Stimulus Alone Isn’t Enough: Bernanke

There will be no lasting recovery without more government action and money to prop up the still ailing financial system, Federal Reserve chief Ben Bernanke said Tuesday. “The global economy will recover, but the timing and strength of the recovery are highly uncertain,” Bernanke said in his speech to the London School of Economics. “Government policy responses around the world will be critical determinants of the speed and vigor of the recovery.” The incoming administration is currently discussing a substantial fiscal package that, if enacted, could provide a significant boost to economic activity, the fed chief said. “In my view, however, fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system.” The government must rid its balance sheets of toxic assets, he explained. He discussed various ways to accomplish this, including the creation of “bad banks” to hold the troubled assets. The government may need to provide more capital infusions to financial firms to help stabilize the still worsening markets, he added. And guarantees may become necessary “to ensure stability and the normalization of credit markets.” In his all but sugar-coated speech, Bernanke said there is still no end in sight to economic turmoil.  But he stressed the U.S. Federal Reserve still has “powerful tools” at its disposal to fight the financial crisis, and will continue to do its part to help. Despite an overnight federal funds rate that cannot be reduced “meaningfully further” as Bernanke put it, the fed can still lend to financial institutions, provide liquidity directly to key credit markets, and buy longer-term securities, as the speech outlined. The virtue of these policies in the current context, according to the fed chief, is that they allow the Fed to continue to push down interest rates and ease credit conditions in a range of markets, despite the fact that the federal funds rate is close to zero. The Fed chairman acknowledged the concern about putting substantial government resources toward the financial industry, but “this disparate treatment, unappealing as it is, appears unavoidable,” he said. Some observers have expressed the concern that, by expanding its balance sheet, the Fed is effectively printing money, an action that will ultimately be inflationary.  Bernanke claimed, however, that the Fed sees “little risk of inflation in the near term; indeed, we expect inflation to continue to moderate,” he said. And he assured the audience that when the time comes, the unwinding of the government’s programs will be “smooth” and “timely.” “In the near term, the highest priority is to promote a global economic recovery,” Bernanke said. “Fiscal policy can stimulate economic activity, but a sustained recovery will also require a comprehensive plan to stabilize the financial system and restore normal flows of credit.” And international cooperation is absolutely essential he repeatedly said, if we are to address the crisis successfully and provide the basis for a healthy, sustained recovery. Write to Kelly Curran at Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.

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