Bernanke Strengthens Economic Warnings

Federal Reserve Chairman Ben S. Bernanke Tuesday outlined the Fed's monetary policy outlook, which was subdued, to Congress.

Although the U.S. economy has continued to recover, economic activity appears to have slowed during the first half of this year, he said in testimony before the Senate Committee on Banking, Housing, and Urban Affairs.

"After rising at an annual rate of 2.5% in the second half of 2011, real gross domestic product (GDP) increased at a 2% pace in the first quarter of 2012, and available indicators point to a still-smaller gain in the second quarter," Bernanke said.

"Conditions in the labor market improved during the latter part of 2011 and early this year, with the unemployment rate falling about a percentage point over that period," he added. "However, after running at nearly 200,000 per month during the fourth and first quarters, the average increase in payroll employment shrank to 75,000 per month during the second quarter. At the same time, the jobless rate has recently leveled out at just over 8%."

Bernanke emphasized two main sources of risk: the euro-area fiscal and banking crisis, and the U.S. fiscal situation.

"Europe's financial markets and economy remain under significant stress, with spillover effects on financial and economic conditions in the rest of the world, including the U.S.," he said.  "Moreover, the possibility that the situation in Europe will worsen further remains a significant risk to the outlook.

"The Federal Reserve remains in close communication with our European counterparts," Bernanke added. "Although the politics are complex, we believe that the European authorities have both strong incentives and sufficient resources to resolve the crisis. At the same time, we have been focusing on improving the resilience of our financial system to severe shocks, including those that might emanate from Europe."

The U.S. fiscal situation is the second important risk to a U.S. economic recovery, Bernanke said.

"As is well known, U.S. fiscal policies are on an unsustainable path, and the development of a credible medium-term plan for controlling deficits should be a high priority," he explained. "At the same time, fiscal decisions should take into account the fragility of the recovery. That recovery could be endangered by the confluence of tax increases and spending reductions that will take effect early next year if no legislative action is taken. The Congressional Budget Office has estimated that, if the full range of tax increases and spending cuts were allowed to take effect--a scenario widely referred to as the fiscal cliff--a shallow recession would occur early next year and about 1.25 million fewer jobs would be created in 2013."

The best way for Congress to help the economy now would be to address the U.S.' fiscal challenges in a manner that addresses the need for long-term sustainability and the fragile nature of the economic recovery, Bernanke said. "Doing so would help reduce uncertainty and boost household and business confidence," he added.

The Federal Open Market Committee (FOMC) decided to ease monetary policy at its June 19-20 meeting by continuing its maturity extension program through 2012 because of the weaker economic outlook, the tame projected path for inflation, and substantial downside risks to economic growth, Bernanke said.

The FOMC "made clear at its June meeting that it is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability," he concluded.