Federal Reserve Chairman Ben Bernanke indicated the Fed should be able to keep interest rates low for some time, as the recent drop in commodity prices coupled with reduced demand for resources should reduce the threat of inflation.
"If not reversed, these developments, together with a pace of growth that is likely to fall short of potential for a time, should lead inflation to moderate later this year and next year," Bernanke said on Friday at the annual economic symposium in Jackson Hole, Wyoming.
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The Fed for the last several months has had to tread carefully to ensure its rate cuts, meant to prime the economic pump, do not spark inflation, which continues to rise at a pace not seen for nearly two decades.
Bernanke acknowledged the slowing U.S. economy and rising inflation have combined to create "one of the most challenging economic and policy environments in memory," something made all the more difficult because turmoil in the financial markets "has not yet subsided".
He added the Fed"s decision to lower the fed funds rate to 2 pct from 5.25 over the last year was "conditioned on our expectation that the prices of oil and other commodities would ultimately stabilize", and said this ongoing expectation has allowed the Fed to keep the fed funds rate low "despite an increase in inflationary pressures".
But while he called recent commodity price declines "encouraging", he said the inflation outlook is still "highly uncertain" and reiterated the Fed would "continue to monitor inflation and inflation expectations closely."
"The FOMC is committed to achieving medium-term price stability and will act as necessary to attain that objective," he said.
Central bankers from around the world are gathered in the mountain resort of Jackson Hole, Wyoming, for an annual symposium. Financial markets, meanwhile, are worried about more home loan losses and concern that U.S. mortgage giants Fannie Mae and Freddie Mac will need a government bailout.
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This time last year, Bernanke told the conference the Fed would take steps to shield the economy from the U.S. housing collapse, but would not bail out investors.
Since then, the Fed has slashed interest rates and lined up billions of dollars in emergency credit to prevent markets from seizing up over mountainous home loan losses.
Bernanke said the financial crisis that has pounded the country—coupled with higher inflation— is taking a toll on the economy and poses a major challenge to Fed policymakers as they try to restore stability.
"Although we have seen some improved functioning in some markets, the financial storm that reached gale force" around this time last year "has not yet subsided, and its effects on the broader economy are becoming apparent in the form of softening economic activity and rising unemployment," Bernanke said.
—Thomson Financial, Reuters and AP contributed to this report.