Testifying on the state of the economy before the Joint Economic Committee in Washington D.C., Fed Chairman Ben Bernanke said there are "grave threats" to financial stability in the U.S.
Bernanke warned that downside risks to the economy and upside risks to inflation are of significant concern. He told the committee that the Fed is watching developments carefully, and will take action as needed to promote growth.
"As you know, the U.S. economy continues to confront substantial challenges, including a weakening labor market and elevated inflation. Notably, stresses in financial markets have been high and have recently intensified significantly," said Bernanke. "If financial conditions fail to improve for a protracted period, the implications for the broader economy could be quite adverse."
Bernanke acknowledged that global financial markets are undergoing extreme pressures and that urgent action is needed by Congress.
"Despite the efforts of the Federal Reserve, the Treasury, and other agencies, global financial markets remain under extraordinary stress," Bernanke said. "Action by the Congress is urgently required to stabilize the situation and avert what otherwise could be very serious consequences for our financial markets and for our economy."
Bernanke expects economic growth to slow in the coming quarters but to pick up as markets normalize.
"Real gross domestic product is likely to expand at a pace appreciably below its potential rate in the second half of this year and then to gradually pick up as financial markets return to more-normal functioning and the housing
contraction runs its course," Bernanke said.
Bernanke commented that inflation may dip if energy prices stay low, but that this scenario remains uncertain.
"Fluctuations in oil prices in the past few days illustrate the difficulty of predicting the future course of commodity prices. Consequently, the upside risks to inflation remain a significant concern as well," Bernanke said.
Bernanke added that he expects the housing market to stabilize, however, a backlog of homes remain on the market.
Bernanke noted that the stabilization of the financial system is essential.
"Over time, a number of factors should promote the return of our economy to higher levels of employment and sustainable growth with price stability, including the stimulus being provided by monetary policy, lower oil and commodity prices, increasing stability in the mortgage and housing markets, and the natural recuperative powers of our economy," Bernanke said.
In a question and answer session following his opening remarks, Bernanke expressed his concern that the markets need confidence. "This is a matter of psychology," Bernanke said. "This is a big problem."
Bernanke said the extraordinary actions being taken are far from the Fed's mandate, but that these measures are being taken with "great reluctance."
Bernanke added the number of firms that are "too big to fail" has increased and that these numbers need to be limited.
by Steve Stecyk and edited by Sarah Sussman
©CEP News Ltd. 2008