Tuesday, January 13, 2009

Bernanke in London - "timing and strength of economic recovery are highly uncertain"

Bernanke's comments to the London School of Economics are probably a little more realistic then some of his comments made 18 months ago. For example, the timing and strength of the recovery is uncertain, the Obama stimulus package is probably "too little too late", the inability of the banks to extend credit is central to the economic crisis, etc. Text in bold is my emphasis. From Market Watch:

There will be no lasting recovery without more government action and money to strengthen the financial system, Federal Reserve Chief Ben Bernanke said Tuesday.

The timing and strength of economic recovery "are highly uncertain," Bernanke told an audience in London. The text of his speech was released in Washington.

In what's likely to be a sobering message to Congress, Bernanke said that the stimulus package championed by President-elect Barack Obama likely would help the economy but wasn't going to be enough.

He said the next step is to get toxic assets off bank balance sheets. He outlined several ways to do this, including setting up "bad banks" to hold the troubled assets. These are likely to be very expensive.

As yet, there is no end of the financial crisis in sight, he said.

"With the worsening of the economy's growth prospects, continued credit losses and asset markdowns may maintain for a time the pressure on the capital and balance-sheet capacities of financial institutions," Bernanke said in a speech to the London School of Economics.

On a related note, coordinated government policy responses will be critical to turning the economy around, he said.

He also stressed the Fed still has the power to fight the financial crisis and economic downturn even though its federal funds target rate cannot be reduced "meaningfully further."

He said that he expects inflation to moderate further and that the Fed would make sure that its "exit strategy" from its unconventional easing would be accomplished in a smooth manner.

Since the crisis began, the Fed has slashed interest rates to record low levels and has expanded its balance sheet by more than $1 trillion to ease the financial crisis.

It has started an alphabet soup of programs that essentially are stepping in to prop up private markets.

Given this uncharted territory, Fed watchers have a slew of questions and Bernanke's speech could be seen as an attempt to address some of the most prominent concerns.

The Fed chairman attempted to ease concern that the new policy could turn out to be the Fed's Vietnam -- meaning it has no exit strategy.

Another question is how financial markets could react when the Fed has to unwind its operations.
Bernanke promised that the Fed "will take all necessary actions to ensure that the unwinding of our programs is accomplished smoothly and in a timely way."

Other analysts have worried that the Fed is taking too many long-term securities on its balance sheet, which may be hard to sell. Bernanke said that the central bank is watching this and does "not expect a significant problem in reducing our balance sheet to the extent necessary at the appropriate time."

Some observers have worried that the Fed is effectively printing money which will ultimately be inflationary.

Bernanke responded that the Fed sees "little risk of inflation in the near term; indeed, we expect inflation to continue to moderate."

Bernanke's talk was also aimed at members of Congress. He urged them to help explain to taxpayers why they must assist in restoring financial markets to health.

"The public in many countries is understandably concerned by the commitment of substantial government resources to aid the financial industry when other industries receive little or no assistance," he said.

"This disparate treatment, unappealing as it is, appears unavoidable," he insisted.

Without the free flow of credit, there would be an immediate downturn in economic activity.
"Responsible policymakers must therefore do what they can to communicate to their constituencies why financial stabilization is essential for economic recovery and is therefore in the broader public interest," he said

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