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Bernanke: U.s. Economy Is Not Facing Stagflation

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By Neil Irwin

Washington Post Staff Writer

Thursday, February 28, 2008; 11:51 AM

The nation's current economic downturn is in many ways a harder problem for policymakers than the 2001 recession, Federal Reserve Chairman Ben S. Bernanke said today. But he rejected the notion that the United States is facing stagflation, the combination of inflation and a stagnant economy that some analysts fear.

In a hearing today, Senate Banking Committee Chairman Christopher Dodd (D-Conn.) suggested to Bernanke that the United States is in a worse position to deal with the economic fallout of the housing and financial market crisis than it was with the collapse of the dot-com bubble in 2001.

"I think that's fair," Bernanke responded, "in that both fiscal and monetary policy face some additional constraints."

He was referring to the high budget deficits that could limit the ability of Congress to cut taxes or raise spending, the high inflation levels that could limit the Fed's ability to cut interest rates, and the crisis in world credit markets that have muted the ability of Fed rate cuts to stimulate the economy

Asked by Sen. Richard Shelby (R-Ala.) about the risk of stagflation, fears of which have risen this month amid high readings on inflation, Bernanke said: "I don't anticipate stagflation. I don't think we're anywhere near the situation that prevailed in the 1970s."

He added that he expects prices of oil and other commodities to stop rising at the breakneck pace they did in 2007, which would bring down inflation levels.

In his second day of semi-annual testimony on monetary policy, Bernanke also said that he expects some smaller banks to face serious challenges as a result of the problems in the real estate markets, although he said that large banking institutions appear to be in good shape.

"There probably will be some bank failures. There are some small, in some cases [newly created] banks that are heavily invested in real estate in locales where prices have fallen and there probably will be some failures," Bernanke said in response to a question from Shelby about whether he expected some banks to fail.

But he stressed that he was referring to smaller institutions. "Among the largest banks," he said, "the capital ratios remain good and I don't expect any serious problems of that sort among the large international banks that make a large proportion of our banking system."

Bernanke said, however, that large banks need to raise more new capital beyond the $75 billion they have already raised.

"I'd like to see them get more" capital, he said. "They have enough now to remain solvent and well above their minimum capital levels. I'm afraid banks will be pulling back, not making new loans. In order to be able to do that they need to be able to get more capital."

In his testimony on Capitol Hill yesterday, Bernanke suggested that he deals with concerns about the slumping economy, more interest rate cuts could well be on the way.

Bernanke told the House Financial Services Committee about the risk that the housing market will get even worse than anticipated, that the labor market will soften more or that credit will become even less available than it is now. "The risks to this outlook remain to the downside," he said in a semiannual report to Congress on the state of the economy.

He repeated language from previous public comments that Fed policymakers "will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks." Translation: We are ready to continue cutting interest rates to try to prevent a dangerous downward spiral in the economy.

"He held pretty close to his script," said Scott Anderson, a senior economist at Wells Fargo. "He didn't say the word recession, but if you read between the lines, all this talk about further downside risk is dealing with the risk we may already be in one."

Bernanke's testimony yesterday was the clearest indication yet that a rush of bad news on the inflation front -- both consumer and wholesale prices rose more in January than expected -- has not deterred the Fed from the most aggressive campaign of interest rate cuts in decades. The central bank has cut the federal funds rate, which it controls directly, by 1.25 percentage points in 2008 and 2.25 percentage points since September.

Futures markets are pricing in a high likelihood of a half-percentage point rate cut at the Fed's March 18 policymaking meeting. The expectation of further rate cuts drove down the value of the dollar, whose value against the euro hit a new low. A euro cost $1.51 yesterday.

Underscoring the softening in the economy, the Commerce Department yesterday said that orders for big-ticket durable goods, a leading indicator of where the economy is heading, fell 5.3 percent in January, more than expected. New-home sales fell 2.8 percent in January, the department reported, also more than analysts had forecast.

Bernanke expressed more explicit concern about inflation yesterday than he did in testimony to the Senate two weeks ago. He and his Fed colleagues project that the most likely scenario is that inflation will come down this year, as food and energy prices level off on world commodity markets.

Bernanke acknowledged that there are rising risks that projection will prove wrong. He said yesterday that "the further increases in the prices of energy and other commodities in recent weeks, together with the latest data on consumer prices, suggest slightly greater upside risks to the projections of both overall and core inflation than we saw last month."

The Fed puts considerable importance on inflation expectations; if consumers and businesses expect prices to keep rising rapidly, it can become a self-fulfilling prophesy. Recently, indicators from the bond market show that investors' expectations of inflation over the coming years have been creeping up.

"Should high rates of overall inflation persist, the possibility also exists that inflation expectations could become less well anchored," Bernanke said, acknowledging this psychological dynamic.

Bernanke resisted taking a position in a hot debate in Congress over whether to allow bankruptcy courts to redefine terms of mortgages on primary residences. Democratic proponents say it would make it possible for many Americans to avoid foreclosure by having a judge redefine mortgage terms. Republican opponents, including the Bush administration, say this would interfere with existing contracts and would make lenders less willing to offer mortgages, raising rates for everyone.

"I think it would help some people," Bernanke said yesterday. "On the other hand, it would probably lead to concern about the value of existing mortgages and, probably, higher interest rates for mortgages in the future. And so it's a very difficult trade-off."

Deflation then ?

Edited by Ash4781

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The depression was his specialist subject. To what extent do you think that he wants the current problem to be deflation (as opposed to stagflation) because that is what he wants to be the super hero and cure?

Like his predecessor then, I think he said he would have liked the challenge of dealing with a depression. He created all the necessary conditions and then pissed off sharpish.

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