Bernanke talks recovery, low rates

Fed Chairman Ben Bernanke provided his semiannual report on monetary policy before a House committee this morning and opened by saying that aggressive policy actions taken around the world last fall "may well have averted the collapse of the global financial system," an event that would have had extremely adverse and protracted consequences for the world economy.

Bernanke may have miscalculated how badly the economy would eventually suffer because of reckless practices on Wall Street and among mortgage lenders, but his response, coupled with actions taken by major central banks, did avoid a catastrophe.

But much of his testimony focused on the economy and credit markets. Credit is still tight, he said, but there have been some "notable improvements" in the financial markets as the extreme aversion to risk has eased.

Better conditions in credit markets have been accompanied by "some improvement in economic prospects." Moreover, the drag on exports appears to be waning as many trading partners see "signs of stabilization."

The FOMC expects output will increase slightly over the remainder of 2009, and the recovery will be gradual next year, with the unemployment rate forecast to peak at the end of the year. See L, W, U, V - the alphabet soup of economic recoveries.

He reiterated that interest rates will stay low for an extended period of time, which is not surprising given that unemployment is expected to remain at unacceptable levels. Still, the Fed is aware of longer-term inflation risks and is prepared to begin withdrawing liquidity when the appropriate time arrives.

Nonetheless, Bernanke will be walking a monetary tightrope as he must balance the need to support any fledgling recovery with concerns about rising prices.

Fiscal responsibility

Bernanke applauded Congress for passing a stimulus package but talked about the need to restore fiscal balance.

"Prompt attention to questions of fiscal sustainability is particularly critical because of the coming budgetary and economic challenges associated with the retirement of the baby-boom generation and continued increases in the costs of Medicare and Medicaid." He added that choices will be difficult but postponing action will only make things worse.

That may asking for too much from lawmakers. Congress has acted in a fiscally responsible manner on rare occasions, and it seems likely that tough choices will only be put off again.