U.S. financial markets are healthier after a turbulent summer, but a full recovery will take time and the Federal Reserve will act as needed to support market stability as well as noninflationary growth, Fed Chairman Ben Bernanke said on Monday.
"Conditions in financial markets have shown 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 told the New York Economic Club.
"The ultimate implications of financial developments for the cost and availability of credit, and thus for the broader economy, remain uncertain," he said. "For now, the Federal Reserve will continue to watch the situation closely and will act as needed to support efficient market functioning and to foster sustainable economic growth and price stability."
The U.S. central bank lowered benchmark overnight interest rates by a surprisingly large half-percentage point to 4.75 percent on September 18. Bernanke said that "by doing more sooner" the Fed hoped it could forestall any damage to the economy from financial disruptions triggered by mortgage delinquencies.
At the same time, policy-makers were prepared to reverse course and raise borrowing costs if inflation pressures -- which seemed to have moderated -- rekindled, he said.
The Fed meets again October 30-31 and markets see a 32 percent chance that policy-makers will cut benchmark overnight borrowing costs by a quarter-percentage point then, as implied by short-term federal funds futures.
Economic information published since the September Fed meeting points to the housing slump exerting a "significant" drag through early 2008, Bernanke said. The Fed is closely monitoring whether tighter credit has affected business or household spending, he added.
Bernanke further said the Fed would keep close watch on employment and labor income, since any income gains would support consumer spending even if home values stagnate or fall.
"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," he said.