Appearing before the Senate Banking Committee at the semiannual Humphrey-Hawkins testimony on Tuesday, Federal Reserve Chairman Ben Bernanke said the economy is facing numerous difficulties.

"The U.S. economy and financial system have confronted some significant challenges thus far in 2008.The contraction in housing activity that began in 2006 and the associated deterioration in mortgage markets that became evident last year have led to sizable losses at financial institutions and a sharp tightening in overall credit conditions ," said Bernanke.



Bernanke said that he sees significant downside risks to growth outlook as many firms are under considerable stress. Bernanke added that judging the balance of risks is challenging and that he sees a limited pass-through of oil to consumer prices.

"The effects of the housing contraction and of the financial headwinds on spending and economic activity have been compounded by rapid increases in the prices of energy and other commodities, which have sapped household purchasing power even as they have boosted inflation," said Bernanke.

Bernanke warned that averting a long-term rise in inflation is critical and that businesses will likely be cautious in their spending plans.

Bernanke predicted that inflation should slow as growth picks up in 2009.

by Steve Stecyk and edited by Cristina Markham