Ben S Bernanke: The economic outlook
Testimony of Mr Ben S Bernanke, Chairman of the Board of Governors of the US Federal
Reserve System, before the Joint Economic Committee, US Congress, Washington DC,
2 April 2008.
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Chairman Schumer, Vice Chairman Maloney, Representative Saxton, and other members of
the Committee, I am pleased to appear before the Joint Economic Committee. In response to
deterioration in the near-term outlook for the economy and intensified strains in financial
markets, in recent months the Federal Reserve has eased monetary policy substantially
further and taken strong actions to increase market liquidity. In my remarks today, I will first
offer my views on conditions in financial markets and the outlook for the U.S. economy, then
discuss recent actions taken by the Federal Reserve.
Although our recent actions appear to have helped stabilize the situation somewhat, financial
markets remain under considerable stress. Pressures in short-term bank funding markets,
which had abated somewhat beginning late last year, have increased once again. Many
lenders have been reluctant to provide credit to counterparties, especially leveraged
investors, and have increased the amount of collateral they require to back short-term
security financing agreements. To meet those demands, investors have reduced their
leverage and liquidated holdings of securities, putting further downward pressure on security
prices.
Credit availability has also been restricted because some large financial institutions, including
some commercial and investment banks and the government-sponsored enterprises (GSEs),
have reported substantial losses and writedowns, reducing their available capital. Several of
these firms have been able to raise fresh capital to offset at least some of those losses, and
others are in the process of doing so. However, financial institutions' balance sheets have
also expanded, as banks and other institutions have taken on their balance sheets various
assets that can no longer be financed on a standalone basis. Thus, the capacity and
willingness of some large institutions to extend new credit remains limited.
The effects of the financial strains on credit cost and availability have become increasingly
evident, with some portions of the system that had previously escaped the worst of the
turmoil - such as the markets for municipal bonds and student loans - having been affected.
Another market that had previously been largely exempt from disruptions was that for
mortgage-backed securities (MBS) issued by government agencies. However, beginning in
mid-February, worsening liquidity conditions and reports of losses at the GSEs, Fannie Mae
and Freddie Mac, caused the spread of agency MBS yields over the yields on comparable
Treasury securities to rise sharply. Together with the increased fees imposed by the GSEs,
the rise in this spread resulted in higher interest rates on conforming mortgages. More
recently, agency MBS spreads and conforming mortgage rates have retraced part of this
increase, and conforming mortgages continue to be readily available to households.
However, for the most part, the nonconforming segment of the mortgage market continues to
function poorly.
In corporate debt markets, yields and spreads on both investment-grade and
speculativegrade corporate bonds rose through mid-March before falling more recently. Issuance of
investment-grade bonds by both financial and nonfinancial corporations has been quite
robust so far this year, but issuance of new high-yield debt has stalled. Strains continue to be
evident in the commercial paper market as well, where risk spreads remain elevated and the
quantity of commercial paper outstanding, particularly asset-backed paper, has decreased.
Commercial and industrial loans at banks grew in January and February, but at a
considerably slower pace than in previous months.
These developments in financial markets - which themselves reflect, in part, greater
concerns about housing and the economic outlook more generally - have weighed on real
economic activity. Notably, in the housing market, sales of both new and existing homes
have generally continued weak, partly as a result of the reduced availability of mortgage
credit, and home prices have continued to fall.1 Starts of new single-family homes declined
an additional 7 percent in February, bringing the cumulative decline since the early 2006
peak in single-family starts to more than 60 percent. Residential construction is likely to
contract somewhat further in coming quarters as builders try to reduce their high inventories
of unsold new homes.
Private payroll employment fell 101,000 in February, after two months of smaller job losses,
with job cuts in construction and closely related industries accounting for a significant share
of the decline. But the demand for labor has also moderated recently in other industries, such
as business services and retail trade, and manufacturing employment has continued on its
downward trend. Meanwhile, claims for unemployment insurance have risen somewhat on
balance, and surveys indicate that employers have scaled back hiring plans and that
jobseekers are experiencing greater difficulties finding work. The unemployment rate edged
down in February and remains at a relatively low level; however, in light of the sluggishness
of economic activity and other indicators of a softer labor market, I expect it to move
somewhat higher in coming months.
After rising at an annual rate of about 3 percent over the first three quarters of last year, real
disposable income has since increased at only about a 1 percent annual rate, reflecting
weaker employment conditions and higher prices for energy and food. Concerns about
employment and income prospects, together with declining home values and tighter credit
conditions, have caused consumer spending to decelerate considerably from the solid pace
seen during the first three quarters of last year. I expect the tax rebates associated with the
fiscal stimulus package recently passed by the Congress to provide some support to
consumer spending in coming quarters.
In the business sector, the pullback in hiring that I noted earlier has been accompanied by
some reduction in capital spending plans, as weaker sales prospects, tighter credit, and
heightened uncertainty have made business leaders more cautious. On a more positive note,
the nonfinancial business sector remains financially sound, with liquid balance sheets and
low leverage ratios, and most firms have been able to avoid unwanted buildups in
inventories. In addition, many businesses are enjoying strong demand from abroad. Although
the prospects for foreign economic growth have diminished somewhat in recent months, net
exports should continue to provide considerable support to U.S. economic activity in coming
quarters.
Overall, the near-term economic outlook has weakened relative to the projections released
by the Federal Open Market Committee (FOMC) at the end of January. It now appears likely
that real gross domestic product (GDP) will not grow much, if at all, over the first half of 2008
and could even contract slightly. We expect economic activity to strengthen in the second
half of the year, in part as the result of stimulative monetary and fiscal policies; and growth is
expected to proceed at or a little above its sustainable pace in 2009, bolstered by a
stabilization of housing activity, albeit at low levels, and gradually improving financial
conditions. However, in light of the recent turbulence in financial markets, the uncertainty
attending this forecast is quite high and the risks remain to the downside.
Inflation has also been a source of concern. The price index for personal consumption
expenditures rose 3.4 percent over the twelve months ending in February, up from 2.3
percent over the preceding twelve-month period. To a large extent, this pickup in inflation has
been the result of sharp increases in the prices of crude oil, agricultural products, and other
globally traded commodities. Additionally, the decline in the foreign exchange value of the
dollar has boosted some non-commodity import prices and thus contributed to inflation.
However, the so-called core rate of inflation - that is, inflation excluding food and energy
prices - has edged down recently after firming somewhat late last year.
We expect inflation to moderate in coming quarters. That expectation is based, in part, on
futures markets' indications of a leveling out of prices for oil and other commodities, and it is
consistent with our projection that global growth - and thus the demand for commodities -
will slow somewhat during this period. And, as I noted, we project an easing of pressures on
resource utilization. However, some indicators of inflation expectations have risen, and,
overall, uncertainty about the inflation outlook has increased. It will be necessary to continue
to monitor inflation developments carefully in the months ahead.
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I turn now to the Federal Reserve's policy responses to these financial and economic
developments.
Well-functioning financial markets are essential for the efficacy of monetary policy and,
indeed, for economic growth and stability. To improve market liquidity and market
functioning, and consistent with its role as the nation's central bank, the Federal Reserve has
supplemented its longstanding discount window by establishing three new facilities for
lending to depository institutions and primary dealers.
The lending facilities now in place offer depository institutions and primary dealers two
complementary alternatives for meeting funding needs. One pair of facilities - the discount
window for depository institutions and the Primary Dealer Credit Facility for primary dealers -
offers daily access to variable amounts of funding at the initiative of the borrowing institution.
A second pair of facilities - the Term Auction Facility for depository institutions and the Term
Securities Lending Facility for primary dealers - makes available predetermined aggregate
amounts of longer-term funding on pre-announced dates, with the interest rate and the
distribution of the awards across institutions being determined by competitive auction.
Although these facilities operate through depository institutions and primary dealers, they are
designed to support the broad financial markets and the economy by facilitating the provision
of liquidity by those institutions to their customers and counterparties.
The Primary Dealer Credit Facility was put in place in the wake of the near-failure of Bear
Stearns, a large investment bank. On March 13, Bear Stearns advised the Federal Reserve
and other government agencies that its liquidity position had significantly deteriorated and
that it would have to file for Chapter 11 bankruptcy the next day unless alternative sources of
funds became available. This news raised difficult questions of public policy. Normally, the
market sorts out which companies survive and which fail, and that is as it should be.
However, the issues raised here extended well beyond the fate of one company. Our
financial system is extremely complex and interconnected, and Bear Stearns participated
extensively in a range of critical markets. With financial conditions fragile, the sudden failure
of Bear Stearns likely would have led to a chaotic unwinding of positions in those markets
and could have severely shaken confidence. The company's failure could also have cast
doubt on the financial positions of some of Bear Stearns' thousands of counterparties and
perhaps of companies with similar businesses. Given the current exceptional pressures on
the global economy and financial system, the damage caused by a default by Bear Stearns
could have been severe and extremely difficult to contain. Moreover, the adverse effects
would not have been confined to the financial system but would have been felt broadly in the
real economy through its effects on asset values and credit availability. To prevent a
disorderly failure of Bear Stearns and the unpredictable but likely severe consequences of
such a failure for market functioning and the broader economy, the Federal Reserve, in close
consultation with the Treasury Department, agreed to provide funding to Bear Stearns
through JPMorgan Chase. Over the following weekend, JPMorgan Chase agreed to
purchase Bear Stearns and assumed Bear's financial obligations.
The Federal Reserve has taken additional measures to improve market liquidity. We have
initiated a series of twenty-eight-day single-tranche term repurchase transactions with
primary dealers, expected to cumulate to $100 billion outstanding, in which dealers may offer
any of the types of collateral that are eligible for conventional open market operations. We
have also expanded and extended reciprocal currency arrangements ("swap lines") with the
European Central Bank and the Swiss National Bank. Using these swap lines, the
participating central banks are providing dollar liquidity to financial institutions in their
jurisdictions, which should improve the functioning of the global market for dollar funding.
These facilities and programs will be kept in place as long as conditions warrant their
ongoing use. We are working closely with the Securities Exchange Commission to monitor
the financial conditions and funding positions of primary dealers who might seek Federal
Reserve credit.
To date, the recent liquidity measures implemented by the Federal Reserve seem to have
been helpful in addressing some of the strains in financial markets. Funding pressures on
primary dealers appear to have eased somewhat, and liquidity seems to have improved in
several markets, including - as noted earlier - the market for agency mortgage-backed
securities. To the extent that these measures improve market functioning, they will have
favorable effects on the ability and willingness to make credit available to the broader
economy. More-liquid markets also increase the efficacy of monetary policy, which in turn
improves our ability to meet the goals set for us by the Congress - namely, to promote
maximum employment and price stability.
As you know, in response to the further weakening of economic conditions, the Federal
Reserve has continued to ease the stance of monetary policy. The FOMC reduced its target
for the federal funds rate by a total of 125 basis points in January and by an additional 75
basis points at its March meeting, leaving the current target at 2-1/4 percent - 3 percentage
points below its level last summer. As the Committee noted in its most recent post-meeting
statement, we anticipate that these actions, together with the steps we have taken to foster
market liquidity, will help to promote growth over time and to mitigate the risks to economic
activity.
Clearly, the U.S. economy is going through a very difficult period. But among the great
strengths of our economy is its ability to adapt and to respond to diverse challenges. Much
necessary economic and financial adjustment has already taken place, and monetary and
fiscal policies are in train that should support a return to growth in the second half of this year
and next year. I remain confident in our economy's long-term prospects.
Thank you. I would be pleased to take your questions.