The fog from the financial market turmoil that has settled over the economic outlook has not lifted, and it remains too early to say whether businesses or consumers will slash their spending as a result of the higher cost of credit, Federal Reserve chairman Ben Bernanke said Monday.
“It remains too early to assess the extent to which household and business spending will be affected by the weakness in housing and the tightening in credit conditions,” Bernanke said in remarks prepared for delivery to the New York Economic Club. (read full text of his speech). This was Bernanke’s first comments on the economic outlook in six weeks. During that time, the Federal Reserve surprised markets with the size of its rate cut at its Sept. 18 meeting. “Conditions in financial markets have shown some improvement since the worst of the storm in mid-August, but a full recovery of market functioning is likely to take time and we may well see some setbacks," Bernanke said. It does seem pretty clear that the housing market downturn isn’t over, he said. The housing sector was weakening even before the credit crunch began in early August, and conditions in the mortgage sector remain out of whack two months later, Bernanke said. That will pull down growth in the fourth quarter and into 2008, he said. “The further contraction in housing is likely to be a significant drag on growth in the current quarter and through early next year,” Bernanke said.
Expectations that the economy grew at a 3% pace in the July-September quarter has some economists have said the market turmoil may turn out to be only a speed bump for the economy, but others remain concerned about a serious downturn. The Commerce Department will release its initial estimate of Q3 growth on Oct. 31. Bernanke said the economy did appear to have momentum in the Q3, but did not tip his hand on the key question about the longer-term outlook except to say so far, so good. “Thus far ... direct evidence of such spillovers onto the broader economy has been limited,” he said.
Bernanke said that the Fed will be watching consumer and business spending carefully to see whether the weakness in home prices affects consumer spending and whether businesses become cautious in hiring. “The labor market has shown some signs of cooling, but these are quite tentative so far, and real income is still growing at a solid pace,” Bernanke said. Bernanke was more upbeat about the inflation outlook despite higher prices of crude oil and other commodities in recent weeks and the decline in the foreign exchange value of the dollar.
“The limited data that we have received since the September FOMC meeting are consistent with continued moderate increases in consumer prices,” Bernanke said. He noted that inflation risks remain. Bernanke also said that the slower growth in coming quarters would help dampen inflation pressures. He said history suggests that price gains from a weaker dollar are small. Bernanke said the Fed judged that the risks to inflation from the surprise half a percentage point rate cut last month were “acceptable,” as “the FOMC was prepared to reverse the policy easing if inflation pressures proved somewhat stronger than expected.”
Bernanke defended the half-point cut, saying that risk management played a role in the decision. “By doing more sooner, policy might be able to forestall some part of the adverse effects of the disruptions in financial markets,” he said. Bernanke said the Fed rate cuts; combined with the technical steps it has taken to restore liquidity to financial markets has reduced some of the pressure in financial markets. “From the perspective of the near-term economic outlook, the improved functioning of financial markets is a positive development in that it increases the likelihood of achieving moderate growth with price stability,” Bernanke said. But the financial markets are not out of the woods, he stressed.
“Considerable strains remain,” Bernanke said.
But Bernanke tried to put some positive gloss on the financial market turmoil, saying the experience might lead to a healthier financial system over the longer term. Bernanke said it was too soon to draw any lessons from the market turmoil. He said Washington regulators “will perform comprehensive reviews” of the events to better understand the episode. But that remains for a later day. In the question and answer session, Bernanke stuck to the Fed’s basic party line that it remains quite difficult for the central bank to identify asset bubbles early enough to keep them from developing.
Many analysts have been critical of this approach, but Fed officials say attacking perceived asset bubbles would have untoward economic consequences. Asked about the weak dollar, Bernanke replied that the Fed’s mandate was to preserve the domestic purchasing power of the dollar but added “no central banker can be entirely indifferent to the exchange value of their country and we certainly will pay attention to that issue.” Much of Bernanke’s speech was a brief history of the financial market turmoil, which began over concern of delinquencies of subprime mortgages and the consequent inability of financial markets to figure out how to value derivatives based on those loans. Asked if there was any information about the financial market turmoil that he would like to have, but did not, Bernanke replied: “I’d like to know what those damn things (derivatives) are worth.” (marketwatch)