ben s bernanke : semiannual monetary policy report to the congress testimony of mr ben s bernanke, chairman of the board of governors of the us federal reserve system, before the committee on banking, housing, and urban affairs, us senate, washington dc, 15 july 2008. * * * chairman dodd, senator shelby, and members of the committee, i am pleased to present the federal reserve's monetary policy report to the congress. the u. s. economy and financial system have confronted some significant challenges thus far in 2008. the contraction in housing activity that began in 2006 and the associated deterioration in mortgage markets that became evident last year have led to sizable losses at financial institutions and a sharp tightening in overall credit conditions. the effects of the housing contraction and of the financial headwinds on spending and economic activity have been compounded by rapid increases in the prices of energy and other commodities, which have sapped household purchasing power even as they have boosted inflation. against this backdrop, economic activity has advanced at a sluggish pace during the first half of this year, while inflation has remained elevated. following a significant reduction in its policy rate over the second half of 2007, the federal open market committee ( fomc ) eased policy considerably further through the spring to counter actual and expected weakness in economic growth and to mitigate downside risks to economic activity. in addition, the federal reserve expanded some of the special liquidity programs that were established last year and implemented additional facilities to support the functioning of financial markets and foster financial stability. although these policy actions have had positive effects, the economy continues to face numerous difficulties, including ongoing strains in financial markets, declining house prices, a softening labor market, and rising prices of oil, food, and some other commodities. let me now turn to a more detailed discussion of some of these key issues. developments in financial markets and their implications for the macroeconomic outlook have been a focus of monetary policy makers over the past year. in the second half of 2007, the deteriorating performance of subprime mortgages in the united states triggered turbulence in domestic and international financial markets as investors became markedly less willing to bear credit risks of any type. in the first quarter of 2008, reports of further losses and write - downs at financial institutions intensified investor concerns and resulted in further sharp reductions in market liquidity. by march, many dealers and other institutions, even those that had relied heavily on short - term secured financing, were facing much more string

their economic projections for the june fomc meeting, monetary policy makers marked up their forecasts for inflation during 2008 as a whole. fomc participants continue to expect inflation to moderate in 2009 and 2010, as slower global growth leads to a cooling of commodity markets, as pressures on resource utilization decline, and as longer - term inflation expectations remain reasonably well anchored. however, in light of the persistent escalation of commodity prices in recent quarters, fomc participants viewed the inflation outlook as unusually uncertain and cited the possibility that commodity prices will continue to rise as an important risk to the inflation forecast. moreover, the currently high level of inflation, if sustained, might lead the public to revise up its expectations for longer - term inflation. if that were to occur, and those revised expectations were to become embedded in the domestic wage - and price - setting process, we could see an unwelcome rise in actual inflation over the longer term. a critical responsibility of monetary policy makers is to prevent that process from taking hold. at present, accurately assessing and appropriately balancing the risks to the outlook for growth and inflation is a significant challenge for monetary policy makers. the possibility of higher energy prices, tighter credit conditions, and a still - deeper contraction in housing markets all represent significant downside risks to the outlook for growth. at the same time, upside risks to the inflation outlook have intensified lately, as the rising prices of energy and some other commodities have led to a sharp pickup in inflation and some measures of inflation expectations have moved higher. given the high degree of uncertainty, monetary policy makers will need to carefully assess incoming information bearing on the outlook for both inflation and growth. in light of the increase in upside inflation risk, we must be particularly alert to any indications, such as an erosion of longer - term inflation expectations, that the inflationary impulses from commodity prices are becoming embedded in the domestic wage - and price - setting process. i would like to conclude my remarks by providing a brief update on some of the federal reserve's actions in the area of consumer protection. at the time of our report last february, i described the board's proposal to adopt comprehensive new regulations to prohibit unfair or deceptive practices in the mortgage market, using our authority under the home ownership and equity protection act of 1994. after reviewing the more - than 4, 500 comment letters we received on the proposed rules, the board approved the final rules yesterday. the new rules apply to all types of mortgage lenders