THE US economy will not grow much, if at all, during the first half of this year and "could even contract slightly", Ben Bernanke said yesterday, admitting for the first time that a "recession is possible".
The chairman of the Federal Reserve said its recent actions - big interest rate cuts and emergency measures to support market liquidity - "appear to have helped stabilise the situation" in financial markets "somewhat", but those markets remained under considerable stress.
Amid tough questioning from Democrats at the US Congress's Joint Economic Committee, Mr Bernanke defended the decision to intervene to save investment bank Bear Stearns from collapse.
The central bank's rescue of Bear raised difficult questions, but "the damage caused by a default . . . could have been severe and extremely difficult to contain", he said. In particular, it could not have been contained within the financial system, "but would have been felt broadly in the real economy".
He also told lawmakers that the Fed's emergency loan to Bear Stearns followed a warning by the company on March 13th that it would have to file for Chapter 11 bankruptcy the following day.
Charles Schumer, Democrat chairman of the Joint Economic Committee, claimed there was a "dichotomy" whereby policymakers were willing to risk public funds to stabilise financial markets but were not intervening directly to support distressed homeowners.
"We address the financial problems because we think they affect Main Street," Mr Bernanke retorted.
Investors saw the remarks as evidence of an increased likelihood of further rate cuts and the S&P 500 rebounded from earlier losses. Investors continued to buy financials, buoyed by a remark by the chairman that another Wall Street dealer was unlikely to fail.
Stephen Stanley, chief economist at RBS Greenwich Capital, said that given the state of the economy, the Fed was likely to reduce the funds rate to 1.5 per cent by June. Economists at Lehman Brothers said: "While the exact timing of rate cuts is hard to pin down, we continue to believe market expectations for the terminal funds rate is too high, and look for the funds rate to reach 1 per cent in early 2009."
The Fed chief said he believed the central bank had been "creative" in innovating new ways to help ease liquidity strains and believed it now had a "full complement of liquidity provision tools". He made no suggestion that he thought it was yet necessary to resort to outright public intervention in the mortgage market. But he promised to tell Congress if he believed additional action was needed.
Mr Bernanke said the Treasury plan to overhaul the regulation of the US financial system was an "interesting and useful first step". But the Fed would need to be sure it had the "powers, authority and expertise" to perform its proposed enhanced role as guardian of overall financial stability. The Fed did not want to lose its existing authority as supervisor of the main bank holding companies.
The Fed expects growth to strengthen in the second half of the year as fiscal and monetary stimulus kicks in, he added. But "the uncertainty attending this forecast is quite high and risks remain to the downside". Mr Bernanke noted the recent improvement in the core inflation rate. But he said that "uncertainty about the inflation outlook as increased".
