Fed's Bernanke Says More Rate Cuts Might Be Needed - TheStreet

Fed's Bernanke Says More Rate Cuts Might Be Needed

An economic turnaround might not end the possibility of deflation, the Fed governor says.
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Federal Reserve

Governor Ben S. Bernanke said Wednesday that an economic recovery wouldn't eliminate the possibility of deflation, and as such, the U.S. central bank must remain prepared to make additional interest-rate cuts to ensure strong growth.

Bernanke also suggested the Fed could use other methods in an effort to keep the economy inflated, such as purchasing long-term bonds.

"Even if the pace of real activity picks up considerably this year and next, persistent slack might result in continuing disinflation," Bernanke said at the University of California in San Diego.

The governor also estimated the Fed's main inflation gauge, the index of personal consumption expenditures, could fall from the current 1.2% to 0.7% by the end of 2004, even with a 4% growth rate for gross domestic product. The central bank's policymakers had projected the so-called central tendency for inflation between 1% and 1.5% next year, on GDP growth of 3.75% to 4.75%.

"For the foreseeable future, the risk of further declines in inflation from an already low level outweighs the risk of a resurgence of inflation," Bernanke said. "Hence, monetary ease appears to be indicated for a considerable period."

Going Even Lower?

Bernanke reiterated that the central bank has the ability to cut the fed funds rate to zero, if necessary. The Fed lowered its benchmark interest rate to 1% last month, the lowest level in 45 years.

"He made it very clear that there is some chance the Fed will have to ease again, on concerns inflation could continue to drop, and that he would not like to see

rates go higher," said Jim O'Sullivan, senior economist at UBS Warburg.

Bernanke also said "the Fed's tools for managing aggregate demand are not limited to control over the short-term nominal interest rate, but include other channels as well."

These methods could range from Fed purchases of longer-term government bonds, a program of oversupplying bank reserves, term lending through the discount window at low rates, and the issuance of options to borrow from the Fed, also at low rates.

Following the comments on Fed repurchases, the 10-year Treasury note rose, sending the yield down to 4.10%. Yields had been as high as 4.22% on Monday owing to expectations the U.S. economy would recover after upbeat comments from Fed Chairman Alan Greenspan last week. Economic strength could lead to higher inflation rates and lower returns on government bond investments.

Setting Targets

Another key aspect of Bernanke's speech was his suggestion that the Fed use some type of inflation-targeting.

"In my view, one useful approach would be for the

Federal Open Market Committee to provide the public with a quantitative, working definition of price stability," he said. "The definition of price stability would be expressed as a range of measured inflation, with the lower boundary of the range a safe distance from zero."

According to economists, the statement suggests there could be a floor for inflation tolerance on the Fed's part. Some observers have criticized the Fed as being vague about the ranges of inflation that would be considered acceptable and the levels of employment and economic activity that would lead to higher inflation.

"It's clear he would support more transparency, and inflation-targeting is not new for

Bernanke," said O'Sullivan, who doesn't believe such a system would be adopted under Greenspan's mandate.