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Bernanke Weighs Risks of New Action

The Federal Reserve chairman, Ben S. Bernanke, went further on Friday in outlining the risks the central bank was prepared to take by pumping more money into the flagging recovery.

Federal Reserve Chairman Ben Bernanke testifies before the Senate Banking, Housing and Urban Affairs Committee on his re-nomination to the position.
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Federal Reserve Chairman Ben Bernanke testifies before the Senate Banking, Housing and Urban Affairs Committee on his re-nomination to the position.

In formal remarks here, Mr. Bernanke explained a viewpoint that had taken shape gradually over several months. The Fed hoped to calm debate over its next move and prepare markets for the likelihood that it would pour money into the economy by resuming purchases of government, and possibly private, debt.

The new action would be aimed at lowering long-term interest rates and spurring growth, but it would also have effects far beyond American shores. It could contribute to the weakening of the dollar and complicate a festering currency dispute that threatens to disrupt global trade relations.

For Americans, additional Fed activity is likely to mean that already low 30-year mortgage rates would fall even further. The moves would not help many savers, however, as yields on certificates of deposit and savings bonds would probably fall as well. But the Fed hopes that making credit even cheaper will encourage businesses and consumers to borrow and spend, and that could eventually bring relief to jobless workers.

Mr. Bernanke’s remarks, at a conference organized by the Federal Reserve Bank of Boston, confirmed Wall Street analysts’ expectations that the Federal Open Market Committee would approve new steps at its next meeting on Nov. 2-3.

The question now is not whether the Fed will resume the debt-buying strategy known as quantitative easing, but how much it will buy, and how quickly, analysts said. Mr. Bernanke did not offer such details.

The stock markets, which have risen since the Fed took an incremental step in August toward additional monetary easing, largely shrugged off Mr. Bernanke’s remarks, though new stimulus efforts would probably raise equity prices, at least in the short run. Stocks ended mixed, with the Dow Jones industrial average slightly lower and the Standard & Poor’s 500-stock index up slightly.

In the past, the Fed sometimes changed rates when the market didn’t expect it. But in this difficult economy, it felt it had to telegraph its moves well in advance so as not to disturb markets or other major economies.

The economic outlook offered by Mr. Bernanke was sobering. He said that the rate of growth was “less vigorous than we would like,” and that the unemployment rate was likely to “decline only slowly” next year, even as the recovery gains steam.

Mr. Bernanke centered his analysis on the Fed’s “dual mandate” to foster maximum employment and price stability. He said that inflation was “too low” relative to the desired rate of “about 2 percent or a bit below,” and that unemployment was “clearly too high” relative to Fed officials’ long-run forecast of 5 to 5.25 percent.

“Given the committee’s objectives, there would appear — all else being equal — to be a case for further action,” Mr. Bernanke said.

Mr. Bernanke noted that one key measure of inflation — the price index for personal consumption expenditures, which excludes food and energy prices — had fallen to about 1.1 percent over the first eight months of this year, from about 2.5 percent in the early stages of the recession.

Weighing in on a debate that has preoccupied Fed officials, Mr. Bernanke planted himself on the side of those who view the high unemployment rate — 9.6 percent — as an outcome of the sharp contraction in economic demand that followed the financial crisis, rather than of structural factors like a mismatch between workers’ qualifications and the skills required by employers.

But Mr. Bernanke acknowledged, with greater candor than Fed officials usually have, the tension between the two parts of the Fed’s mandate.

“Whereas monetary policy makers clearly have the ability to determine the inflation rate in the long run, they have little or no control over the longer-run sustainable unemployment rate, which is primarily determined by demographic and structural factors, not by monetary policy,” he said.

In interviews, economists at the conference here offered mixed reactions.

“The Fed is trying to achieve too much,” said Mickey D. Levy, chief economist at Bank of America. “They want to stimulate demand, but there are a lot of nonmonetary factors that are inhibiting the economy, including distressed mortgages and foreclosures, the need for households to save, and a whole array of factors deterring businesses from hiring.”

John B. Taylor, a Stanford economist, disagreed with Mr. Bernanke’s conclusions. “From my perspective, the cost-benefit analysis would suggest that it wouldn’t be a good idea to do a big, massive quantitative easing because the gains are quite small in terms of the impact on interest rates,” he said.

But Laurence H. Meyer, a former Fed governor, defended Mr. Bernanke’s stance.

“If the economy has a negative shock, or continues to grow as slowly as it has, it’s going to be sliding toward deflation,” he said. “The Fed can’t sit on its hands,” he added, and should pursue additional action “as long as it has an effect — even if it’s small.”

Dean Maki, chief United States economist at Barclays Capital, said more Fed action “should be positive for economic growth, though the amount is uncertain.”

The Fed lowered short-term rates to nearly zero in December 2008 and then pursued its first round of quantitative easing beginning in 2009. By April this year, it had bought $1.7 trillion in mortgage-related debt and Treasury securities to put downward pressure on long-term rates.

As recently as the spring, the Fed was considering when and how it would begin to raise interest rates. But as the recovery stumbled, the Fed reversed course, and by late summer it was debating how best to prop up the recovery.

Mr. Bernanke cautioned that “unconventional policies have costs and limitations that must be taken into account in judging whether and how aggressively they should be used.”

He admitted that the debt-buying strategy was largely untested. “We have much less experience in judging the economic effects of this policy instrument, which makes it challenging to determine the appropriate quantity and pace of purchases and to communicate this policy response to the public,” he said.

And he acknowledged a fear that new asset purchases might “reduce public confidence” in the Fed’s ability to eventually make a smooth return to normal monetary policy and lead to “an undesired increase in inflation expectations.” But he said he was confident that the Fed could tighten policy when the time came.

Along with more quantitative easing, the Fed could communicate that it intended to keep short-term interest rates low for even longer than markets expected. That could help lower longer-term rates, as they partly reflect expectations of future short-term rates. But Mr. Bernanke appeared to play down that option, saying it would be difficult to convey that intention “with sufficient precision and conditionality.”

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