Federal Reserve Chairman Ben Bernanke went to Capitol Hill today to provide Congress with an update on the struggling US economy. The Fed forecast he summarized called for very slow growth in 2008, but no recession; and that was the good news.
The Feds forecast says that growth could be as low a 1.3 percent for all of 2008, down sharply from its July forecast. And with the economy expected to pick up only in the second half of the year, that could mean almost no growth at all in the first six months.
Chairman Bernanke acknowledged the problem in the second paragraph of his testimony. "The economic situation has become distinctly less favorable since our July report," said the chairman.
He went on to say what many Americans already know, that strains in credit markets are continuing to affect many households and businesses.
"The housing market is expected to continue to weigh on economic activity in coming quarters," Bernanke said. "Home builders still faced with abnormally high inventories of unsold homes are likely to cut the pace of their building activity further."
That will further cut jobs in the construction industry, Bernanke said. The central bank's forecast sees U.S. unemployment rising to about 5.25 percent by the end of 2008.
The Fed has already battled the economic slowdown by slashing its benchmark interest rate by 2.25 percentage points.
Bernanke signaled in his testimony that Fed policymakers are likely to cut again when they meet March 18. But a number of legislators, including Republican Gary Miller of California, complained the Feds rate cutting isn't reducing interest rates for borrowers.
"It has done a good job of lowering the cost of funds to lenders," Miller said, "but from mid-January we're looking at the opposite when it comes of mortgage rates to people who want to buy a house....They tend to be going up."
Bernanke acknowledge that "It's been more difficult to lower long term mortgage rates through fed action." But, he said, "We are able, of course, to lower short term rates and they do have implications for, for example, resets of existing mortgages."
Bernanke went on to say those lower short term rates also affect the ability of banks and others to finance their holdings of assets. He concluded, "I think we do still have power to influence the housing market and the broader economy, but your points are well taken."
The Fed also faces a challenge from inflation, partly fueled by oil prices at a $100 a barrel. That could restrain its ability to cut interest rates further.
Rep. Miller asked Bernanke how the Fed would respond if oil prices don't come down.
"Oil prices don't have to come down to reduce inflation pressure," Bernanke said, "They just have to flatten out."
"But what it they don't flatten out," Miller countered.
"Well, if they continue to rise at this pace, it's going to create a very difficult problem for our economy," said Bernanke, "because on the one hand it's going to generate more inflation.... but it's also going create more weakness."
That's because, the chairman said, higher oil prices would be like a tax "extracting income from American consumers." So the challenge the Fed faces right now — whether to fight inflation, or keep cutting interest rates to support a weak economy — could get even tougher.
Bernanake was also asked whether he believed current approaches to the housing crisis and growing foreclosure problem are adequate.
The primary effort now is a voluntary program organized by the Bush administration that urges lenders to work with beleaguered homeowners to help them keep their homes.
Bernanke said the Fed is considering its options, but that he remains skeptical about programs that include government purchases of stressed mortgages, or giving bankruptcy judges the power to modify loans.