Bernanke Signals More Rate Cuts

"Should high rates of overall inflation persist, the possibility also exists that inflation expectations could become less well-anchored," said Bernanke. "Any tendency of inflation expectations to become unmoored or for the Fed's inflation-fighting credibility to be eroded could greatly complicate the task of sustaining price stability and could reduce the flexibility of the FOMC to counter shortfalls in growth in the future."

Having taken the reins from his predecessor, Alan Greenspan, at the end of a housing boom that was juiced by a long period of loose monetary policy, Bernanke faces a difficult task in guiding the Fed through the U.S. housing bust. On the one hand, financial markets could lose stability if the Fed stops providing cheaper credit. On the other, the continuation of low interest rates could unleash a dangerous spiral of inflation or give rise to more speculative bubbles in the markets.

"A critical task for the Federal Reserve over the course of this year will be to assess whether the stance of monetary policy is properly calibrated to foster our mandated objectives of maximum employment and price stability in an environment of downside risks to growth, stressed financial conditions, and inflation pressures," said Bernanke. "In particular, the FOMC will need to judge whether the policy actions taken thus far are having their intended effects."