Bernanke's Speech to the Austin Chamber of Commerce

Following is Chairman Ben Bernanke's Speech to the Austin Chamber of Commerce:

Economic Outlook Despite the efforts of the Federal Reserve and other policymakers, the U.S. economy remains under considerable stress. Economic activity was weakening even before the intensification of the financial crisis this fall. The sharp falloff in consumer spending during the summer was particularly striking. According to the latest estimates, real gross domestic product (GDP) declined at an annual rate of 0.5 percent in the third quarter, with personal consumption falling at an annual rate of 3.7 percent.

J. Scott Applewhite

However, economic activity appears to have downshifted further in the wake of the deterioration in financial conditions in September. Employment losses, which had been averaging about 100,000 per month for much of the year, accelerated to more than 250,000 per month, on average, in September and October, and the unemployment rate jumped to 6.5 percent in October. Moreover, recent increases in the number of new claims for unemployment insurance suggest that labor market conditions worsened further in November. Housing markets remain weak, with low demand and the increased number of distressed properties on the market contributing to further declines in house prices and ongoing reductions in new construction. In reaction to worse economic prospects and tightening credit conditions, households have continued to retrench, putting consumer spending on a pace to post another sharp decline in the fourth quarter. In particular, sales of light motor vehicles fell to an annual rate of 10-1/2 million units in October, the lowest level since 1983, and November sales reports are downbeat.

Business activity also slowed in recent months. Excluding the effects of the hurricanes and the Boeing strike on production, manufacturing output fell 2 percent over the months of September and October, orders and shipments of nondefense capital goods fell markedly in October, and most survey measures of business conditions are at or close to record lows.

Amid the bad news, there have been some positives. The pronounced declines in the prices for crude oil and other commodities have helped to reverse what had been a significant drag on household purchasing power through much of the year.

And there have been a few tentative signs of stabilization in financial markets.

For instance, short-term funding costs for banks and commercial paper issuers have come down recently, and issuance of investment-grade bonds by nonfinancial corporations appears to have held up well. Banks have recently issued bonds backed by the FDIC guarantee. That said, investor concerns about credit quality have increased further, and risk aversion remains intense. As a result, in almost all credit markets, spreads remain wider, maturities shorter, and availability more constrained than was the case before the intensification of the crisis this fall.

The likely duration of the financial turmoil is difficult to judge, and thus the uncertainty surrounding the economic outlook is unusually large. But even if the functioning of financial markets continues to improve, economic conditions will probably remain weak for a time. In particular, household spending likely will continue to be depressed by the declines to date in household wealth, cumulating job losses, weak consumer confidence, and a lack of credit availability.

The global economy has also slowed. Many industrial countries were affected by the financial crisis from the beginning, but the latest economic data point to a more noticeable weakening of conditions. And emerging market economies, which were little affected at first, are slowing now as well. One implication of these developments is that exports are not likely to be as great a source of strength for U.S. economic activity in coming quarters as they had been earlier this year.

At the same time, the increase in economic slack and the declines in commodity prices and import prices have alleviated upward pressures on consumer prices.

Moreover, inflation expectations appear to have eased slightly. These developments should bring inflation down to levels consistent with price stability.

Although the near-term outlook for the economy is weak, a number of factors are likely over time to promote the return of solid gains in economic activity and employment in the context of low and stable inflation. Among those factors are the stimulus provided by monetary policy and possible fiscal actions, the eventual stabilization in housing markets as the correction runs its course, and the underlying strengths and recuperative powers of our economy. The time needed for economic recovery, however, will depend greatly on the pace at which financial and credit markets return to more-normal functioning.

The Outlook for Policy Going forward, our nation's economic policy must vigorously address the substantial risks to financial stability and economic growth that we face. I will conclude my remarks by discussing the policy options of the Federal Reserve, focusing on the three aspects of policy that I laid out earlier: interest rate policy, liquidity policy, and policies to stabilize the financial system.

Regarding interest rate policy, although further reductions from the current federal funds rate target of 1 percent are certainly feasible, at this point the scope for using conventional interest rate policies to support the economy is obviously limited. Indeed, the actual federal funds rate has been trading consistently below the Committee's 1 percent target in recent weeks, reflecting the large quantity of reserves that our lending activities have put into the system. In principle, our ability to pay interest on excess reserves at a rate equal to the funds rate target, as we have been doing, should keep the actual rate near the target, because banks should have no incentive to lend overnight funds at a rate lower than what they can receive from the Federal Reserve. In practice, however, several factors have served to depress the market rate below the target. One such factor is the presence in the market of large suppliers of funds, notably the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, which are not eligible to receive interest on reserves and are thus willing to lend overnight federal funds at rates below the target.1 We will continue to explore ways to keep the effective federal funds rate closer to the target.

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