Ben S Bernanke: Economic outlook and financial markets
Testimony of Mr Ben S Bernanke, Chairman of the Board of Governors of the US Federal
Reserve System, before the Committee on the Budget, US House of Representatives,
Washington DC, 20 October 2008.
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Chairman Spratt, Representative Ryan, and other members of the Committee, I appreciate
this opportunity to discuss recent developments in financial markets, the near-term economic
outlook, and issues surrounding the possibility of a second package of fiscal measures.
Financial developments
As you know, financial markets in the United States and some other industrialized countries
have been under severe stress for more than a year. The proximate cause of the financial
turmoil was the steep increase and subsequent decline of house prices nationwide, which,
together with poor lending practices, have led to large losses on mortgages and
mortgagerelated instruments by a wide range of institutions. More fundamentally, the turmoil is the
aftermath of a credit boom characterized by underpricing of risk, excessive leverage, and an
increasing reliance on complex and opaque financial instruments that have proved to be
fragile under stress. A consequence of the unwinding of this boom and the resulting financial
strains has been a broad-based tightening in credit conditions that has restrained economic
growth.
The financial turmoil intensified in recent weeks, as investors' confidence in banks and other
financial institutions eroded and risk aversion heightened. Conditions in the interbank lending
market have worsened, with term funding essentially unavailable. Withdrawals from prime
money market mutual funds, which are important suppliers of credit to the commercial paper
market, severely disrupted that market; and short-term credit, when available, has become
much more costly for virtually all firms. Households and state and local governments have
also experienced a notable reduction in credit availability. Financial conditions deteriorated in
other countries as well, putting severe pressure on both industrial and emerging-market
economies. As confidence in the financial markets has declined and concerns about the U.S.
and global economies have increased, equity prices have been volatile, falling sharply on
net.
In collaboration with governments and central banks in other countries, the Treasury and the
Federal Reserve have taken a range of actions to ameliorate these financial problems. To
address ongoing pressures in interbank funding markets, the Federal Reserve significantly
increased the quantity of term funds it auctions to banks and accommodated heightened
demands for funding from banks and primary dealers. We have also greatly expanded our
currency swap lines with foreign central banks. These swap lines allow the cooperating
central banks to supply dollar liquidity in their own jurisdictions, helping to reduce strains in
global money markets and, in turn, in our own markets. To address illiquidity and impaired
functioning in the market for commercial paper, the Treasury implemented a temporary
guarantee program for balances held in money market mutual funds, helping to stem the
outflows from these funds. The Federal Reserve put in place a temporary lending facility that
provides financing for banks to purchase high-quality asset-backed commercial paper from
money market funds, thus providing some relief for money market funds that have needed to
sell their holdings to meet redemptions. Moreover, we soon will be implementing a new
Commercial Paper Funding Facility that will provide a backstop to commercial paper markets
by purchasing highly rated commercial paper from issuers at a term of three months.
The recently enacted Emergency Economic Stabilization Act provided critically important
new tools to address the dysfunction in financial markets and thus reduce the accompanying
risks to the economy. The Troubled Asset Relief Program (TARP) authorized by the
legislation will allow the Treasury to undertake two highly complementary activities. First, the
Treasury will use TARP funds to provide capital to financial institutions. Indeed, last week,
nine of the nation's largest financial institutions indicated their willingness to accept capital
from the program, and many other institutions, large and small, are expected to follow suit in
coming weeks. Second, the Treasury will purchase or guarantee troubled mortgage-related
and possibly other assets held by banks and other financial institutions. Taken together,
these measures should help rebuild confidence in the financial system, increase the liquidity
of financial markets, and improve the ability of financial institutions to raise capital from
private sources.
As another measure to improve confidence, the act also temporarily raised the limit on the
deposit insurance coverage provided by the Federal Deposit Insurance Corporation (FDIC)
and the National Credit Union Administration from $100,000 to $250,000 per account,
effective immediately. Unfortunately, the loss of confidence in financial institutions became
so severe in recent weeks that additional steps in this direction proved necessary. The FDIC,
the Federal Reserve Board, and the Secretary of the Treasury in consultation with the
President determined that significant risks to the stability of the financial system were
present. With this determination, the FDIC was able to use its authority to provide, for a
specified period, unlimited insurance coverage of funds held in non-interest-bearing
transactions accounts, such as payroll accounts. In addition, the FDIC announced that it
would guarantee the senior unsecured debt of FDIC-insured depository institutions and their
associated holding companies. In taking the dramatic steps of providing capital to the
banking system and expanding guarantees, the United States consulted with other countries,
many of whom have announced similar actions. Given the global nature of the financial
system, international consultation and cooperation on actions to address the crisis are
important for restoring confidence and stability.
These measures were announced less than a week ago, and, although there have been
some encouraging signs, it is too early to assess their full effects. However, I am confident
that these initiatives, together with other actions by the Treasury, the Federal Reserve, and
other regulators, will help restore trust in our financial system and allow the resumption of
more-normal flows of credit to households and firms. I would like to reiterate the critical
importance of the recent legislation passed by the Congress; without that action, tools
essential for stabilizing the financial system and thereby containing the damage to the
broader economy would not have been available. That said, the stabilization of the financial
system, though an essential first step, will not quickly eliminate the challenges still faced by
the broader economy.
Economic outlook
Even before the recent intensification of the financial crisis, economic activity had shown
considerable signs of weakening. In the labor market, private employers shed 168,000 jobs
in September, bringing the total job loss in the private sector since January to nearly
900,000. Meanwhile, the unemployment rate, at 6.1 percent in September, has risen 1.2
percentage points since January. Incoming data on consumer spending, housing, and
business investment have all showed significant slowing over the past few months, and
some key determinants of spending have worsened: Equity and house prices have fallen,
foreign economic growth has slowed, and credit conditions have tightened. One brighter note
is that the declines in the prices of oil and other commodities will have favorable implications
for the purchasing power of households. Nonetheless, the pace of economic activity is likely
to be below that of its longer-run potential for several quarters.
As I noted, the slowing in spending and activity spans most major sectors. Real personal
consumption expenditures for goods and services declined over the summer and apparently
fell further in September. Although the weakness in household spending has been
widespread, the drop-off in purchases of motor vehicles recently has been particularly sharp.
Increased difficulty in obtaining auto loans appears to have contributed to the decline in auto
sales. Consumer sentiment has been quite low, reflecting concerns about jobs, gasoline
prices, the state of the housing market, and stock prices.
In the business sector, orders and shipments for nondefense capital goods have generally
slowed, and forward-looking indicators suggest further declines in business investment in
coming months. Outlays for construction of nonresidential buildings, which had posted robust
gains over the first half of the year, also appear to have decelerated in the third quarter.
Although the less favorable outlook for sales has undoubtedly played a role, the softening in
business investment also appears to reflect reduced credit availability from banks and other
lenders.
As has been the case for some time, the housing market remains depressed, with sales and
construction of new homes continuing to decline. Indeed, single-family housing starts fell 12
percent in September, and permit issuance also dropped sharply. With demand for new
homes remaining at a low level and the backlog of unsold homes still sizable, residential
construction is likely to continue to contract into next year.
International trade provided considerable support for the U.S. economy over the first half of
the year. Domestic output was buoyed by strong foreign demand for a wide range of U.S.
exports, including agricultural products, capital goods, and industrial supplies. Although trade
should continue to be a positive factor for the U.S. economy, its contribution to U.S. growth is
likely to be less dramatic as global growth slows.
The prices of the goods and services purchased by consumers rose rapidly earlier this year,
as steep increases in the prices of oil and other commodities led to higher retail prices for
fuel and food, and as firms were able to pass through a portion of their higher costs of
production. These effects are now reversing in the wake of the substantial declines in
commodity prices since the summer. Moreover, the prices of imports now appear to be
decelerating, and consumer surveys and yields on inflation-indexed Treasury securities
suggest that expected inflation has held steady or eased. If not reversed, these
developments, together with the likelihood that economic activity will fall short of potential for
a time, should bring inflation down to levels consistent with price stability.
Over time, a number of factors are likely to promote the return of solid gains in economic
activity and employment in the context of low and stable inflation. Among those factors are
the stimulus provided by monetary policy, the eventual stabilization in housing markets that
will occur as the correction runs its course, improvements in our credit markets as the new
programs take effect and market participants work through remaining problems, and the
underlying strengths and recuperative powers of our economy. The time needed for
economic recovery, however, will depend greatly on the pace at which financial and credit
markets return to more-normal functioning. Because the time that will be needed for financial
normalization and the effects of ongoing credit problems on the broader economy are difficult
to judge, the uncertainty currently surrounding the economic outlook is unusually large.
Fiscal policy
I understand that the Congress is evaluating the desirability of a second fiscal package. Any
fiscal action inevitably involves tradeoffs, not only among current needs and objectives but
also - because commitments of resources today can burden future generations and
constrain future policy options - between the present and the future. Such tradeoffs
inevitably involve value judgments that can properly be made only by our elected officials.
Moreover, with the outlook exceptionally uncertain, the optimal timing, scale, and
composition of any fiscal package are unclear. All that being said, with the economy likely to
be weak for several quarters, and with some risk of a protracted slowdown, consideration of
a fiscal package by the Congress at this juncture seems appropriate.
Should the Congress choose to undertake fiscal action, certain design principles may be
helpful. To best achieve its goals, any fiscal package should be structured so that its peak
effects on aggregate spending and economic activity are felt when they are most needed,
namely, during the period in which economic activity would otherwise be expected to be
weak. Any fiscal package should be well-targeted, in the sense of attempting to maximize the
beneficial effects on spending and activity per dollar of increased federal expenditure or lost
revenue; at the same time, it should go without saying that the Congress must be vigilant in
ensuring that any allocated funds are used effectively and responsibly. Any program should
be designed, to the extent possible, to limit longer-term effects on the federal government's
structural budget deficit.
Finally, in the ideal case, a fiscal package would not only boost overall spending and
economic activity but would also be aimed at redressing specific factors that have the
potential to extend or deepen the economic slowdown. As I discussed earlier, the
extraordinary tightening in credit conditions has played a central role in the slowdown thus far
and could be an important factor delaying the recovery. If the Congress proceeds with a
fiscal package, it should consider including measures to help improve access to credit by
consumers, homebuyers, businesses, and other borrowers. Such actions might be
particularly effective at promoting economic growth and job creation.
Thank you. I would be pleased to take your questions.