Federal Reserve Chairman Ben Bernanke offered a fairly upbeat assessment of the U.S. economy on Tuesday, saying the recent surge in oil prices is unlikely to have a major effect on either growth or inflation, as long as higher prices do not become sustained.
Bernanke told the Senate Banking Committee he saw increasing evidence that the economic recovery has enough momentum to be become self-supporting. But job growth remains far too anemic, he said, indicating Bernanke is not considering cutting short the Fed's $600 billion bond-buying stimulus.
We do see some grounds for optimism about the job market over the next few quarters, Bernanke said, citing a steep recent decline in the jobless rate among other factors.
Bernanke said downside risks to growth had diminished and, for the first time, stated the risk of deflation was now negligible. The threat of deflation, a downward spiral in wages and prices that could derail the economy, was a key justification for the Fed's bond-buying spree.
It's encouraging to see that the risk of deflation is moderating according to the Fed, said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington. That's one of the keys that will be necessary for the Fed to wind down its quantitative easing program going forward.
Bernanke reiterated a warning that a failure by Congress to raise the U.S. government's debt ceiling could lead to a debt default that would have dire consequences for the economy.
It would be extremely dangerous and very likely a recovery-ending event, he said.
The U.S. government faces bumping up against its statutory borrowing ceiling of $14.3 trillion sometime in April or May, and a failure to lift the ceiling could raise the specter of a first-ever U.S. debt default and push up interest rates sharply.
At the same time, Bernanke did not appear concerned that the recent spike in the price of crude oil, driven in part by a wave of pro-democracy revolutions in the Middle East and North Africa, would do much harm to the U.S. economic outlook.
The price of U.S. crude oil futures, which briefly surpassed $100 a barrel in late February, were trading at almost $99 a barrel on Tuesday. Crude had traded at roughly $86 a barrel before protests swept through Egypt in late January.
Bernanke said the Fed expects inflation to remain low and that long-term inflation expectations appear contained, based on both market indicators and surveys of consumers.
The most likely outcome is that the recent rise in commodity prices will lead to, at most, a temporary and relatively modest increase in U.S. consumer price inflation, Bernanke said.
However, he warned that if expectations of future inflation were to build, the Fed may need to act.
We will continue to monitor these developments closely and are prepared to respond as necessary to best support the ongoing recovery in a context of price stability, he said.
The economy expanded at just a 2.8 percent annual pace in the fourth quarter of 2010. The jobless rate fell to 9 percent January, the lowest level since April 2009 but still considered painfully high. While hiring appears to be picking up, the pace is too slow to make much of a dent in unemployment.
With official interest rates held near zero percent since December 2008, the Fed in November embarked on a controversial program to buy government debt to keep down long-term rates. Bernanke said buoyant financial markets suggest the policy is working, but the labor market still has a long way to go.
Until we see a sustained period of job creation, we cannot consider the recovery to be truly established, Bernanke said.
Much of the discussion at the hearing centered around Washington's heated budget debate. Bernanke refrained from offering detailed advice on fiscal matters, but urged lawmakers to get the deficit under control.
The long-term imbalances are not just a long-term risk, Bernanke said. They're a near and present danger.
MANDATE BATTLE BREWING
Financial markets had little reaction to Bernanke's comments. U.S. stocks were little changed after the release of Bernanke's testimony and data showing growing strength in the U.S. factory sector. U.S. government bonds pared losses.
Andrew Tilton, economist at Goldman Sachs, said the Fed will most likely complete its bond-buying program over the next few months and then call it a day. The bar is pretty high for either curtailing bond buys or expanding the program, Tilton said.
In a hint of the discussion to come in two days of congressional hearings, Democrat Tim Johnson, the Senate Banking Committee's chairman, kicked off the session with a strong defense of the Fed's dual mandate of price stability and maximum sustainable employment. Bernanke will also appear before a panel in the House of Representatives on Wednesday.
Some Republicans who have been critical of the Fed's ultra-easy monetary policy have vowed to introduce legislation forcing the central bank to focus solely on inflation.
Johnson suggested that would not be an easy fight.
As the economy continues to struggle to recover, we should be using every tool in the toolbox to create jobs and spur growth, he said in a statement. Taking tools away from the Fed now is the wrong idea at the wrong time.
Bernanke said he sees the Fed's current mandate as adequate.
We think it's appropriate and we are right now not seeking any change, Bernanke said. Congress, of course, can certainly discuss that issue and we'll do whatever Congress tells us to do.