As Federal Reserve Board Chairman Ben Bernanke makes his second appearance on Capitol Hill today, the big words in economic analysis are hope and risk. Following just behind seems to be worry, as economic experts react to both economic signals and Bernanke’s first day of testimony (before the House Financial Services Committee) on Wednesday. The subject of experts’ worry varies, however.
Meanwhile two reports out this morning underscore the economy’s sluggishness. CBS News said, “The Labor Department reported Thursday that new applications for unemployment benefits rose by 19,000 to 373,000 last week. The increase was larger than many economists were expecting. They were forecasting claims to rise to around 350,000 last week.” In addition, “The Commerce Department reported Thursday that the gross domestic product increased at a scant 0.6 percent pace in the October-to-December quarter. The reading — unchanged from an initial estimate a month ago — underscored just how much momentum the economy has lost. In the prior quarter, the economy clocked in at a brisk 4.9 percent pace.”
In light of Bernanke’s testimony Wednesday, The New York Times’ Edmund Andrews gave the lay of the land: “The hope is that lower interest rates will encourage consumers and businesses to spend more, while the risk is that the spending will aggravate inflation.”
But, he added, “the success or failure of the Fed’s strategy could depend on something outside Mr. Bernanke’s immediate control: foreign confidence in the American dollar and foreign willingness to keep financing the United States’ huge external debt.” He added, “The dollar has plunged 24 percent against a basket of six major currencies in the last four years, and on Wednesday it slipped to its lowest level yet since the United States let the dollar float freely in 1973.”
Weak dollar: pluses and minuses
While a weak dollar “tends to bolster American exports by making them cheaper in foreign markets,” he noted that “it also pushes up inflation by raising the cost of foreign imports. And while the United States pays for foreign oil in dollars, many analysts contend that part of the recent run-up in oil prices was tied to the steadily declining value of the dollar.”
A different worry was expressed by Alice Rivlin of the Brookings Institution when she testified before the same House committee the day before Bernanke: the spreading contagion of housing foreclosures:
“If the consensus forecast is roughly right, we will have slow growth for a couple more quarters, but will avoid recession and see growth resuming by the end of the year,” she testified. “But the situation is precarious. In housing, a spreading wave of foreclosures could undermine consumer confidence and increase the probability of recession. Continued risk aversion of investors and unwillingness to lend on the part of financial institutions could raise the probability even more and turn a slowdown into a full-blown economic rout that could spread beyond our borders. The hardest challenges now are how to minimize housing foreclosures and how to get the credit markets functioning more normally — both without spending excessive public resources or rewarding people who made dumb or irresponsible decisions.”
With the caveat of the need to contain the spread of foreclosures, Rivlin concluded that so far, “I think the policy response to the current economic situation is on the right track. The Fed has acted aggressively and with some imagination to keep the financial services sector liquid and ease monetary policy. The stimulus package will certainly help avoid recession or mitigate a downturn if it occurs.”
Will Americans spend or save?
Much rides on what Americans do with the money they’ll receive from the stimulus. Rivlin expressed confidence that it is targeted to people who will spend it, but Matthew Benjamin writes at Bloomberg.com that a Bloomberg/Los Angeles Times survey shows “most Americans plan to save rather than spend their tax rebates. … Only 18 percent of respondents said they will spend their rebate on purchases, while slightly more than three in 10 said they prefer to use the money to pay off debt, and a third said they’ll pocket it.” Benjamin quotes Douglas Elmendorf of Brookings as saying, however, that “people in Washington assume that about 40 percent of the money will be spent.”
The prospect of increased spending leads to the next worry: inflation. Scott Lanman and Steve Matthews of Bloomberg.com report that “Bernanke’s readiness to cut interest rates to avert a recession is stoking concerns that prices will get out of hand.” They quote John Silvia, chief economist at Wachovia Corp in Charlotte, N.C., who spoke after Bernanke’s testimony Wednesday: “Bernanke has really overweighted the economic risks relative to inflation,” he said.
Backed into a corner
William Neikirk of the Chicago Tribune put the dilemma this way: “There are two economic beasts staring down Federal Reserve Chairman Ben Bernanke and, by extension, the U.S. economy: a debilitating recession and destructive inflation. Backed into a corner from the spreading effects of a housing-triggered credit crunch, Bernanke indicated Wednesday that inflation is the lesser worry as he signaled the central bank will focus its attention on preventing a steep economic downturn.”
In his testimony, Neikirk wrote, “the embattled Fed chairman suggested another interest rate reduction is coming in March to help revive the economy. Analysts believe the Fed could make it a cut of half a percentage point, as Bernanke continues to try to get ahead of the curve on a financial market squeeze that many say he was late in anticipating. … Bernanke came to the Fed as an advocate of ‘inflation targeting,’ meaning the Fed would raise interest rates if inflation rose above a specified range. But he has backed away from that idea. Though inflation now appears to reigniting, he is being forced by events to look the other way until financial markets regain stability.”
Ultimately, Neikirk writes, “the danger Bernanke faces is a miscalculation in which the Fed lowers interest rates further to spur growth only to find that it fans inflation.”
Susan Albright, a MinnPost managing editor, writes about national and foreign developments. She can be reached at salbright [at] minnpost [dot] com.