WASHINGTON – Federal Reserve Chairman Ben Bernanke told Congress Wednesday that the economy has emerged from its anemic spell, but overall growth for the year will be lower than expected. Inflation remains the chief concern, he said.
Delivering a midyear Fed economic report to Capitol Hill, Bernanke struck a somewhat cautious tone. He suggested that the economy appears likely to expand "at a moderate pace" over the second half.
Still, the Fed chief told the House Financial Services Committee that growth this year will be slower than the Fed projected in February. Growth, however, should strengthen a bit next year, he said. The inflation forecast wasn't changed. It calls for prices other than food and energy to edge lower.
Against this backdrop, the Fed is likely to leave interest rates where they are through the rest of this year. "They aren't moving," said Stuart Hoffman, chief economist at PNC Financial Services Group.
For just over a year, the Federal Reserve has held a key interest rate at 5.25 percent, providing a period of stability to borrowers. Before that, the Fed had boosted rates for two years to fend off inflation.
On Wall Street, stocks fell, with the Dow Jones industrials down more than 100 points. Investors reacted uneasily to Bernanke's assessment of the economy and news that two Bear Stearns Cos. hedge funds were essentially worthless.
Bernanke took pains Wednesday to hedge the Fed's bets and outline risks to the economy.
One risk is that energy and commodity prices could continue to rise sharply, boosting the prices of lots of other goods and services and thus spreading inflation through the economy.
The Fed "has consistently stated that upside risks to inflation are its predominant" concern, Bernanke said.
The panel's chairman, Rep. Barney Frank, D-Mass., said that finding "troubles me." In Frank's view, the biggest problem is the growing gap between low-wage and high-wage workers. Democrats have accused the Bush administration of not doing enough to narrow this gap.
Overall consumer prices calmed down in June, the government reported Wednesday. They rose by just 0.2 percent — the smallest increase in five months — helped by cheaper gasoline. Gasoline prices, however, have since crept up and are hovering past $3 a gallon.
Another risk is that the housing slump could turn out worse than expected, sapping consumer spending and possibly causing overall economic growth to be weaker, Bernanke said.
The economy barely budged in the first quarter, growing at pace of just 0.7 percent, the worst in more than four years. The sour housing market was the principal culprit.
But other factors in that dismal performance — including cutbacks in inventory investment by businesses, weak federal defense spending and a bloated trade deficit — are showing some signs of improvement. Given that, the economy could grow close to 3 percent in the April-to-June quarter, Bernanke said. The government's estimate of second-quarter growth will be released later this month.
The housing market will remain sluggish for some time, partly because of some now tighter lending standards and the recent rise in mortgage rates, Bernanke said.
Even if the demand for housing were to stabilize somewhat, the pace of new home building will probably fall as builders work down excess stocks of unsold homes, he said.
"Thus declines in residential construction will likely continue to weigh on economic growth over coming quarters, although the magnitude of the drag on growth should diminish over time," Bernanke said.
Bernanke also outlined efforts by regulators to deal with problems in the market for risky mortgages. Those are mortgages made to people with spotty credit histories.
Foreclosures and delinquencies for these "subprime" mortgages have spiked. Some big subprime lenders have been forced out of business.
Borrowers and lenders have been clobbered by rising interest rates and weak home values. Congress has blasted the Fed and other regulators for not doing enough to crack down on lax lending standards, which had contributed to the problems.
"Rising delinquencies and foreclosures are creating personal, economic and social distress for many homeowners and communities — problems that likely will get worse before they get better," Bernanke said.
To better protect consumers, the Fed is looking at ways to improve mortgage disclosure and ways to curb unfair or deceptive lending practices. It also is encouraging lenders to work with troubled homeowners.
Rep. Spencer Bachus, R-Ala., talked about problems involving rogue mortgage brokers losing licenses in one state but then setting up shop in another. "Basically — to me, they're criminals," he said. "And they're inflicting a tremendous amount of pain."
Bernanke said it might be helpful to have federal licensing or some federal data base to keep track of problem brokers.
On another issue, Bernanke said hedge funds and private equity firms can spread risk, boost liquidity and thus can be good for national economic activity. "They certainly are a benefit to the economy," he said. There's an effort in Congress to raise taxes on these firms.
In new economic projections, the Fed expects the economy to grow between 2.25 and 2.50 percent, as measured from the fourth quarter of last year to the fourth quarter of this year. That's lower than the old forecast of 2.5 percent and 3 percent.
For 2008, the economy should pick up and expand between 2.50 and 2.75 percent. Yet, that also was lower than previously estimated.
"Core" inflation, meanwhile, should increase by 2 percent and 2.25 percent this year, the same as the previous projection. Core inflation excludes the more volatile categories of energy and food.
The unemployment rate — currently at 4.5 percent — could rise as high as 4.75 percent this year, which would still be considered relatively low by historical standards. That's also unchanged from the Fed's old forecast.