February 28, 2008 / 12:05 AM / 11 years ago

Bernanke: U.S. not facing 1970s-style stagflation

WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke said on Thursday the United States was not headed toward 1970s-style “stagflation” but acknowledged inflation could complicate the central bank’s effort to spur the economy.

Federal Reserve Chairman Ben Bernanke testifies on the state of the economy before the House Financial Services Committee on Capitol Hill, February 27, 2008. REUTERS/Kevin Lamarque

“I don’t anticipate stagflation,” Bernanke told the Senate Banking Committee, referring to the painful mix of economic stagnation and spiraling inflation the economy suffered three decades ago. “I don’t think we’re anywhere near the situation that prevailed in the 1970s.”

In a second day of testimony on the Fed’s semiannual economic report, Bernanke said current price pressures reflected strong global demand for oil, metals and food, and said the cost of these commodities should stabilize in coming months.

“If that’s the case, then inflation should come down and we’d have, therefore, the ability to respond to what is both a slowdown in growth and a significant problem in financial markets,” he said.

The U.S. central bank has cut its target for overnight interest rates by 2.25 percentage points to 3 percent since mid-September in an effort to put a floor under an economy widely seen at risk of falling into recession.

While the Fed is widely expected to lower rates further, surprisingly high inflation readings have fueled concern the central bank might go too far in its effort to spur growth.

“While it is difficult to see our nation’s economy experience minimal growth, the consequences of failing to restrain inflation would be far more painful and far more difficult to unwind,” warned Sen. Richard Shelby of Alabama, the committee’s top Republican.

Even as Bernanke spoke, U.S. crude oil futures surged to an all-time high of $102.74, breaking the inflation-adjusted peak of $102.53 reached in 1980.

FED JOB MORE DIFFICULT

Bernanke was called on to defend the Fed’s forecast of declining inflation after repeating remarks he had delivered a day earlier before a House of Representatives panel in which he made clear he was prepared to lower borrowing costs further.

“It is important to recognize that downside risks to growth remain,” he said.

In taking questions on Thursday, Bernanke admitted price pressures could make it harder for the Fed to ensure the economy keeps growing, drawing a contrast with efforts to combat recession in 2001, when inflation was lower.

“We do have greater inflation pressure at this point than we did in 2001,” he said. “I think that’s fair in that both fiscal and monetary policy face some additional constraints.”

A deep housing market downturn and a related tightening in the availability of credit have driven the economy to the edge of recession, if not into one, economists say.

Bernanke said some small U.S. banks could go under from the financial stress of housing market woes and mortgage losses, a comment that drove stock prices down. “I expect there will be some failures,” he said.

The Fed chief said it was important for policy-makers and the mortgage industry to move beyond temporary fixes for the subprime mortgage problems and look for long-term solutions.

He urged senators to continue to work on reforms to the Federal Housing Administration and to government-sponsored housing enterprises, and said additional steps may be needed.

But he added: “I don’t have any additional recommendations right now” — suggesting he was cool to proposals on Capitol Hill for the government to take a more active role in helping troubled homeowners.

Bernanke said the Fed was closely watching the slumping dollar, which hit a record low against the euro on Thursday, but added that he believed foreign investors still had confidence in the United States.

Fed action to ensure the economy returns to solid growth over the medium term would help ensure continued foreign investment, Bernanke said, adding that the central bank had not seen a shift out of dollar-denominated assets held by foreign governments. “I anticipate that we’ll continue to have the capital flows we need,” he said.

Additional reporting by Joanne Morrison, Emily Kaiser, Mark Felsenthal and Alister Bull, Editing by Chizu Nomiyama

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