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Bernanke signals flexibility on tapering

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Federal Reserve Board Chairman Ben Bernanke told lawmakers Wednesday that if the economy fails to satisfy the Fed’s expectations, its plans to taper bond buying could change and the Fed could even “potentially increase purchases for a time.”

The economy continues to recover at a “moderate pace,” with housing having contributed “significantly” to recent gains, but the unemployment rate is only seeing “moderate” improvement — standing at 7.6 percent in June, Bernanke said in the Fed’s semiannual monetary report to members of the House Financial Services Committee.

Bernanke signaled to the committee that the Fed would adjust its bond-buying program — better known as quantitative easing — depending on how the economy performs. “Our intention is to keep monetary policy accommodative,” he said.

“We are relying on near-zero short-term interest rates, together with our forward guidance that rates will continue to be exceptionally low — our second tool — to help maintain a high degree of monetary accommodation for an extended period after asset purchases end, even as the economic recovery strengthens and unemployment declines toward more-normal levels,” Bernanke told lawmakers.

After Bernanke delivered his report, 10-year Treasury yields fell to 2.49 percent from 2.63 percent. The Dow Jones industrial average rose 0.1 percent in afternoon trading, while the Standard & Poor’s 500 index and Nasdaq rose 0.3 percent and 0.2 percent respectively.

In late June, Bernanke said that the Fed would likely curtail its stimulus bond buying later this year, which sent the markets into a tailspin and spooked investors.

As Bernanke stated in his prepared testimony, “if economic conditions were to improve faster than expected, and inflation appeared to be rising decisively back toward our objective, the pace of asset purchases could be reduced somewhat more quickly.” However, “on the other hand, if the outlook for employment were to become relatively less favorable, if inflation did not appear to be moving back toward 2 percent, or if financial conditions — which have tightened recently — were judged to be insufficiently accommodative to allow us to attain our mandated objectives, the current pace of purchases could be maintained for longer.”

Jim O’Sullivan, chief U.S. economist at High Frequency Economics, noted in reaction to Bernanke’s testimony, that in starting to scale down the purchasing program, “the data will matter,” as Bernanke said the Fed is not “on a preset course.” O’Sullivan said that Bernanke was “emphasizing the no-imminent-tightening point a bit more” than he has before.

The lengthy hearing covered many issues, including worries about the recent spike in mortgage interest rates. “Mortgage rates are a bit higher and we have to monitor that,” Bernanke said. “We’ll see how housing and house prices go from here.”

In his testimony, Bernanke said that housing has “contributed significantly to recent gains in economic activity.” Home sales, house prices, and residential construction, he said, “have moved up over the past year, supported by low mortgage rates and improved confidence in both the housing market and the economy.”

He went on to note that “rising housing construction and home sales are adding to job growth, and substantial increases in home prices are bolstering household finances and consumer spending while reducing the number of homeowners with underwater mortgages.” Housing activity and prices, he said, “seem likely to continue to recover, notwithstanding the recent increases in mortgage rates,” noting the importance of monitoring developments in this sector carefully.

Some lawmakers noted that both the House and Senate are currently considering legislation to reform the government-sponsored enterprises — Fannie Mae and Freddie Mac. Bernanke said that the Fed “agrees” that some type of reform needs to take place, as the Fed “for many years warned about [GSEs’] lack of capital.”

The key question, Bernanke said, is “What role should the government play?” The private sector should play a bigger role in housing finance going forward, one reason being so there’s “more product innovation,” he said.

As to unemployment, Bernanke said while the 7.6 percent rate in June is a half percentage point lower than in the months before the Federal Open Market Committee (FOMC) initiated its current asset purchase program in September, the “jobs situation is far from satisfactory.”

Despite the fact that nonfarm payroll employment has increased by an average of about 200,000 jobs per month so far this year, “the unemployment rate remains well above its longer-run normal level, and rates of underemployment and long-term unemployment are still much too high,” Bernanke said.

As to inflation, Bernanke said that consumer price inflation “has been running below” the FOMC’s “longer-run objective of 2 percent.” With “measures of longer-term inflation expectations hav[ing] generally remained stable,” this “should help move inflation back up toward 2 percent,” he said. “However, the committee is certainly aware that very low inflation poses risks to economic performance — for example, by raising the real cost of capital investment — and increases the risk of outright deflation. Consequently, we will monitor this situation closely as well, and we will act as needed to ensure that inflation moves back toward our 2 percent objective over time.”

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