February 26, 2013 / 5:00 AM / 5 years ago

WRAPUP 6-Bernanke says Fed stimulus benefits clear, downplays risks

* Fed cognizant of bond-buying risks, but benefits outweigh
    * Bernanke warns on impact of scheduled budget cuts
    * Bernanke's defense of stimulus helps support stock markets

    By Pedro da Costa and Alister Bull
    WASHINGTON, Feb 26 (Reuters) - Federal Reserve Chairman Ben
Bernanke strongly defended the U.S. central bank's monetary
stimulus before Congress on Tuesday, easing financial market
worries over a possible early retreat from bond purchases.
    Bernanke said Fed policymakers are cognizant of potential
risks from their extraordinary support for the economy,
including the possibility that it might fuel unwanted inflation
or stoke asset bubbles.
    But in testimony on the central bank's semi-annual report on
monetary policy, he said the risks did not seem material at the
moment, adding that the central bank has all the tools it needs
to retreat from its monetary support in a timely fashion.
    "We do not see the potential costs of the increased
risk-taking in some financial markets as outweighing the
benefits of promoting a stronger economic recovery and more
rapid job creation," Bernanke told the Senate Banking Committee.
    The Fed chairman also urged lawmakers to avoid sharp
spending cuts set to take effect on Friday, warning that they
could combine with earlier tax increases to create a
"significant headwind" for the modest economic recovery.
    In response to the financial crisis and deep recession of
2007-2009, the Fed not only slashed official interest rates
effectively to zero, but also bought more than $2.5 trillion in
mortgage and Treasury debt in an effort to push down long-term
interest rates and spur hiring.
    The Fed is currently buying $85 billion in bonds each month
and has said it plans to keep purchasing assets until it sees a
substantial improvement in the outlook for the labor market.
    Minutes of the Fed's Jan. 29-30 policy meeting, released
last week, said a number of officials felt the potential risks
posed by the bond purchases could warrant tapering off or ending
them before hiring picks up, comments that sparked a sharp stock
market sell-off. However, several others argued there was a
danger in halting them prematurely.
    Bernanke appeared to be in the latter camp. "The benefits of
asset purchases, and of policy accommodation more generally, are
clear," he said, citing improvements in the housing and auto
    "There is no risk-free approach to this situation," he said.
"The risk of not doing anything is severe as well. So, we are
trying to balance these things as best we can."
    Bernanke's testimony and stronger-than-expected data on
housing and consumer confidence helped settle jitters in U.S.
stock markets over Europe's debt crisis, with the Dow Jones
industrial average closing up nearly 116 points, or 0.8
    "What Bernanke is saying, bottom line, indicates that there
will not be a reversal anytime soon in the stimulus program,"
said Peter Cardillo, chief market economist at Rockwell Global
Capital in New York.
    When asked pointedly by Republican Senator Bob Corker about
whether the Fed's easy policies were contributing to competitive
currency devaluations globally and laying the groundwork for
inflation, Bernanke was unequivocal.
    "My inflation record is the best of any Federal Reserve
chairman in the post-war period," he retorted. "We are not
engaged in a currency war."
    Democrats, for their part, seized on Bernanke's remarks to
fuel their argument that looming budget cuts could have a dire
economic impact, as they sought to gain political advantage over
Republicans, who prefer spending cuts over higher taxes.
    Committee newcomer Elizabeth Warren, a Democrat, pressed
Bernanke on what she said is an implicit subsidy that large
banks enjoy in the form of lower borrowing costs from being
perceived as too big to fail.
    Bernanke countered that Dodd-Frank financial reform rules
had given regulators more power to wind down failing financial
institutions, making the issue less of a concern.
    "The subsidy is coming because of market expectations that
the government would bail out these firms if they fail. Those
expectations are incorrect," Bernanke said.           

   In unusually direct remarks on fiscal policy, Bernanke warned
that the spending cuts known as the sequester that are set to
take hold later this week would threaten an already challenged
economic expansion.
    "The Congress and the administration should consider
replacing the sharp, frontloaded spending cuts required by the
sequestration, with policies that reduce the federal deficit
more gradually in the near term but more substantially in the
longer run," Bernanke said.
    The U.S. economy braked sharply in the fourth quarter, but
is forecast to grow around 2 percent or more this year. The
unemployment rate has remained elevated, and registered 7.9
percent in January.
    Bernanke, who appears for a second day of testimony before a
House of Representatives panel on Wednesday, said persistent
joblessness was a scourge with potentially long-lasting effects.
    "High unemployment has substantial costs, including not only
the hardship faced by the unemployed and their families, but
also the harm done to the vitality and productive potential of
our economy as a whole," Bernanke said.
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