Video: Bernanke debut

By Martin Wolk Executive business editor
updated 2/15/2006 4:20:15 PM ET 2006-02-15T21:20:15

New Federal Reserve Chairman Ben Bernanke raised some eyebrows with his Capitol Hill testimony Wednesday, voicing concern about rising inflation and leaving the way open for more interest rate hikes than expected.

Bernanke, in the first of two days of congressional testimony, said he agreed with the assessment of Fed policy-makers at their final meeting under former Chairman Alan Greenspan Jan. 31 that more rate hikes may be needed. And he assured House committee members that he intended “maintain continuity” with monetary policy practices of the 18-year Greenspan era.

While there were no bombshells in Bernanke’s appearance on Capitol Hill, he delivered a forecast that put core inflation at about 2 percent this year, at the upper limit of what the Fed considers tolerable, economists noted. Inflation-adjusted gross domestic product is expected to grow about 3.5 percent, the same as last year, according to the Fed’s forecast.

And Bernanke’s prepared testimony underscored the risks that inflation could worsen due to a pass-through of higher energy costs and the growing strain on U.S. economic capacity.

The comments “had a modestly hawkish tilt, as one might expect from a new Fed Chairman who needs to establish his inflation-fighting credentials,” said Goldman Sachs chief U.S. economist Jan Hatzius in a note.

Monetary policy hawkishness implies the Fed will be aggressive in raising interest rates to keep a lid on inflation.

“I think after reading (the testimony) a bit more closely people came away and said, ‘You know, this guy is pretty hawkish,’” said Mark Vitner, senior economist at Wachovia Securities. “When I take his testimony and look at the reality I think we’re going to have a hard time getting 3.5 percent growth and not having an acceleration in inflation.”

That means the Fed might ultimately have to raise the benchmark overnight lending rate from the current 4.5 percent to as much as 5.5 percent instead of the 5 percent that is the highest peak predicted by most forecasters.

Vitner said the Fed’s course will depend on consumer spending and housing. If the housing market continues to cool and consumer spending pulls back, the Fed probably can get away with another hike at its next meeting in late March and possibly one more. But if consumer spending and housing are stronger than expected, the Fed might have to be more aggressive.

“Ironically, if they were to do that, they would really run the risk of overdoing it,” he said.

Rich Yamarone, director of economic research for Argus Research, said Bernanke’s hawkish tone was a calculated signal to inflation-sensitive bond markets that he intends to be vigilant about inflation even if that means overshooting the rate-hike cycle.

Major Market Indices

“Any signs of a dovish approach to policy could have proved severely costly,” triggering a potentially drastic sell-off in bonds, he said in a note. That could send long-term interest rates sharply higher, “crush the housing market and invite all sorts of inflation.”

Stock prices closed slightly higher as financial markets digested Bernanke’s remarks, and bond market interest rates rose slightly.

Not everyone was convinced that the Fed will have to raise interest rates more than once or twice more. After all Bernanke said that the housing market has been slowing and that if anything the risk is that “prices and construction could decelerate more rapidly than currently seems likely.”

That kind of slowdown actually would help the Fed in its effort to keep a lid on growth with much further hiking of rates.

“I still think the light at the end of the tightening tunnel is in place,” said Stuart Hoffman, chief economist at PNC Financial Services. Bernanke confirmed that one more quarter-point hike is a certainty, and beyond that one more is possible depending on economic data.

Hoffman thinks any more hikes are unlikely this year unless inflation unexpectedly shoots higher.

Bernanke, an experience former Fed governor and longtime Princeton University economist, avoided making any market-moving gaffes although some members of the House Financial Services committee appeared eager to win his endorsement for their views.

Bernanke was careful not to take sides on questions about tax policy although he said high budget deficits and the rising cost of government programs like Social Security and Medicare were unsustainable unless Congress takes action.

“The implications of these obligations are quite draconian in the long run,” he said. “We need to be addressing those long-term issues soon.”

He said it was up to Congress to determine the size of the federal government and its programs, and whether taxes need to be raised or expenditures cut to bring fiscal policy in balance.

While Bernanke avoided making big headlines, several panel members seemed to welcome the change from Greenspan and his drawn-our sometimes inscrutable responses to their questions.

Rep. Christopher Shays, R-Conn., was among several who thanked Bernanke for his relatively short, direct answers.

Rep. Maxine Waters, D-Calif., told Bernanke she would miss Greenspan but added: “No one talks like him, and we don’t want you to.”

Bernanke returns to Capitol Hill Thursday to present the Fed's latest forecast to a Senate panel and answer questions from its members.

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