Federal Reserve Chairman Ben S. Bernanke said damage from the financial crisis has left the U.S. economy growing at a slower pace than policy makers want even as the central bank’s more than $1 trillion in bond purchases have reduced interest rates.
“By buying mortgage-backed securities and Treasuries we did, I think, additionally stimulate the economy,” Bernanke said Friday in response to a question after he spoke at a Princeton University conference.
“We avoided what could have been a global meltdown,” Bernanke said. “But even so, we got a taste of how powerful a financial crisis is on real activity. That blow which knocked the world economy into a deep recession in the second half of ‘08 and the early ‘09, we are only recovering from that at a pace slower than we would like.”
U.S. central bankers said Sept. 21 they were “prepared to provide additional accommodation if needed to support the economic recovery.” They also left the benchmark lending rate in a range of zero to 0.25 percent while noting that inflation measures were at levels “somewhat below” the central bank’s mandate to achieve stable prices and full employment.
The Fed statement boosted speculation the central bank will buy more Treasuries sometime later this year. Yields on U.S. 2- year notes fell to a record low of 0.407 percentage point Sept. 21 and were 0.440 percentage point in New York trading yesterday. The Standard & Poor’s 500 Index rose 2.1 percent to 1,148.67, a four-month high. Fed officials next meet Nov. 2-3.
“The purchases reduced interest rates directly by raising the prices of the assets that we purchased,” Bernanke said.
The economy expanded at a 1.6 percent annual rate in the second quarter, and is probably finishing the current quarter at a 1.4 percent annual rate, according to estimates by St. Louis forecasting firm Macroeconomic Advisers.
“We will continue to monitor this and to do our best to understand the determinants,” Bernanke said in response to a question about the pace of the recovery.
Sluggish growth has kept the unemployment rate above 9 percent for every month this year. Inflation, as measured by the personal consumption expenditures price index, minus food and energy, rose at a 1.4 percent rate in July.
“Although financial markets are for the most part functioning normally now, a concerted policy effort has so far not produced an economic recovery of sufficient vigor to significantly reduce the high level of unemployment,” Bernanke said in his speech.
New regulation should reduce the risk of future financial crises, he said, while calling for more research on asset price bubbles, market liquidity and decision-making during panics.
“Numerous steps, both prescribed in the legislation and taken independently by regulators, will work to make our financial system more resilient to shocks,” the Fed chairman said in the speech. Still, the rules “do not by any means guarantee that financial crises will not recur,” he said.
The Fed chief cited tougher capital and liquidity standards for financial institutions and rules that require more derivatives to “be standardized and traded on exchanges rather than over the counter.”
Bernanke said the financial crisis exposed gaps in economics, the regulation of financial institutions and in risk management inside banks and brokers. Tougher risk management standards by both regulators and firms, improved supervision, and more stringent standards for financial strength should “reduce the risk of crises and mitigate the effects of any that do happen,” he said.
Central bankers drew on 19th century lender-of-last-resort theory developed by Walter Bagehot to manage a non-traditional financial panic, he said. Instead of depositors fleeing banks, short-term creditors were fleeing financial institutions such as investment banks and non-bank mortgage lenders.
Invoking emergency authority, the Fed created programs such as the Commercial Paper Funding Facility to provide hundreds of billions in credit to companies and banks after the usual channels of lending and financing broke down.
“The excessive dependence of some financial firms on unstable short-term funding led to runs on key institutions, with highly adverse implications for the functioning of the system as a whole,” Bernanke said.
The Fed chairman blamed the runs on a regulatory structure that didn’t encompass lenders working outside the banking system or place enough emphasis “on the detection of systemic risks.”
Fed officials have revamped their approach to systemic risk, he said. Bernanke, 56, was chairman of Princeton’s economics department from 1996 to 2002.
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