department added.

And reports on consumer spending, hiring and the housing market have all shown a deteriorating economic environment in the months since then.

The biggest worry, Bernanke noted, is the tenacious and self-perpetuating infirmity of the labor market, which is holding back the consumer spending needed for any sustainable recovery.

"Households' caution is understandable," he said. "Importantly, the painfully slow recovery in the labor market has restrained growth in labor income, raised uncertainty about job security and prospects, and damped confidence."

Recent government surveys show that bank lending to households remains tight, and that anxious Americans are socking away more of their income than officials at the Fed had thought.

"On the one hand, this finding suggests that households, collectively, are even more cautious about the economic outlook and their own prospects than we previously believed," Bernanke said. "But on the other hand, the upward revision to the saving rate also implies greater progress in the repair of household balance sheets."

Still, it's not just households that are suffering.

In the past year, the Fed has found that "a divide has opened between large firms that are able to tap public securities markets and small firms that largely depend on banks," with bank-dependent smaller firms facing "significantly greater problems obtaining credit."

This has made firms "reluctant to add permanent employees, citing slow growth of sales and elevated economic and regulatory uncertainty," and has prompted the Fed to work "to help banks strike a good balance between appropriate prudence and reasonable willingness to make loans to creditworthy borrowers."

Bernanke and his colleagues on the Federal Open Market Committee still expect the economy to keep growing the rest of this year, if more modestly than they had hoped, and to pick up in 2011.

But unemployment is so pervasive now -- at an official rate of 9.5 percent that doesn't even include the people who have given up looking for a job -- that the Fed wants the markets to know it is standing by for further action if needed. So the Fed has prepared three tools aimed at making more money available for businesses to boost employment.

The first is a resumption of Fed purchasing of long-term Treasury bonds and mortgage-backed securities. At the height of the crisis, this was the biggest "nontraditional" move the Fed took -- buying up hundreds of billions of dollars' worth of bonds in a bid to provide banks and other lenders with more cash they could make available to businesses and prospective homebuyers.

The Fed eased itself out of that program late last year and earlier this year when the economy seemed to be recovering on its own. But earlier this month, the committee said the money it gets from maturing government bonds would be reinvested in new Treasury securities.

The idea of going back into the mortgage market at this point would be a radical move, and one, Bernanke acknowledged, that would come with potential risks, including "the fact that, lacking much experience with this option, we do not have very precise knowledge of the quantitative effect of changes in our holdings on financial conditions."

The second potential remedy is rhetorical: a change in the Fed's current promise to keep interest rates exceptionally low "for an extended period" -- understood by markets to mean no increase before next year. A lot of investment decisions ride on expectations for future rate moves, and Bernanke said the committee might consider making a de facto promise to keep rates this low for an even longer period.

And a third option, Bernanke said, is to consider lowering the rate the Fed itself pays to banks that deposit their reserve cash with the regional Federal Reserve banks, to give these banks "an incentive to increase their lending to nonfinancial borrowers" and companies that raise operating cash by selling very short-term bonds.

The Fed is taking none of these steps right away. And it will be a while, still, before it's clear whether the prospect of renewed action alone is enough to make a difference.