Bernanke: Economy better, but ...

Fed chairman says the economy is showing signs of stabilization, but added that the housing and labor markets are still not recovering.

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By Chris Isidore, senior writer

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NEW YORK ( -- Federal Reserve Chairman Ben Bernanke told lawmakers Tuesday that the economy has started to show signs of stabilization, although he cautioned that improvement is uncertain and likely to be gradual going forward.

Bernanke also reiterated that the Fed will be able to keep inflation at bay by unwinding many of the various lending programs it has put in place to encourage banks to start lending again. But he declined to give a time frame for when the Fed might begin its so-called exit strategy.

The head of the central bank, appearing before the House Financial Services Committee in his semi-annual testimony on the state of the economy, forecast a relatively sluggish recovery.

Bernanke said the unemployment rate would be higher than preferred levels until at least 2012. But he added that steps taken by the Fed to pump money into the economy have started to pay benefits.

"The pace of decline appears to have slowed significantly, and final demand and production have shown tentative signs of stabilization," he said.

But at the same time he cautioned that even with improvements, "financial conditions remain stressed, and many households and businesses are finding credit difficult to obtain."

Bernanke repeated the Fed's recent forecast that the economy would grow in the second half of this year, and picking up steam over time. He said he expects employers to start adding jobs either later this year or early next year but said it would take time for labor markets to return to normal.

"I want to be clear we have a very long haul here," he said. "Unemployment will stay high for quite some time. It's not going to feel like a very strong economy."

But Bernanke stopped short of endorsing some proposals for Congress to pass an additional round of economic stimulus -- at least at this time.

"Less than a quarter of the first stimulus has been spent. It's early to make a judgment about that," he said about a second stimulus package.

The chairman's comments were somewhat more cautious than the central bank's economic forecast that was prepared for the June 24 meeting and released to the public last week.

San Diego State University finance professor Dan Seiver said part of the reason for caution is the desire of Fed policymakers to continue to pump credit and cash into the economy as long as possible. Talk of a strong recovery ahead would only raise pressure on Bernanke to lay out plans to raise rates and unwind its other programs.

"He doesn't want to tighten up until it's clear we're really out of the ditch,
Seiver said.

Some lawmakers questioned the steps taken by the Fed to try to fix the economy and argued that the economy had not yet taken a turn for the better for most Americans.

"So far there has been very little bang for the taxpayer's buck," said Rep. Spencer Bachus, R-Ala., the ranking Republican member of the House Financial Services Committee.

Rep. Melvin Watt, D-N.C., praised the Fed's steps in the last year, saying that it had been a "sturdy" hand. But he said that despite signs of improved economic activity, "unfortunately my constituents are not yet feeling it."

This is not an exit

Bernanke also said the Fed is confident it will be able to employ a smooth "exit strategy" to remove the programs that were put in place to help the economy, without causing a shock to the financial system or a spike in prices.

Many investors and economists have been looking for the Fed to spell out such an exit strategy in recent weeks.

Bernanke said that many of the programs will naturally wind down as the financial system settles down, since they are pumping money into the system at higher than normal market rates. He said slow growth and a weak labor market will also continue to keep inflation in check.

David Wyss, chief economist for Standard & Poor's, noted that the size of the Fed's balance sheet is more than double what it was a year ago. But he also pointed out that the balance sheet has shrunk about 8% from the peak levels in December, a sign that the Fed is quietly unwinding some of its programs.

"The Fed has allowed [the special programs] to run down as the market has returned closer to normal," said Wyss. "They haven't been buying as much long-term Treasurys as they announced they might. They haven't needed to. Yields came down anyway."

Partly due to inflation fears, the yield on the U.S. 10-year Treasury rose to about 4% last month as investors sold long-term bonds. Bond prices and yields move in opposite directions. But yields have since fallen to about 3.5%.

Seiver said that the Fed won't be able to quietly unwind its positions simply through market forces though. He thinks the central bank will have to get more aggressive in pulling credit and cash out of the market or risk feeding inflation pressures.

"There's still a lot of excess liquidity sitting out there. At some point the Fed will have to drain that," he said. "The problem will be that it will probably happen before the political powers think it's time for tightening, like next fall, right before the congressional election. If they start tightening then, there will be a lot of screaming."

Talkback: Do you think Ben Bernanke is doing a good job of managing the economic crisis? Share your comments below. To top of page

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