HIGHLIGHTS-Bernanke's Q&A testimony to House panel

WASHINGTON, July 18 (Reuters) - Below are highlights from the question and answer session of a House Financial Services Committee hearing on Wednesday with Federal Reserve Chairman Ben Bernanke testifying on monetary policy and the U.S. economy. Bernanke's prepared testimony was virtually identical to his presentation to the Senate Banking Committee on Tuesday.

> For a story on Wednesday's hearing, see > For a Take a Look at Fed policy stories, see > TABLE-Federal Reserve economic forecasts > For a text of Bernanke's prepared testimony, see > REUTERS TV-Libor overshadows Bernanke's economic views:

BERNANKE ON DOWNSIDES OF A HIGHER INFLATION TARGET:

"I recognize that some people would advocate that we set an inflation target at, say, 4 percent and maintain that for a number of years. I don't think first that we could do that without losing control of the inflation process. Secondly, I'm very skeptical that it would increase confidence among businesses and households that increase economic activity. I think it would create a lot of problems in financial markets as well. And so I don't think that's a strategy that has a lot of support on the Federal Open Market Committee."

BERNANKE ON LIMITS OF QUANTITATIVE EASING:

"The Federal Reserve can only buy Treasuries and agencies, and moreover quantitative easing typically involves buying longer-term Treasuries and agencies in terms of bills, for example. So, there are finite amounts of that available and, moreover, beyond a certain point if the Federal Reserve owned too much it would greatly hurt market functioning which would have the result of reducing the efficacy of the policy. So, I wouldn't say that we're at that point yet, but ultimately there would be some limit to how much you can do."

"I don't have a number for you (on how close we are to that limit) but we still have some capacity at this point."

BERNANKE ON ALTERNATIVES TO THE CURRENT LIBOR SYSTEM:

"The Federal Reserve Bank of New York made some recommendations for reform which have not been fully adopted. So one strategy would be to switch to a market based indicator. The Federal Reserve has not come out in favor of a specific one, but a number of possibilities include repo rates, the so-called OIS index and even potentially Treasury bill rates, for example. So there are a number of possible candidates."

BERNANKE ON FIRING PRIMARY DEALERS:

When asked if NY Fed could fire a primary dealer, Bernanke said : "If there are questions raised about the integrity and competence about a primary dealer, yes, that could happen certainly."

BERNANKE ON EURO ZONE INSTABILITY:

"I don't think (the euro zone) is close to having a long-term solution that will solve the problem. Until they find those long-term solutions we are going to continue seeing period of financial market volatility."

BERNANKE ON MONETARY POLICY LIMITATIONS:

"Monetary policy cannot do much about long-run growth, all we can try to do is to try to smooth out periods where the economy is depressed because of lack of demand. Because of the financial crisis, the economy has been slow to reach back to its potential and we are trying to provide additional support so that the recovery can bring the economy back to its potential. But in the medium and long term monetary policy cannot do anything to make the economy healthier or growth faster, except to keep inflation low, which are committed to doing."

BERNANKE ON WHY INFLATION WON'T BE A PROBLEM:

When asked if inflation will be a problem when the economy recovers, Bernanke said:

"No it will not. We know how to reverse what we did, we know how to take the money out of the system, we know how to raise interest rates. So it will be a similar pattern to what we have seen in previous episodes where the Fed cut rates, provided support for the recovery and when the economy reached a point of take off, where it could support itself on its own, the Fed pulled back, took away the punch bowl. And we can do that and we will do that when the time comes."

BERNANKE ON HOUSE BILL ON MONETARY POLICY AUDITS:

"The term 'audit the Fed' is deceptive. The public thinks that auditing means checking the books, looking at the financial statements, making sure that you're not doing special deals, and that kind of thing. All of those things are (already) completely open."

"The one thing that I consider to be absolutely critical though about the bill is that it would eliminate the exemption for monetary policy and deliberations."

"The nightmare scenario I have is one in which some future Fed chairman would decide to raise the federal funds rate by 25 basis point, and somebody in this room would say, 'I don't like that decision. I want the GAO to go in and get all the records, get all the transcripts, get all the preparatory materials and give us an independent opinion on whether or not that was the right decision.' And I think that would have a chilling effect and would prevent the Fed from operating on an apolitical, independent basis that is so important and which experience shows is much more likely to lead to a low inflation, healthy currency kind of economy."

BERNANKE ON THE BUDGET:

"There ought to be a more gradual approach. I'm not saying we shouldn't consolidate the budget but don't want it to happen all in one day."

BERNANKE ON RAISING RATES PREMATURELY:

"Concern has been raised, and I fully understand it and sympathize with it, that low interest rates penalize people who live off the interest earnings of their investments and their savings. My response is that if we are going to have good returns on investment and capital overall, we need a healthy economy. If we raise interest rates prematurely and cause the economy to go into recession, that's not going to be the environment where people can make a good return on their retirement funds or other investments."

BERNANKE ON THE GOLD STANDARD:

"A gold standard doesn't imply stability in the prices of the goods and services that people buy every day, it implies a stability in the price of gold itself."

BERNANKE ON WHETHER A RECESSION LOOMS AHEAD:

"At this point we don't see a double dip recession. We see continued moderate growth. But we are very committed to ensuring, or at least doing all we can to ensure, that we continue to make progress on the employment side. And we have stated that we are prepared to take action as needed to try to make sure that we see continued progress on employment."

BERNANKE ON 'FISCAL CLIFF' IMPACT ON THE RECOVERY:

"The collective impact of the tax increases and spending cuts together come something close to 5 percent of GDP, which if all hit at the same time would be very negative for growth. It is important to combine a more gradual approach with a longer term plan to address the sustainability (issue)."

BERNANKE ON ADDRESSING FISCAL ISSUES:

"I would suggest that in looking at these issues you might want to go beyond the 10-year window, which is usually the basis for fiscal decisions, and at least consider implications of actions for an even longer horizon. It is very important for fiscal stability, for financial stability, for Congress to provide a credible plan for stabilizing our long-term fiscal situation as soon as possible."

BERNANKE ON THE DUAL MANDATE:

"Inflation is low, in fact it's below our 2 percent target. So I think the dual mandate has served us well. We do have the ability to address both sides. That said, we will do whatever Congress tells us to do. Low inflation does contribute to healthy employment in the long-term, so they are complementary in that respect."

BERNANKE ON BENEFITS OF REGULATORY REFORMS:

"I wouldn't want to rule out regulatory and tax factors in part of the uncertainty... It's possible that some of these regulations have some impact on the cost of credit but there have been a lot of analysis that suggests that the benefits in terms of reducing the risk of a financial crisis are extremely large and that whatever costs are involved are worthwhile."

BERNANKE ON A BILL TO AUDIT THE FED:

"There is...one important exception to what the GAO is allowed to audit under current law, and that's specifically monetary policy deliberations and decisions. So what the Audit the Fed bill would do would be to eliminate the exemption for monetary policy deliberations and decisions from the GAO audit. So in effect what it would do is allow Congress for example to ask the GAO to audit a decision taken by the Fed about interest rates for example. Now that is very concerning because there's a lot of evidence that an independent central bank that makes decisions based strictly on economic considerations and not based on political pressure will deliver lower inflation and better economic results in the longer term."