Federal Reserve Chairman Ben Bernanke said on Wednesday the central bank is ready to ease monetary policy further if the economy weakens and inflation moves lower, suggesting policymakers are actively mulling further stimulus.
"The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support," Bernanke said in prepared testimony before the House of Representatives Financial Services Committee.
Bernanke laid out three options the central bank would consider. He said the Fed could launch another round of Treasury bond buying, the third such effort since 2009. It could cut the interest paid to banks on the reserves they hold as a way to encourage them to lend more.
The Fed could also be more explicit in spelling out just how long it planned to keep rates at record-low levels. That would give investors confidence about the Fed's efforts to continue supporting the economy.
Bernanke specifically noted Fed forecasts for June, which were already revised down significantly from April, had not incorporated recent data, particularly last Friday's dismal employment report. That data showed job growth essentially grinding to a halt in the last two months, pushing the jobless rate up to 9.2 percent.
Minutes from the Fed's June meeting, released on Tuesday, showed some policymakers believe the Fed should stand ready to provide more support to the economy if the recovery flags, rekindling the threat of a debilitating downward spiral in prices and wages. Others on the policy-setting Federal Open Market Committee, however, felt inflation risks might force the central bank to withdraw stimulus sooner than is currently anticipated.
Bernanke also weighed in on the debt ceiling debate raging in Washington, saying the U.S. would continue to pay interest on government debt if Congress failed to extend the debt ceiling by August 2. "The assumption is that as long as possible, the Treasury would want to try to make payments on the principal and interest to the government debt, because failure to do that would certainly throw the financial system into enormous disarray and have major impacts on the global economy," Bernanke said.
The Fed chief's outlook on the economy was cautious, and for good reason. After recovering from the steepest recession in generations beginning in the summer of 2009, the economy has lost momentum in recent months. Gross domestic product expanded just 1.9 percent in the first three months of the year, and the second quarter does not look to have been much better.
Bernanke held to the view that recent weakness was due in part to temporary factors like high energy costs and the effects on global industry from Japan's earthquake and tsunami.
But he acknowledged the labor market remains weaker than the Fed would like.
"The most recent data attest to the continuing weakness of the labor market," Bernanke said.
Lawmakers are likely to grill Bernanke on the effectiveness of the Fed's second round of bond buying, a $600 billion stimulus program just completed at the end of June. Bernanke argues in his testimony that the program was effective at keeping borrowing costs down and stimulating economic activity.
He said the Fed estimates round two of quantitative easing, or QE2, lowered long-term interest rates by between 0.1 and 0.3 percentage point, which Bernanke said would be roughly equivalent to a 0.40 to 1.20 percentage point decline in the federal funds rate, which is currently set in a range between zero and 0.25 percent.
Regarding inflation, Bernanke reiterated the recent rise in prices was mostly linked to transitory factors such as higher energy and commodity prices, and should trend back down