By Ros Krasny
AUSTIN, Texas (Reuters) - Federal Reserve Chairman Ben Bernanke on Monday urged decisive action to protect the economy and said the central bank had alternative tools it could employ to help as interest rates approach zero.
"Our nation's economic policy must vigorously address the substantial risks to financial stability and economic growth," Bernanke told the Greater Austin Chamber of Commerce.
On a day when the arbiter of U.S. business cycles said the United States fell into recession last December, Bernanke said the economy was still under "considerable stress" and had slipped further since markets crumbled anew in September.
"Households have continued to retrench, putting consumer spending on a pace to post another sharp decline in the fourth quarter," the Fed chief warned.
Bernanke said further cuts in overnight interest rates beneath the Fed's current target of 1 percent were "certainly feasible," but he suggested the U.S. central bank would also use other unconventional measures to spur growth.
"Although conventional interest rate policy is constrained by the fact that nominal interest rates cannot fall below zero, the second arrow in the Federal Reserve's quiver -- the provision of liquidity -- remains effective," he said.
He said the Fed could directly purchase "substantial quantities" of longer-term securities issued by the U.S. Treasury or government-sponsored agencies to lower yields and stimulate demand.
Bernanke also said the Fed could side-step institutions that are reluctant to lend and pump money directly into specific markets. The Fed has already done this in the market for commercial paper, short-term debt companies use to finance day-to-day operations, and last week it announced a program to push funds into markets for consumer-related debt as well.
U.S. Treasury prices rose sharply, pushing yields to their lowest in five decades, as expectations built the Fed would become a large buyer. Prices for stocks, however, cratered. The Dow Jones industrial average closed down nearly 680 points, or 7.7 percent .
GOING TO ZERO?
The Fed is widely expected to lower benchmark U.S. interest rates by a half-percentage point to 0.5 percent at its next scheduled meeting on December 15-16. It is also expected to discuss what other policy tools could be used, and Bernanke's speech was seen as a game plan for likely next steps.
At 0.5 percent, the overnight federal funds would be the lowest on records that date back to mid-1958. Bets on a zero rate by January are also increasing.
"While (the Fed) could lower rates a little bit more, the fact is that if we have to do more, most of it is going to come in the form of something other than just straight interest rate cuts," said Stephen Stanley, chief economist at RBS Greenwich Capital in Greenwich, Connecticut.
In calling for vigorous action to support the economy, Bernanke said the economy was likely to be sluggish for some time. "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," he said.
But he said there was no comparison between the current downturn -- already the third-longest since the 1930s -- and the Great Depression, when the U.S. economy contracted for over a decade, one in four U.S. workers was unemployed and bank failures were rampant.
"Let's put that out of our minds. There is no comparison in terms of severity."
Bernanke drew a distinction between the aggressive actions he and his colleagues have taken and blunders by the 1930s-era Fed, including excessively tight monetary policy and inaction as the financial system collapsed. He said he was being guided in part by his reading of history.
"I made my own mistakes, but I don't want to make someone else's mistakes," he said.
(Writing by Ros Krasny and Alister Bull; Editing by Dan Grebler)