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Bernanke: Fed would supply more stimulus if needed

WASHINGTON — Federal Reserve Chairman Ben Bernanke said Wednesday that the central bank is prepared to provide additional stimulus if the economic lull persists.

Delivering his twice-a-year economic report to Congress, Bernanke laid out three options the central bank would consider. One possibility, he said, was another round of Treasury bond buying. That would make the third such effort since 2009.

The Fed chief’s reassurances helped drive stock prices higher, but it also underscored the fragile state of the economy more than two years after economists said the recession had ended. Unemployment has risen for three straight months and a debt crisis in Greece and other European countries threatens to weaken the global economy.

Bernanke warned U.S. lawmakers that their failure to raise the nation’s borrowing limit by Aug. 2 could trigger a major financial crisis. He said that if government defaults on its debt, it would throw “shock waves through the entire financial system.”

Bernanke said more stimulus would only be necessary if economic conditions worsened and deflation re-emerged as a threat. Deflation is a destabilizing period of falling prices.

He also said the Fed was nimble enough to respond if the opposite happened. He said the Fed was ready to raise interest rates that have been held at record lows for nearly three years, should the central bank fear a greater risk of inflation.

‘All options on the table’

“We have to keep all options on the table,” Bernanke told the House Financial Services Committee on the first of two days of Capitol Hill testimony. “If we get to the point where the recovery is faltering” and inflation is dropping toward zero, then the central bank would consider the additional stimulus options, he said.

The Dow Jones industrial average rose more than 93 points in afternoon trading. Broader indexes also increased.

In addition to purchasing Treasury bonds, Bernanke said the Fed could help the economy by:

  • Cutting the interest paid to banks on the reserves they hold as a way to encourage them to lend more.
  • Communicating in more explicit terms how long it planned to keep rates at record-low levels. That would give investors confidence about the Fed’s efforts to continue supporting the economy.

The Fed last month agreed to end on schedule its program to boost the economy through the purchase of $600 billion in Treasury bonds. But the central bank also acknowledged that the economy had slowed in the first half of the year. As a result, it lowered its economic growth forecast for 2011 and said unemployment wouldn’t fall below 8.6 percent this year.

Since then, the government reported a second straight month of dismal hiring in June. The economy added just 18,000 jobs last month, the fewest in nine months. The unemployment rate rose to 9.2 percent — the highest rate this year.

Temporary factors to blame for sluggish economy

Companies pulled back sharply on hiring after adding an average of 215,000 jobs per month from February through April. The economy typically needs to add 125,000 jobs per month just to keep up with population growth. And at least twice that many jobs are needed to bring down the unemployment rate.

The Fed has said that temporary factors, such as high gas prices and supply chain disruptions caused by the Japan crisis, are partly to blame for the sluggish period.

Bernanke told Congress that the Fed believes those impediments should ease in the second half of the year. But if that forecast proves wrong, he said the Fed is prepared to do more.

“The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might re-emerge, implying a need for additional policy support,” Bernanke said.

Economists noted that Bernanke was careful to balance the possibility of further Fed stimulus with the possibility that inflation could become a problem.

Paul Ashworth, chief U.S. economist at Capital Economics, said the Fed would likely hold off on further steps unless deflation emerges as a threat again. Ashworth said any decision would not come until next year.

“The Fed wants to wait and see if the drop off in economic growth was due to transitory factors and whether inflation drops back,” Ashworth said.

The Fed launched its last round of bond buying last when deflation worries were increasing. The bond-buying program was the Fed’s second round of “quantitative easing.” That’s a term economists use for a tool the Fed can use to drive down long-term interest rates by purchasing Treasury bonds.

Fed divided over stimulus

The topic of new stimulus was raised at the same June meeting in which Fed policymakers agreed to end the last program. Some members said the Fed should be open to additional measures if growth failed to pick up enough to “meaningfully” reduce the unemployment rate, according to minutes of the June 21-22 meeting.

Others expressed concerns about inflation and said the central bank would need to take steps to begin removing its low-interest rate policies “sooner than currently anticipated.”

The minutes highlighted a division at the Fed between officials who are most worried that the economy is growing too slowly, including Bernanke, and some regional bank presidents who are concerned that the Fed’s policies could spark high inflation.

Bernanke spoke to the minority’s concerns in his testimony. He said that the central bank would be prepared to start raising interest rates faster than currently contemplated, if prices don’t moderate.

The Fed has kept its key interest rate at a record low near zero since December 2008. Most private economists believe the Fed will not start raising interest rates until next summer. And some say the Fed won’t increase rates until 2013, based on the slumping economy.