Bernanke Puzzled by Weakness, Warns Against Cuts

The Associated Press contributed to this report
Federal Reserve Chairman Ben Bernanke didn't offer much hope for a third round of stimulus, and stock prices fell after his speech Thursday afternoon. In fact, he made it clear that the Fed has been surprised at how weak the economy is, which is a bit like the doctor telling you he's flummoxed that you're not getting better. It doesn't inspire much confidence. No wonder the Dow lost 119 points.

Bernanke did note that several factors have kept consumers from spending more: from high unemployment and falling home values to still-heavy debt loads and higher gasoline prices.

"Even taking into account the many financial pressures they face, households seem exceptionally cautious," Bernanke said in his speech, to the Economic Club of Minnesota in Minneapolis. Bernanke said that higher prices for gas, cars and other consumer goods were due, in part, to temporary factors, such as supply disruptions stemming from Japan's earthquake and nuclear crisis. As those factors continue to ease, the Fed chief said he expects inflation to moderate in the coming months.

Moneywatch economics blogger Mark Thoma said he thought the most interesting thing to come out of the speech was the fact that Bernanke issued (another) call to avoid austerity while the economy is weak. In the chairman's words: "There is ample room for debate about the appropriate size and role for the government in the longer term, but -- in the absence of adequate demand from the private sector -- a substantial fiscal consolidation in the shorter term could add to the headwinds facing economic growth and hiring."

For a Fed chairman, that's a pretty powerful warning to the GOP to lay off the spending cuts in the near future. Congress, he said, "should not ... disregard the fragility of the economic recovery."

The economy barely grew in the first half of the year: It expanded at an annual rate of just 0.7 percent. And the government said last week that employers added zero net jobs in August.

Some economists suggested that Bernanke might be hesitant to elaborate on the Fed's policy options because of the opposition he faces on its interest-rate setting panel. Three members of the panel dissented at the August meeting, when the Fed said it planned to keep short-term rates at record lows at least until mid-2013 as long as the economy remains weak. It was the first time since 1992 that as many as three panel members had dissented from a policy decision.

"Bernanke probably didn't want to antagonize the hawks who voted against the decision at August's meeting," said Paul Ashworth, chief U.S. economist at Capital Economics, referring to members who fear that rates kept too low for too long can ignite inflation.

But Ashworth said he still expected the Fed to act further at the September meeting to provide support for the economy.

One possibility is for the Fed to increase the percentage of long-term Treasury securities in the mix of securities it holds. That approach would have the advantage of exerting further downward pressure on long-term rates without swelling the Fed's already record-level of securities holdings.

The worsening jobs outlook has escalated the pressure on President Barack Obama. He was expected Thursday night to introduce a $300 billion jobs package before a joint session of Congress. The plan will likely include extensions of the Social Security tax cut and long-term unemployment benefits, tax incentives for businesses that hire and money for public works projects.

But that effort faces opposition from congressional Republicans, who argue that Obama's previous stimulus program was a failure. They want deeper spending cuts to fight the government's soaring budget deficits.