In testimony given before Congress last week, Federal Reserve Chairman Ben Bernanke said high unemployment and low inflation “requires a highly accommodative monetary policy.”
The U.S. economy has gradually improved since the beginning of the year, with GDP estimated to have risen at approximately 2.5 percent during the first quarter, following a 1.75 percent increase last year.
Unemployment has fallen by more than 0.5 percent since last summer, and gains in total nonfarm payroll have averaged more than 200,000 jobs each month for the past six months. Payroll employment has grown by approximately six million jobs, and unemployment has fallen 2.5 percent from peak levels.
Consumer inflation has remained low, with personal consumption expenditures rising only one percent in the year ending in March—down from approximately 2.25 percent in the previous year.
“This slow rate of inflation partly reflects recent declines in consumer energy prices, but price inflation for other consumer goods and services has also been subdued,” Bernanke said. “Nevertheless, measures of longer-term inflation expectations have remained stable and continue to run in the narrow ranges seen over the past several years. Over the next few years, inflation appears likely to run at or below the two percent rate that the Federal Open Market Committee judges to be most consistent with the Federal Reserve’s statutory mandate to foster maximum employment and stable prices.”
Bernanke said economic challenges over the past four years have been offset by the Fed’s “highly accommodative monetary policy,” pointing to improvements in the housing market and falling unemployment.
“To promote economic growth and stability in the longer term, it will be essential for fiscal policymakers to put the federal budget on a sustainable long-run path,” Bernanke said. “Importantly, the objectives of effectively addressing longer-term fiscal imbalances and of minimizing the near-term fiscal headwinds facing the economic recovery are not incompatible. To achieve both goals simultaneously, the Congress and the Administration could consider replacing some of the near-term fiscal restraint now in law with policies that reduce the federal deficit more gradually in the near term but more substantially in the longer run.”
Additionally, Bernanke said the Federal Open Market Committee would provide policy accommodation by cutting its federal funds rate target, thereby putting downward pressure on interest rates. He said that federal funds and short-term money market rates have remained near-zero, prompting the committee to pursue other policy alternatives.
The FOMC has said its federal funds rate target range of zero to 0.25 percent will remain “at least as long as the unemployment rate remains above 6.5 percent.”
“This guidance underscores the Committee’s intention to maintain highly accommodative monetary policy as long as needed to support continued progress toward maximum employment and price stability,” Bernanke said.
Bernanke said large-scale purchases of longer-term Treasuries and mortgage-backed securities at a pace of $40 billion per month will continue “until the outlook for the labor market has improved substantially in a context of price stability.”
“Recognizing the drawbacks of persistently low rates, the FOMC actively seeks economic conditions consistent with sustainably higher interest rates,” Bernanke said. “Unfortunately, withdrawing policy accommodation at this juncture would be highly unlikely to produce such conditions. A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further. Such outcomes tend to be associated with extended periods of lower, not higher, interest rates, as well as poor returns on other assets. Moreover, renewed economic weakness would pose its own risks to financial stability. Because only a healthy economy can deliver sustainably high real rates of return to savers and investors, the best way to achieve higher returns in the medium term and beyond is for the Federal Reserve–consistent with its congressional mandate–to provide policy accommodation as needed to foster maximum employment and price stability.”