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Bernanke's options down to comforting words

The U.S. economy appears to be stalling. Yet the Federal Reserve has run out of simple steps it can take to revive it.
Image: Ben Bernanke
Chairman of the Federal Reserve Ben Bernanke's task isn't confined to restoring public confidence. Equally vital, he must forge consensus within the fractious Fed itself.Alex Brandon / AP
/ Source: The Associated Press

The U.S. economy appears to be stalling. Yet the Federal Reserve has run out of simple steps it can take to revive it.

That's the test facing Fed Chairman Ben Bernanke as he addresses a conference Friday in Jackson Hole, Wyoming. Without any easy options left, Bernanke must try to prevent another recession by persuading people and businesses to feel confident enough about the future to spend more today.

Weak consumer spending and a scarcity of jobs have put the economy at risk of lapsing into another downturn. Short-term interest rates near zero have yet to rejuvenate the economy. The benefits of federal stimulus programs are fading, and Congress has declined to pass any major new economic aid.

That puts increasing weight on Bernanke's words. The Fed chairman will speak at 10 a.m. EDT, less than two hours after the government spells out just how fragile the economy is. The Commerce Department is expected to report the economy grew at an anemic annual rate of 1.4 percent from April to June. Growth in the current quarter is shaping up to be just as weak.

Bernanke's task isn't confined to restoring public confidence. Equally vital, he must forge consensus within the fractious Fed itself. Some Fed officials have been reluctant to have the central bank invest more money than it already has to try to stimulate borrowing and spending.

At a Fed meeting this month, Bernanke did manage to persuade his colleagues to pursue a new step to try to invigorate the economy: The Fed will use a relatively small amount of money generated by its portfolio of mortgage securities to buy government debt. The goal is to further ease rates on mortgages and other loans.

Any additional efforts by Bernanke to lower long-term rates will likely run into resistance. One Fed governor, Kevin Warsh, has expressed concern that further such efforts could alarm investors about the economy.

Others worry that further steps might feed inflationary pressures. Some Fed officials, like Charles Plosser, president of the Federal Reserve Bank of Philadelphia, have raised concerns about taking further stimulative steps while the economy is still growing, however slowly.

And in a speech after the Fed's meeting this month, Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis, noted that the Fed's decision this month to buy more government debt led investors to think the U.S. economy was worse than it is.

Bernanke's challenge now may be even more difficult than his role in rescuing the financial system. As dangerous as the financial crisis was, Bernanke had powerful tools at his disposal, and he used them. Besides slashing the Fed's key interest rate to a record low, he presided over a series of unorthodox steps to unfreeze credit, spur lending and stabilize the banking system.

Since the financial crisis struck in 2008, the Fed's balance sheet has swollen from roughly $860 billion to $2.3 trillion. From March 2009 to March this year, the Fed bought $1.25 trillion in mortgage securities and $175 billion in debt from Fannie Mae and Freddie Mac. It also bought $300 billion in government debt during 2009.

Those unconventional steps were widely credited with helping avoid another Great Depression. They landed Bernanke the honor of Time magazine's "Person of the Year" for 2009.

But as Fed watchers like Alan Blinder, a former Fed vice chairman, have noted, the Fed has used up its most potent tools. And low rates, normally an elixir for a sluggish economy, have yet to stimulate much growth this time.

The benchmark interest rate controlled by the Fed has been almost zero for more than a year now. Yet the recovery is deflating. Some economists fear the economy could slip into reverse.

Those factors lie at the heart of Bernanke's challenge: How to persuade individuals and companies to feel good enough about their financial futures to buy homes and cars, expand payrolls and resuscitate the recovery? Beyond the rate-cutting and other actions Bernanke's Fed already has taken, few strong ideas have emerged for what else the Fed should be doing.

Ethan Harris, an economist at Bank of America Merrill Lynch, notes that several Fed bank presidents have sparked public uncertainty by pushing in conflicting directions. Some have expressed concerns about inflation, others about deflation — a prolonged drop in the prices of wages, goods and assets like homes and stocks.

"They're hurting rather than helping confidence with their noisy public debate," Harris says.

Bernanke needs "to give a sense of confidence there is someone with a steady hand on the tiller," Harris says. "One decisive speech can quiet the noise."

Beyond public words, Bernanke does have some remaining options for reviving the economy. He could, for example, launch another trillion-dollar-plus program to buy government debt or mortgages securities. The idea would be to stimulate borrowing and spending and avoid deflation.

But even if Bernanke could persuade most other Fed members to go along, the efforts could backfire. Credit that becomes too cheap, for example, might feed speculative bubbles in the prices of assets like stocks, bonds and commodities that could burst and hurt the economy.

Another large-scale program to buy government debt also could raise concerns with global investors that the Fed is printing money to pay for record-high U.S. budget deficits. Such worries could cause investors to demand higher returns to lend their money. Inflation pressures could build.

Bernanke also could cut to zero the rate the Fed pays banks to keep money parked at the central bank. The idea would be to give banks an incentive to lend more. But it's far from clear that it would work. Banks are being more cautious about lending money they already have. And demand for loans remains weak.

But ultimately, Bernanke's powers of persuasion may be his most potent tool.

"The challenge is for Bernanke to communicate to the world at large — to financial markets and the public — that monetary policy is currently contributing to the economic expansion, and we need to be patient, says William Poole, former president of the Federal Reserve Bank of St. Louis.