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Ben Bernanke: No policy shift unless economy sags

(MoneyWatch) Federal Reserve Chairman Ben Bernanke indicated today that the risks to the U.S. economy have increased and that the central bank is prepared to take action if conditions deteriorate further. Yet he offered no sign in his testimony before the Congressional Joint Economic Committee that the Fed is prepared to change course at its next monetary policy meeting later this month.

Expectations that the Fed might ease policy were raised this week when three regional bank presidents -- John Williams of San Francisco, Dennis Lockhart of Atlanta, and Eric Rosengren of Boston -- all hinted at a willingness to consider further monetary easing in a bid to boost economic growth. Remarks by Fed governor Janet Yellen also encouraged speculation that Bernanke might hint that the Fed was ready to change in policy.

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But with Bernanke's testimony, expectations that the Fed will alter its stance anytime soon have been all but eliminated. Instead, the Fed will stay in "wait and see" mode on the belief that its policy stance is already highly accommodative. Further easing is only called for if the economy begins to show signs of weakening further or turns downward. The Fed's greatest fear is deflation, and any sign that inflationary expectations are plunging would likely spur a change in policy.

For now, the central bank believes it has done enough. By contrast, many economists outside the Fed are urging immediate action to help the recovery along and to ensure against future problems related to Europe's ongoing debt crisis or a from a spike in oil prices. There is lag between the time the Fed alters policy and when the change affects the economy, and a wait-and-see approach is risky in that it can cause the Fed to end up behind the curve. Nevertheless, the Fed feels the risks of acting now, in particular the risk of inflation, trump fears about present and future economic growth.

Bernanke also discussed fiscal policy in his testimony, urging lawmakers to put the budget deficit on a long-run sustainable path without "unnecessarily impeding the current economic recovery." He cited the "fiscal cliff" -- the scheduled expiration of tax cuts and a planned reduction in government spending on Jan. 1 of next year -- as an immediate concern, and he is clearly worried about the impact on the economy if there is a large reduction in the federal deficit while the economy is still struggling to recover.

Bernanke indicated that the Fed would appreciate help from lawmakers in the short-run in speeding the recovery, previously mentioning the need for increased infrastructure spending. Like most mainstream economists, he is calling for more fiscal stimulus in the short-run, or at least no reduction in what is already being done, and a plan for a sustainable long-run budget. Whether Congress can deliver or not is an open question. Stimulus in the near term is a long shot given the political gridlock in Congress, and the ability of lawmakers to solve the long-run problem also adds a high degree of uncertainty.

But however the budget negotiations turn out, as Bernanke notes it will have consequences for monetary policy, and the Fed would feel more confident in its own abilities if it had more support from Congress.

Overall, the main message from Bernanke's testimony is that the Fed is aware that the risks to the economic outlook have increased. But the bank is not yet convinced that current troubles are anything more than a bump in the road, and its worries about the future are not enough to motivate action.

That may change if conditions deteriorate -- we will have to "wait and see" -- but for now present policy will continue.

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