Despite a recent spike in the unemployment rate, the danger that the U.S. economy has fallen into a "substantial downturn" appears to have waned, Federal Reserve Chairman Ben Bernanke said Monday.
Addressing a Fed conference in Chatham, Massachusetts, on Monday night, Bernanke said a government report last week showing the unemployment rate rising from 5 percent in April to 5.5 percent in May - the biggest one-month jump in two decades - was "unwelcome." However, the Fed chief said other forces should "provide some offset to the headwinds that still face the economy."
The Fed's powerful doses of interest rate cuts, the government's $168 billion stimulus package, further progress in the repair of problems in financial and credit markets, a gradual ebbing of the drag from the deep housing slump and still solid demand from abroad for U.S. exports should help the economy over the remainder of this year, he said.
Although economic activity is "likely to be weak" during the current April-to-June quarter, Bernanke said "the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so."
Last Friday fears were rekindled that the country could be headed for a deep recession after the unemployment rate zoomed and oil prices registered their biggest single-day leap.
However, Bernanke said, "Recent incoming data, taken as a whole, have affected the outlook for economic activity and employment only modestly."
Still, soaring energy prices are a double-edged sword for the country. Oil prices closed Monday at $134.35 a barrel, down from last week's high of $139.12 a barrel. They risk putting a further damper on growth as well as spreading inflation through the economy, Bernanke said.
"Inflation has remained high," largely reflecting sharp increases in the prices of globally traded commodities, Bernanke said. "The latest round of increases in energy prices has added to the upside risks to inflation and inflation expectations," he said.
The Fed is paying close attention to the extent to which consumers, investors and businesses believe prices will rise in the future, he said. If consumers, investors and businesses believe inflation will continue to go up, they will change their behavior in ways that aggravate inflation, turning it into a self-fulfilling prophecy.
The Fed "will strongly resist an erosion of longer-term inflation expectations, as an unanchoring of those expectations would be destabilizing for growth as well as for inflation," Bernanke said.
Bernanke spoke Monday evening to a conference on understanding inflation and the implications for Fed policymakers in setting interest rates. The forum was sponsored by the Federal Reserve Bank of Boston. His comments on the economy's outlook were fairly brief and were part of a larger, mostly academic speech.
Last week, Bernanke sent his strongest signal yet that the Fed's rate-cutting campaign was probably over for now because of growing concerns that soaring oil and other commodity prices - along with a weakened dollar - are aggravating inflation.
To help brace the economy, the Fed dropped rates in late April to 2 percent, a nearly four-year low, continuing a rate-cutting campaign that started last September.
Many economists believe the Fed will hold rates steady at its next meeting on June 24-25 and probably through much, if not all, of this year. However, some believe inflation could flare up and force the Fed to begin boosting rates later this year or next year.
Inflation forecasting is important to Fed policymakers when determining the best course on interest rates. Even with extensive research over the years, much remains to be learned about both inflation forecasting and inflation control, Bernanke said. And there are areas where additional research could prove helpful.
Policymakers and analysts often have relied on information from commodity futures markets to help shape inflation forecasts, Bernanke said. In recent years, though, information from futures markets has "underpredicted commodity price increases ... leading to corresponding underpredictions of overall inflation," he said. The "poor recent record" on that front raises the question of whether policymakers should continue to use this source of information and, if so, how, Bernanke said.
Despite the recent record, Bernanke said he didn't think it was reasonable to ignore information about supply and demand culled by futures markets. However, it does seem reasonable, he said, to treat such information as highly uncertain.
Working to make economic data timelier and more accurate also would be useful to policymakers trying to divine inflation's direction. Moreover, it would also be helpful for policymakers to know more about how people's inflation expectations are influenced by Fed interest rate actions, Fed communications and economic developments such as oil price shocks.
"Much evidence suggests that expectations have become better anchored than they were a few decades ago, but that they nonetheless remain imperfectly anchored," Bernanke said.
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