U.S. "close to faltering," Fed ready to act: Bernanke (Reuters)

WASHINGTON (Reuters) – The Federal Reserve is prepared to take further steps to help an economy that is "close to faltering," Fed chairman Ben Bernanke said on Tuesday in his bleakest assessment yet of the fragile U.S. recovery.

Citing anemic employment, depressed confidence, and financial risks from Europe, Bernanke urged lawmakers not to cut spending too quickly in the short term even as they grapple with trimming the long-run budget deficit.

He made clear that the U.S. central bank's policy committee considers inflationary pressures well under control and given high unemployment, would be ready to ease monetary conditions further following the launch of a new stimulus measure in September.

"The Committee will continue to closely monitor economic developments and is prepared to take further action as appropriate to promote a stronger economic recovery in the context of price stability," Bernanke told the Joint Economic Committee of Congress.

His language was firmer than the policy-setting Federal Open Market Committee's statement less than two weeks ago, when the Fed said it would monitor the outlook and was "prepared to employ its tools as appropriate."

Since then, uncertainty about the outcome of the euro zone's sovereign debt crisis has undermined U.S. business and consumer confidence and helped to slow economic growth. The business cycle monitoring group ECRI last Friday said that the U.S. economy is tipping into a new recession.

Asked whether another round of bond purchases, known as quantitative easing, was in store, Bernanke was noncommittal.

"We never take anything off the table because we don't know where the economy is going to go. We have no immediate plans to do anything like that," he said.

The prospect of further Fed support for the economy lifted U.S. stocks though, after the market saw selling early in the day, pushing the S&P 500 briefly dipping into bear market territory.

Andrew Tilton, economist at Goldman Sachs, said contagion from the European crisis is a serious risk, threatening to tighten credit availability in the United States and weaken exports to the region. "This impact is likely to slow the U.S. economy to the edge of recession by early 2012," he said.

Recent U.S. economic data has been mixed after a dismal August, with a key manufacturing survey showing an unexpected improvement, but the slightly better tone has not been sufficient to dispel fears of another downturn.

Fresh clarity on the state of the economy will come on Friday, when the Labor Department releases monthly employment figures. Economists in a Reuters poll forecast a paltry gain of 60,000 jobs for September, and Bernanke in his testimony offered little hope for much improvement.

"Recent indicators, including new claims for unemployment insurance and surveys of hiring plans, point to the likelihood of more sluggish job growth in the period ahead," he told the Joint Economic Committee of Congress.

FISCAL WARNING

Bernanke said government belt-tightening was likely to prove a significant drag on the world's largest economy, which averaged less than 1.0 percent annualized growth in the first half of the year.

"An important objective is to avoid fiscal actions that could impede the ongoing economic recovery," he said,

Stressing that higher inflation earlier in the year had not become ingrained in the economy, Bernanke argued price pressures will remain subdued for the foreseeable future.

That backdrop made it easier for the Fed to launch its latest monetary easing effort in September, when it announced it would be selling $400 billion in short-term Treasuries and using the proceeds to buy longer-dated ones.

Bernanke estimated the new policy would lower long-term interest rates by about 0.20 percentage point which he said was roughly equivalent to a half percentage point reduction in the benchmark federal funds rate. Already 10-year Treasury note yields are at multi-year lows of 1.83 percent, helping keep mortgage and corporate borrowing costs extraordinarily cheap.

"We think this is a meaningful but not an enormous support to the economy. I think it provides some additional monetary accommodation, it should help somewhat on job creation and growth. It's particularly important now the economy is close -- the recovery is close -- to faltering," Bernanke said.

"We need to make sure that the recovery continues and doesn't drop back and the unemployment rate continues to fall downward."

INFLATION VS JOBS

Republican lawmakers pressed Bernanke on whether the Fed's dual mandate for full employment and price stability meant that it had to make compromises on inflation. On the 2012 presidential campaign trail, Republican candidate, Texas Governor Rick Perry earlier said it would be "treasonous" for the Fed to add further money to the economy.

Bernanke was categorical in defending the Fed's record of price stability in recent decades. He noted inflation has averaged 2.0 percent during his tenure and blamed regulatory failures, not excessively low rates, for the financial crisis.

Some economists believe the central bank could announce more concrete targets for policy goals, by linking the path of rates directly to unemployment and or inflation.

In response to the financial crisis and recession of 2008-2009, the Fed slashed interest rates to effectively zero and more than tripled the size of its balance sheet to a record $2.9 trillion, buying bonds off banks balance sheets. Bernanke said this was not bailing out Wall Street, but was part of its mandate to provide price and financial stability.

View the original article here

Bernanke puzzled by weak consumer spending (AP)

WASHINGTON – Federal Reserve Chairman Ben Bernanke said he's surprised by how cautious consumers have been in the two years since the recession officially ended. But the Fed chief offered no hints of any steps the Fed would take to boost the weak economy.

Bernanke said Thursday that a number of factors are keeping consumers from spending more, including high unemployment, a temporary spike in energy prices, falling home prices and high debt burdens.

"Even taking into account the many financial pressures they face, households seem exceptionally cautious," Bernanke said, according to a transcript of a speech his is giving in Minneapolis.

Bernanke acknowledged that prices for gas, cars and other consumer goods have risen sharply this year. But he said the increases were partly because of temporary factors, such as supply chain disruptions stemming from the Japan crisis. He said he expects inflation will moderate in the coming months as those factors ease.

The Fed will consider range of policy options at its next meeting later this month. Bernanke said. But he offered no clues as to what it might do. His comments were familiar to ones he made last month during a speech in Jackson Hole, Wyo.

Some economists say the Fed must take further action to help the economy avoid another recession.

The economy barely grew in the first half of the year, and the government said last week that employers stopped adding jobs in August.

Consumers and businesses are feeling less confident after a rocky summer. Lawmakers fought over raising the federal borrowing limit, Standard & Poor's downgraded long-term U.S. debt, and stocks have fluctuated wildly after plunging in late-July and early August.

On Aug. 9, the Federal Reserve said it planned to keep interest rates very low until at least mid-2013, assuming the economy remained weak. Minutes from that meeting showed some Fed officials had pushed for more aggressive steps.

One possibility is for the Fed to increase the percentage of long-term Treasury securities in the central bank's mix of holdings. That approach would have the advantage of exerting downward pressure on long-term interest rates without adding to the Fed's already record-level of securities holdings.

Still, three regional bank presidents dissented from the Aug. 9 decision. They had expressed concerns that the Fed's policies were contributing to higher inflation.

The worsening jobs outlook has also put pressure on President Barack Obama. He is expected on Thursday to introduce a $300 billion jobs package before a joint session of Congress. The plan will likely include extensions of the payroll tax cut and long-term unemployment benefits, tax incentives for businesses that hire and money for public works projects.

But the effort faces strong opposition from congressional Republicans, who say that Obama's previous stimulus program was a failure. They want deeper spending cuts to fight the government's soaring budget deficits.

View the original article here

Poker-faced Bernanke buys more time for Fed options (Reuters)

JACKSON HOLE, Wyoming (Reuters) – Like a skilled poker player, Federal Reserve Chairman Ben Bernanke kept some cards close to his vest when facing fellow central bankers in cowboy country.

In doing so, he may have bought himself time to play the strongest hand possible when he is ready.

Bernanke's speech on Friday at an annual Fed conference here came at a time of alarm about a fading U.S. economic recovery and concern about the health of Europe's banks.

Many were looking for a clear signal the central bank is ready to step in with further monetary policy stimulus after Bernanke led the Fed into taking massive stimulus measures over the last few years.

He acknowledged slower-than-hoped-for growth in the world's largest economy and warned that high long-term unemployment could leave lasting scars.

Although he said the Fed would consider what more it could do to boost growth -- comments that helped push up U.S. share prices -- he stopped short of outlining new moves, unlike his Jackson Hole speech last year that was seen as opening the door to a second round of massive bond buying.

"Not much detail," was the curt analysis of Bernanke's speech by a prominent analyst at the exclusive retreat, which brings together an international elite of policymakers, economic thinkers and well-connected financial gurus.

CAREFUL GOING

The Fed is caught between a flagging recovery and persistently high unemployment on one side, and political pressures against more monetary easing on the other. It has already pushed interest rates close to zero and bought $2.3 trillion in bonds to try to lower longer-term borrowing costs.

The Fed is also split internally about what to do next, adding to the challenge faced by Bernanke.

Participants at the conference gave the chairman -- who looked relaxed in faded jeans and a polo shirt -- high marks for deftly maneuvering the fine line between offering hope of monetary relief without overcommitting the central bank.

"The Fed is going to continue to tread slowly," said Barry Eichengreen, an economics professor at the University of California at Berkeley.

The most tantalizing tidbit Bernanke provided was that the Fed's next policy meeting will run for two days instead of one on September 20-21.

A two-day meeting will allow Fed staff to present studies of possible courses of action and will let each of the 17 members of the policy-setting Federal Open Market Committee air views on policy and where the economy is heading.

The expansion of the meeting underscores the degree to which Bernanke is worried about high unemployment, weak manufacturing data, stock market volatility and strains at European banks.

It also suggests he may see a need to line up support for more action at the Fed, where three policymakers dissented against an early-August decision to let financial markets know the central bank expects to hold interest rates at ultra-low levels through the middle of 2013.

The opportunity for a fuller discussion suggests Bernanke is inclined to loosen monetary policy further but wants more data, such as the August jobs report due on Friday, to buttress his case.

One idea that is clearly on the agenda is more bond buying matched by a draining of bank reserves to keep the size of the Fed's already bloated balance sheet in check.

This could help pressure longer-term interest rates lower without fueling fears in financial markets the Fed's massive balance sheet might eventually fuel inflation.

HEARTS AND MINDS

By emphasizing the process rather than tools, Bernanke may have been seeking to smooth over the rift exposed by the three who cast "no" votes at the central bank's last policy meeting.

Attendees at the conference here said the risk of future dissents would not deter Bernanke from acting, but that the Fed chairman would seek as much support as possible.

"Anything the Fed does will be more effective in terms of calming the markets and restoring confidence if they are unanimous when they do it," Eichengreen, a panelist at one of the conference sessions, told Reuters Insider.

Detailed analysis by Fed staff economists on the possible benefits of further balance sheet measures may also help a core group of Fed policymakers close to Bernanke, that includes Vice Chair Janet Yellen and New York Fed President William Dudley, overcome skepticism about the effectiveness of new moves.

"They're done and they know it. They've got nothing left," scoffed an analyst attending the conference.

Despite the doubts, discussions on the sidelines of the event made clear some at the Fed believe there is evidence an effort to further flatten longer-term interest rates could help the economy.

One U.S. monetary policy insider was heartened by the recommendation by International Monetary Fund chief Christine Lagarde at the conference that central bankers dive back into unconventional measures to provide additional monetary help.

KUDOS FROM THE CROWD

Bernanke also got high marks for shifting some of the burden for restoring growth to governments and politicians, a theme also emphasized by Lagarde.

While addressing the importance of cutting deficits, politicians should also be sensitive to the fragile recovery and develop a less nerve-wracking process for making budget decisions than the showdown in Congress that brought the United States close to a debt default this summer, he said.

"To me the more interesting part of the chairman's remarks was the shot across the bow of the government saying, 'Don't keep layering expectations on the Federal Reserve guys, you have a job to do,'" Columbia University professor Glenn Hubbard told Reuters Insider.

Bernanke arrived in Wyoming several days early and told attendees he had gone to a rodeo with his family. He jokingly told the conference that seeing that slice of Americana had given him a lot to think about.

He may have decided a little bit of cowboy reticence would suit his Jackson Hole message.

(With additional reporting by Dan Burns and Ann Saphir; Editing by Maureen Bavdek)

View the original article here

Lawmakers snipe, Bernanke warns as deadline nears (AP)

By JIM KUHNHENN and NANCY BENAC, Associated Press Jim Kuhnhenn And Nancy Benac, Associated Press – 30?mins?ago

WASHINGTON – Fuming lawmakers pointed fingers at one another and President Barack Obama on Thursday as negotiations over raising the national debt limit entered a perilous endgame. Federal Reserve Chairman Ben Bernanke warned of economic damage, and an anxious Wall Street envisioned catastrophe if the U.S. defaulted on its obligations.

Obama and congressional leaders were meeting again late in the day at the White House. But the president's blunt declaration that "enough is enough" as the previous evening's talks ended did nothing to quell the rancor as a new day of positioning and posturing played out.

Senate Majority Leader Harry Reid stood on the Senate floor Thursday and sniped that House Majority Leader Eric Cantor shouldn't even be part of the talks anymore, noting that the Virginia Republican has been called "childish." Not long after, Senate Republican Leader Mitch McConnell stood to serve notice that the debt problem belonged squarely in Obama's lap.

"Republicans will not be reduced to being the tax collectors for the Obama economy," McConnell said. "Don't expect any more cover from Republicans on it than you got on health care. None."

Federal Reserve Chairman Ben Bernanke, testifying on Capitol Hill, warned legislators that failing to raise the debt limit in time to avoid default would only end up increasing the federal deficit, calling that a "self-inflicted" wound.

He said default would drive up interest costs on the $14.3 trillion debt and reduce government revenues by slowing economic growth.

None of the back-and-forth was a promising prelude to negotiations scheduled to resume at the White House, less than three weeks before an Aug. 2 deadline for increasing the government's borrowing authority. Thursday's talks were to focus on the touchy matters of how to cut spending on Medicare and Medicaid and raise more tax revenue.

Behind the scenes, meanwhile, legislators and White House officials continued to work on a backup plan offered by McConnell.

Obama is demanding that budget negotiators find common ground by week's end, as the financial world watches with growing jitters.

"No one can tell me with certainty that a U.S. default wouldn't cause catastrophe and wouldn't severely damage the U.S. or global economy," Jamie Dimon, CEO of JPMorgan Chase & Co., told reporters Thursday. "And it would be irresponsible to take that chance."

Already, Moody's Investors Service is reviewing the government's credit rating, saying there is a small but rising risk that it will default on its debt. If Moody's were to lower the rating, the consequences could ripple through the economy, pushing up rates for mortgages, car loans and other debts. A Chinese rating agency, Dagong Global Credit Rating Co., also warned of a possible downgrade.

Reid sketched the potential consequences of default in dire terms, saying Social Security checks, veterans' benefits and paychecks for troops would stop. "Millions of Americans could lose their jobs," he added.

A Reid spokesman later clarified that Social Security benefits "could" stop, as Obama previously had warned, but it wouldn't be a certainty.

Republicans have called such statements scare tactics.

In the cauldron of the White House Cabinet Room, Obama and top lawmakers bargained for nearly two hours late Wednesday. Obama curtly ended the session when Cantor, R-Va., urged him to accept a short, monthslong increase in debt instead of one that would last through next year's presidential election.

"Enough is enough. ... I'll see you all tomorrow," Obama said, rising from the negotiating table and leaving the room, according to several officials familiar with the session.

Reid said that while other Republican leaders were willing to negotiate in good faith, Cantor "has shown he shouldn't even be at the table."

The United States hit its current $14.3 trillion debt ceiling in May and the Obama administration says the government will default on its obligations if the debt limit is not increased by Aug. 2. For a new debt ceiling to last to the end of 2012 would require raising it by about $2.4 trillion.

Republicans, in control of the House of Representatives in part because of the support of tea party activists, say they will not vote to raise the limit if Obama doesn't agree to at least an equal amount of deficit reductions over 10 years.

Obama and the top eight House and Senate leaders met for the fourth time in as many days Wednesday, and, despite the tense ending, agreed to meet again Thursday.

A congressional aide said the White House discussed with lawmakers the possibility of moving talks this weekend to the presidential retreat at Camp David in Maryland. But a spokesman for House Speaker John Boehner said the Ohio Republican told the White House he saw no need for that. And Obama aides later said they planned to continue holding meetings at the White House for the next few days.

Despite McConnell's assertions that the debt problem belongs to Obama, fresh polling from Quinnipiac University suggested voters would be more apt to hold Republicans responsible than Obama, by 48 percent to 34 percent, if the debt limit is not raised. The same survey showed voters were about evenly split on whether they're more concerned about raising the limit and increasing government debt, or seeing the government go into default and damaging the economy.

"The American people aren't very happy about their leaders, but President Barack Obama is viewed as the best of the worst, especially when it comes to the economy," said Peter Brown, assistant director of Quinnipiac's Polling Institute.

That helps explain why McConnell put forward a plan that would give Obama new powers to overcome Republican opposition to raising the debt ceiling.

The proposal would place the burden on Obama to win debt ceiling increases up to three times, provided he was able to override congressional vetoes — a threshold Obama could manage to overcome even without a single Republican vote and without massive spending cuts. Conservatives promptly criticized the plan for giving up the leverage to reduce deficits. But the plan raised the prospect of combining it with some of the spending cuts already identified by the White House in order to win support from conservatives in the House.

In an interview with radio talk-show host Laura Ingraham, McConnell described his plan in stark political terms, warning fellow conservatives that failure to raise the debt limit would probably ensure Obama's re-election in 2012. He predicted that a default would allow Obama to argue that Republicans were making the economy worse.

"You know, it's an argument he has a good chance of winning, and all of a sudden we (Republicans) have co-ownership of a bad economy," McConnell said. "That's a very bad positioning going into an election."

Sen. Charles Schumer, D-N.Y., said that while the president and other Democrats would still prefer a larger agreement, McConnell's plan was an acceptable option — especially if some consensus spending cuts were added. He said McConnell and Reid were discussing the idea.

Democratic officials said that even as Obama confronted Cantor and Boehner in Wednesday's meeting, he commended McConnell.

"Sen. McConnell at least has put forth a proposal," a Democratic official quoted the president as saying. "It doesn't reduce the deficit and that's what we have to do. It just deals with the debt limit. Now Sen. McConnell wants me to wear the jacket for that."

The officials said Obama went on to say they all had a responsibility to find a compromise.

____

Associated Press writers Dave Espo, Laurie Kellman, Ben Feller, Julie Pace, Martin Crutsinger and Erica Werner in Washington and Pallavi Gogoi in New York contributed to this report.

View the original article here

Bernanke: Default on debt would increase deficit (AP)

WASHINGTON – Federal Reserve Chairman Ben Bernanke warned U.S. lawmakers Thursday that they would deliver a "self-inflicted" wound to the nation's economy by holding up efforts to raise the government's borrowing limit.

Republicans have held up increasing the borrowing limit because of concerns of growing spending that has widened the federal deficits.

Bernanke told a Senate panel that a default on the debt would lead to even greater federal deficits. Interest rates would rise, and the government would be forced to pay higher rates on its debt. At the same time, higher rates would slow the economy and an already-weak job market. That would curtail tax revenue.

The government hit its $14.3 trillion borrowing limit in May. The Treasury Department said it will default on its debt if the limit is not raised by Aug. 2.

"I think it would be a calamitous outcome. It would create a severe financial shock," Bernanke told the Senate Banking Committee during his second appearance before Congress this week. "Treasury securities are critical to the entire financial system ... A default on those securities would throw the financial system potentially into chaos."

Bernanke was on Capitol Hill to deliver his semiannual economic report. But his second day of testimony was dominated by questions over borrowing limit impasse.

Republicans are demanding that any increase be accompanied by an equal amount of spending cuts. President Barack Obama and Democrats have insisted that tax increases be a part of any long term deficit-cutting deal, something Republicans have rejected.

On Wednesday, Moody's Investors Service said it will consider lowering the United States' credit rating because of a small but rising risk that the government will default on its debt.

A downgrade would raise interest rates on U.S. treasury bonds, increasing the interest paid by U.S. taxpayers. It would also push up rates for mortgages, car loans and other debts, which are linked to Treasury rates.

The United States pays an average of about 3 percent on its existing debt, according to the Treasury Department. In 2010, that added up to $197 billion in interest payments.

The nonpartisan Congressional Budget Office has forecast that interest payments will rise to $463 billion by 2014. That is under an assumption that the U.S. keeps its top credit rating. A reduced rating would force the government to pay higher interest rates.

The impact of a default would also destabilize U.S. and global financial markets, Bernanke said, which would weaken economic growth

View the original article here

Bernanke: Cutting too much too soon could hurt U.S. (Reuters)

By Mark Felsenthal and Pedro Nicolaci da Costa Mark Felsenthal And Pedro Nicolaci Da Costa – 26?mins?ago

WASHINGTON (Reuters) – U.S. Federal Reserve Chairman Ben Bernanke warned Congress on Thursday that overzealous cuts to government spending in the short term could derail an already fragile recovery and said a U.S. debt default may wreak financial havoc.

"I only ask ... as Congress looks at the timing and composition of its changes to the budget, that it does take into account that in the very near term the recovery is still rather fragile, and that sharp and excessive cuts in the very short term would be potentially damaging to that recovery," Bernanke told members of the Senate Banking Committee.

Congress and the White House are stalemated in talks on cutting the budget deficit, with Republicans seeking $2.4 trillion in spending cuts in exchange for agreeing to raise the $14.3 U.S. government borrowing limit. The U.S. Treasury has said it will run out of money after August 2 to pay all of the country's bills if the a deal is not reached to raise the debt ceiling.

On the second day of delivering the Fed's semiannual monetary policy report to Congress, Bernanke renewed his warning that a United States debt default would be devastating for the U.S. and global economies.

"It would be a calamitous outcome," Bernanke said. "It would create a very severe financial shock that would have effects not only on the U.S. economy, but the global economy."

Failure to raise the debt limit in time would constitute a "self-inflicted wound" to the economy, he added.

NEW DOWNGRADE THREATS

Moody's Investors Service warned late on Wednesday that the U.S. could lose its top credit rating in coming weeks if a standoff between the White House and congressional Republicans over raising the statutory borrowing limit is not resolved.

Earlier on Thursday, China -- the United States' biggest foreign creditor -- urged the U.S. government to adopt responsible policies to protect investors' interests after the Moody's warning.

Another ratings agency, Standard & Poor's, also privately told U.S. lawmakers and business groups that it might still cut the U.S.'s rating if the government fails to make any of its expected payments -- on debt or other obligations -- a congressional aide said on Thursday.

In comments that mirrored his remarks on Wednesday, Bernanke repeated that the Fed is prepared to act if the modest recovery from the recession that ended two years ago falters.

He also made clear, however, the Fed is not at that point now. For one thing, inflation is higher than in late 2010, when the Fed readied its most recent round of bond buying, he told lawmakers in response to questions.

"Today the situation is more complex," Bernanke said. "We're not prepared at this point to take further action."

On Wall Street, stocks fell as Bernanke's comments raised questions about the Fed's readiness to ease rates further. The dollar rose against most major currencies as another round of monetary stimulus looked remote.

Economic reports released on Thursday suggested the economy will struggle to regain speed in the second half of the year, as the Fed has forecast. The number of Americans claiming initial unemployment benefits dropped last week, but remained elevated and retail sales barely rose in June, government data showed.

Also last month's producer prices posted their steepest decline since February 2010 as energy prices eased.

While Fed policymakers have been worried about rising inflation, the risk of a damaging deflationary spiral could force the central bank to act to promote growth.

Economists polled by Reuters cut their outlook for U.S. growth to 2.5 percent this year. That forecast put the United States ahead of major European economies except Germany, but behind some major emerging markets including China.

Although Bernanke told Congress said the Fed's $600 billion bond buying program has been effective in lowering long-term interest rates and coaxing investors to take greater risks, it has been controversial, and several lawmakers questioned it on Thursday.

"I believe the stage is set for a resurgence of inflation if the Fed is not careful," Senator Richard Shelby told Bernanke at the hearing.

View the original article here

Bernanke: U.S. will keep paying bondholders after August 2 (Reuters)

WASHINGTON (Reuters) – Federal Reserve Chairman Ben Bernanke on Wednesday said the United States would keep paying interest on government debt if Congress failed to reach a deal to lift the debt ceiling by August 2.

The central banker's comments offered the first public indication of how the Obama administration would prioritize its financial obligations after August 2, when the U.S. Treasury says the government would run out of money to pay all its bills.

"The assumption is that as long as possible, the Treasury would want to try to make payments on the principal and interest to the government debt, because failure to do that would certainly throw the financial system into enormous disarray and have major impacts on the global economy," Bernanke said.

Bernanke's testimony on Capitol Hill came as President Barack Obama and congressional leaders prepared for a fourth straight day of talks aimed at breaking a logjam over taxes and spending cuts. Talks have hit an impasse with lawmakers from both sides blaming each other for failure to compromise and reach a deal.

Treasury Secretary Timothy Geithner has warned of a catastrophic impact in the global financial system if the $14.3 trillion U.S. debt system is not raised in time.

Bernanke confirmed for the first time that the Obama administration is making contingency plans in case the debt talks fail to produce a deal. He said its top priority was to ensure that holders of U.S. bonds were paid on time.

However, prioritizing the debt would mean ordinary Americans would suffer.

"As a matter of arithmetic, fairly soon after that date there would have to be significant cuts in Social Security, Medicare, military pay or some combination of those in order to avoid borrowing more money," Bernanke said, focusing on areas that could affect key voting blocs ahead of 2012 elections.

"If, in fact, we ended up defaulting up the debt -- or even if we didn't ... it's possible that simply defaulting on our obligations to our citizens might be enough to create a downgrade in credit ratings and higher interest rates for us, which would be counterproductive of course because that makes the deficit worse," he said.

SAFEST SECURITY

Bernanke said if the United States defaults on its debt it would be a "major crisis" since the Treasury security is viewed as the safest and most liquid security in the world.

"It's the foundation for much of our financial system and the notion that it would become suddenly unreliable and illiquid would throw shockwaves through the entire global financial system."

Failure to seal a deal by August 2 could spook investors globally, causing U.S. interest rates to surge and stock prices to plummet, putting the United States at risk of another recession, Treasury officials and economists have warned.

Obama's Democrats and Republican lawmakers are sharply divided over tax and spending issues as they try to meet the August 2 deadline.

The president will host talks at the White House with Republican and Democratic leaders at 4 p.m. (2000 GMT) on Wednesday, the fourth meeting in as many days.

This week's talks have been marked by acrimony on both sides and a lack of progress.

Democrats, who say any deficit reduction plan should include a mix of spending cuts and tax increases, have accused Republicans of intransigence for refusing to consider revenue increases. Republicans contend that Democratic insistence on tax increases would put the economy at risk.

(Additional reporting by Donna Smith, Thomas Ferraro and Caren Bohan; Editing by Vicki Allen)

View the original article here

Bernanke "prepared to respond" if economy worsens (Reuters)

WASHINGTON (Reuters) – Federal Reserve Chairman Ben Bernanke said on Wednesday the central bank is ready to ease monetary policy further if the economy weakens and inflation moves lower, hinting policymakers are actively mulling further stimulus.

While holding to a view that recent economic softness would eventually pass, he appeared less confident in that projection -- and more willing to entertain the possibility of another round of stimulus.

"The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support," Bernanke told the U.S. House of Representatives Financial Services Committee.

Bernanke specifically noted Fed forecasts for June, which were already revised down significantly from April, had not incorporated recent data, particularly last Friday's dismal employment report. It showed job growth essentially ground to a halt in May and June, while jobless rate rose to 9.2 percent.

U.S. stocks, which have taken a drubbing over the last week on worries about Europe's debt troubles and on concerns about the U.S. economic outlook, rallied 1.2 percent, while Treasury bond prices and the dollar tumbled.

Asked whether the Fed would be willing to launch another bond purchase program if the economy slumps, Bernanke said: "We have to keep all the options on the table. We don't know where the economy is going to go."

Pressed on the budget, Bernanke reiterated his warning that a failure to raise the U.S. debt ceiling would deal a severe blow to the global economic recovery.

"Cutting programs or raising taxes in ways that will reduce aggregate demand ... is going to slow the economy," he said.

Minutes from the Fed's June meeting, released on Tuesday, showed some policymakers believe the Fed should stand ready to provide more support to the economy if the recovery flags, rekindling the threat of a debilitating downward spiral in prices and wages.

Others on the policy-setting Federal Open Market Committee, however, felt inflation risks might force the central bank to withdraw stimulus sooner than is currently anticipated.

DOOR OPEN TO QE3

Still, given the change in tune, some investors were betting the more dovish members of the committee would win the day in pushing for a third round of quantitative easing if the economy continues to deteriorate.

"My initial reaction was 'QE3 here we come'," said Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "We suspected the Fed would come up with some sort of QE3 in light of the disturbance surrounding the sovereign debt markets."

Bernanke did not go into great detail regarding Europe, but the Fed chief's outlook on U.S. growth prospects was understandably cautious.

After recovering from the steepest recession in generations beginning in the summer of 2009, the U.S. economy has lost momentum in recent months. Gross domestic product expanded just 1.9 percent in the first three months of the year, and the second quarter does not look to have been much better.

Bernanke held to the view that recent weakness was due in part to temporary factors like high energy costs and the effects on global industry from Japan's earthquake and tsunami.

But he acknowledged the labor market remains weaker than the Fed would like.

"The most recent data attest to the continuing weakness of the labor market," Bernanke said.

Bernanke defended the second round of bond buys against critics who said it had been ineffective.

He said the Fed estimates round two of quantitative easing, or QE2, lowered long-term interest rates by between 0.1 and 0.3 percentage point, which Bernanke said would be roughly equivalent to a 0.40 to 1.20 percentage point decline in the federal funds rate, which is currently set in a range between zero and 0.25 percent.

Regarding inflation, Bernanke reiterated the recent rise in prices was mostly linked to transitory factors such as higher energy and commodity prices, and should trend back down.

View the original article here