Federal Reserve Chairman Ben Bernanke warned Tuesday that the financial crisis has not only darkened the country's current economic performance but also could prolong the pain.
The Fed chief's more gloomy assessment appeared to open the door wider to an interest rate cut on or before Oct. 28-29, the central bank's next meeting, to brace the wobbly economy.
Bernanke said the Fed will "need to consider" whether its current stance of holding rates steady "remains appropriate" given the fallout from the worst financial crisis in decades.
If the Fed does lower its key rate from 2 percent it would mark an about-face. The Fed in June had halted an aggressive rate-cutting campaign to revive the economy out of fear those low rates would aggravate inflation. Since then, financial and economic conditions have deteriorated, while record-high energy prices have calmed, giving the Fed more leeway to again cut rates.
Many believe the country is on the brink of, or already in, its first recession since 2001.
"The outlook for economic growth has worsened," Bernanke said told the annual meeting here of the National Association for Business Economics.
All told, economic activity is likely to be "subdued" during the remainder of this year and into next year, Bernanke said. "The heightened financial turmoil that we have experienced of late may well lengthen the period of weak economic performance and further increase the risks to growth," he warned.
Consumers — major shapers of economic activity — have buckled under the weight of rising joblessness, shrinking paychecks, hard-to-get credit, declining net wealth and tanking home and stock values. All the strains are "now showing through more clearly to consumer spending," Bernanke said.
Inflation numbers are "very ugly right now," Bernanke acknowledged. Even so, he believed slowing growth in the United States and overseas will continue to damp prices for energy, food and other commodities, meaning a better inflation outlook ahead. Inflation will moderate "pretty significantly" over the next few quarters, he predicted.
Meanwhile, worsening sales prospects and a heightened sense of uncertainty have begun to weigh more heavily on businesses, making them more cautious to hire and to invest in their companies, he said.
Employers cut jobs in September at the fastest pace in more than five years, the government reported last week. Payrolls were slashed by 159,000 last month alone. It was the ninth straight month of job losses. A staggering 760,000 jobs have disappeared so far this year.
The financial and credit crises, which took a turn for the worst in September and continue to stubbornly persist, are likely to "increase the restraint on economic activity in the period ahead," Bernanke said.
Even households with good credit histories are now facing difficulties obtaining mortgages or home equity lines of credit, he noted. Banks are also reducing credit card limits and denial rates on auto loan applications are rising, he said.
Banks, too, are feeling the strain of a lockup in lending, particularly in the market for commercial paper.
To that end, the Fed on Tuesday announced a radical plan to buy massive amounts of this short-term debt in an effort to break through a credit clog that is imperiling the economy.
"The expansion of Federal Reserve lending is helping financial firms cope with reduced access to their usual sources of funding," Bernanke explained.
Invoking Depression-era emergency powers, the Fed will begin buying commercial paper — short-term funding that many companies rely on to pay their workers and buy supplies.
Bernanke believed the Fed's bold actions — along with the $700 billion financial bailout signed into law by President Bush on Friday — will help restore confidence in financial markets and help them function more normally.
"These are momentous steps, but they are being taken to address a problem of historic dimensions," he said.
He also defended the timing of the actions by the Fed and the Bush administration. "We have learned from historical experience with severe financial crises that if government intervention comes only at a point at which many or most financial institutions are insolvent or nearly so, the costs of restoring the system are greatly increased. This is not the situation we face today," he said.
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