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Bernanke Says Fed Could Cut Rates Further
Wednesday July 23, 4:43 pm ET
By Glenn Somerville


WASHINGTON (Reuters) - Federal Reserve Governor Ben Bernanke said on Wednesday the U.S. central bank would be prepared to cut interest rates all the way to zero if necessary to ward off a fall in inflation that could hurt recovery.

Speaking to a California university audience, Bernanke said if the Fed were to reduce overnight borrowing costs to zero, it would look at so-called nontraditional methods of trying to spur growth, such as buying long-term bonds.

He expressed confidence those methods, which could include stepped-up buying of long-term government bonds in markets, would work if the Fed needed to turn to them. But policymakers still appear focused on using their central tool of controlling short-term interest rates for now.

"Monetary ease appears to be indicated for a considerable period," Bernanke said. "Keeping the federal funds target at or near its current level may be sufficient.

"Alternatively, as Chairman (Alan) Greenspan testified last week, we could certainly cut the rate from where it is now," he told the Economics Roundtable of the University of California at San Diego.

Bernanke's comments sent the U.S. dollar tumbling in value on concern it meant cheaper credit would make the currency less attractive. Bond prices gained, apparently on the prospect they could be a sought-after purchase at some future point as well as a safer haven for investors now.

MARKETS WATCHFUL, WARY

Though he has been a Fed governor for less than a year, Bernanke's comments on inflation are closely monitored by financial market participants eager for clues on how strongly the central bank counts on relatively robust growth estimates that Fed Chairman Alan Greenspan made public last week.

In his semi-annual testimony to Congress on the economy, the Fed chief said U.S. expansion could accelerate to a range of 3.75 percent to 4.75 percent in 2004, a far cry from the feeble 1.4 percent pace posted in the first quarter this year, the last period for which figures are available.

In a separate appearance on Wednesday, Dallas Federal Reserve Bank President Robert McTeer said he was optimistic the economy was on the cusp of faster growth but conceded "hard evidence" of it was hard to come by.

"While I am optimistic that things are about to pick up, I have been optimistic like that for a while now and it's more a hunch and hope, and so forth, than it is any hard evidence so far," McTeer said.

Bernanke told questioners that the Fed was determined to get growth on track and that the central bank has room to keep trimming the federal funds rate, which is charged on overnight loans between banks, from its 45-year low of 1 percent.

"We're not done yet," he said. Fed policymakers reduced the fed funds rate a quarter percentage point on June 25, citing concern about the economic risks from a further fall in inflation, and are next scheduled to meet on Aug. 12.

NOTHING DRASTIC COMING

Bernanke said he personally did not foresee "a drastic change" in the inflation rate and said he considered deflation a "remote" possibility. "Should further declines occur, a more gradual downward drift over a period of one to two years would be the more likely scenario, " he said.

Bernanke said he was well aware that reducing short-term rates more would carry some cost, including reducing interest income for savers like senior citizens and eroding profits in money markets.

But, he emphasized: "We should be willing to cut the funds rate to zero, should that prove necessary to provide the required support to the economy."

He made clear that preventing a further slowing in inflation -- or outright deflation in which widespread price declines set in -- must be a priority for Fed policymakers.

"I hope we can agree that a substantial fall in inflation at this stage has the potential to interfere with the ongoing U.S. recovery," Bernanke said.

He said that while the risk of deflation was "remote," it could do "significant economic harm" if it were set loose. Deflation, which has not been seen in the U.S. economy on a sustained basis since the 1930s, erodes asset values and could destabilize the nation's financial system.

Bernanke said there some influences were countering a trend toward soft prices, including the dollar's falling value against other currencies that raises prices for imported goods as well as the fact that most consumers still anticipate modest increases rather than decreases in prices ahead.

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