WASHINGTON (CN) – Unemployment will peak at the end of this year and economic output will slowly grow through 2010, and accelerate in 2011, Federal Reserve Chair Benjamin Bernanke predicted Tuesday during his semiannual report to the House Financial Services Committee. “I want to be clear that we have a very long haul here,” he said.
“The pace of decline appears to have slowed significantly,” he said from the chamber with standing room only, but noted that the labor market is continuing to weaken, with unemployment expected to rise above 9.5 percent, where it sits now.
Despite the mediocre economic outlook, Bernanke put his support behind the Recovery Act. “If the fiscal stimulus package didn’t exist we would anticipate that there would be higher unemployment,” he said, adding that policy actions “may well have averted the collapse of the global financial system.” Republicans likely cringed, although none visibly.
He also said the economic conditions “warrant maintaining the federal funds rate at exceptionally low levels for an extended period.” The Federal Open Market Committee, which sets interest rates, lowered the federal funds rate to a historically low rate of zero to a quarter of a percent, where it rests today.
In his testimony, Bernanke defended the autonomy of the Fed and its role in providing billions in controversial loans, advised Congress to do its part in restoring confidence in the markets, and eased concerns that low interest rates would spark inflation.
In response to worries from Minnesota Democrat Keith Ellison that low interest rates might spark inflation, Bernanke said the Fed is able to raise interest rates to make sure inflation is not a problem.
Bernanke also defended the necessity of billions of dollars in loans made by the Fed to failing companies, such as American International Group and Bear Sterns. He said that without such bailouts, the downturn would have been much worse, and called “too big to fail” companies an “enormous problem.”
When Indiana Democrat Joe Donnelly asked what would have happened if the government had walked away from the crisis, Bernanke replied that “the credit market would have likely collapsed,” and that the global banking system might have also collapsed.
The economic downturn and controversial loans have brought the Fed under fire, and Bernanke used the testimony to add his voice to the debate now raging over the Fed’s jurisdiction and powers.
Among the changes already underway, Bernanke and Obama have agreed to get presidential approval before approving any unusual lending. At the same time, Treasury Secretary Timothy Geithner laid out plans a couple weeks ago to grant the Fed new oversight of the $592 trillion derivatives market, which is largely unregulated.
Congress recently expanded the authority of the Government Accountability Office to audit the credit extended to companies, like those to AIG. But Congress is considering more. Texas Republican Ron Paul, for example, has put forward legislation that would greatly expand the audit authority of the accountability office and it has been co-signed by a majority of the House.
Bernanke said the Congress was wise in its recent rules to exclude “some highly sensitive areas, notably monetary policy deliberations,” from the scope of the office’s reviews.
He discouraged the idea of a larger audit, saying that the financial markets would view the move as a “serious weakening of monetary policy independence.” Reviews in monetary policy deliberations could be “seen as efforts to try to influence monetary policy decisions,” he clarified.
The Fed is unique from other government agencies in its political independence. Congress does not control its budget and it typically has the authority to act on its own, without interference from Congress or the president.
Many agree that autonomy of the Fed is important because it may have to make unpopular decisions. In the case of accelerated inflation, for example, the Fed might raise interest rates, which would likely slow economic growth and induces job losses.
In a move that stood out from the Fed-focused hearing, Bernanke turned the spotlight on Congress and urged them to plan now for fiscal responsibility in order to restore confidence in the markets. He warned of pending problems, like the jump in Medicare expenses associated with the retirement of the baby-boom generation, the growing debt, and its associated interest. “Unless we demonstrate a strong commitment to fiscal sustainability,” he said, “we risk having neither financial stability nor durable economic growth.”
The debt is currently 40 percent of gross domestic product, but is expected to balloon to 60 percent by next year.