Bernanke confident can keep U.S. inflation at bay

WASHINGTON Wed Feb 25, 2009 4:15pm EST

Federal Reserve Chairman Ben Bernanke testifies to the House Financial Services Committee on Capitol Hill, February 25, 2009. REUTERS/Joshua Roberts

Federal Reserve Chairman Ben Bernanke testifies to the House Financial Services Committee on Capitol Hill, February 25, 2009.

Credit: Reuters/Joshua Roberts

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WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke said on Wednesday that he had an exit strategy from the U.S. central bank's recent massive monetary expansion that will keep inflation under control as the economy recovers.

As he had on Tuesday, Bernanke also told lawmakers he saw no need for the United States to nationalize banks, and he lifted Wall Street shares after he assured there was no plan for the government take over Citigroup. (C.N)

A severe U.S. recession has brought price pressures sharply to heel and the Fed chief said that inflation would not be a problem for the next couple of years, but would be confronted when the time came and economic growth picked back up.

"We are quite confident that we can raise interest rates, reduce the money supply and do that all in a timely way to avoid any inflationary consequences," Bernanke told the House of Representatives Financial Services Committee in a second day of testimony on the Fed's monetary policy report.

The Fed has cut benchmark overnight interest rates almost to zero and has pumped over $1 trillion into credit markets to keep them functioning after the collapse of the U.S. housing market sparked a global credit crisis last year.

Bernanke defended the Fed's aggressive actions, and said steps taken by the U.S. central bank and others last fall averted what could have been a "global financial meltdown."

"I do quite seriously believe we avoided in mid-October ... a collapse of the global financial system which would have led us into a truly deep and very protracted economic crisis," he said.

EXIT STRATEGY

The Fed chairman acknowledged that at some point economic growth would begin to take up the economy's slack, and said that would mean reversing policy to prevent the enormous increase in the U.S. money supply from creating inflation.

"It is very important for us, once the economy begins to recover -- as usual, the Fed would have to begin to tighten policy -- it is very important for us to begin then to unwind our monetary expansion," he told lawmakers.

Critics worry it will be hard for the Fed to abandon major programs to prop up the market for mortgages and consumer loans, and fear a troubling inflation will be the eventual result. These programs have ballooned the size of the Fed's balance sheet to almost $2 trillion.

Bernanke acknowledged the risks, but said many of the emergency measures taken by the Fed to boost credit markets would expire with time, and he stressed there was more than one way to tighten monetary policy to curb inflation.

"We also have other tools, such as our ability to pay interest on reserves, which will help us raise interest rates, even if we don't get the amount of money outstanding back down as quickly as we otherwise would like."

NOT NATIONALIZING CITI

The Fed has had to go around the nation's banks to support lending because massive mortgage losses have savaged their balance sheets and curbed their willingness to extend credit.

In an effort to bring banks back to health, the government has invested more than $200 billion in them, which some fear is a step toward outright nationalization.

But Bernanke said nationalization was not needed, and he singled out Citigroup as a prime example of a big bank that was not heading into public hands.

"Nationalization to my mind is when the government seizes the bank, zeros out the shareholders and begins to manage and run the bank, and we don't plan anything like that," he said.

"It may be the case that the government will have a substantial minority share in Citi or other banks, but again we have the tools ... (to) make sure that we get the good results we want ... without all the negative impact of going through a bankruptcy process or some kind of seizure."

Speculation the government will be forced to nationalize some troubled financial institutions, including Citigroup and Bank of America (BAC.N), has weighed heavily on U.S. stocks in recent days. On Wednesday, shares pared losses on Bernanke's comments, and Citigroup moved into the plus column for a time.

"This debate over nationalization kind of misses the point," said Bernanke.

(Additional reporting by Lucia Mutikani, Glenn Somerville and Tim Ahmann in Washington; Editing by James Dalgleish)

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