Bernanke: Economy not out of the woods yet

WASHINGTON (CNNMoney.com) -- Federal Reserve Chairman Ben Bernanke told a congressional panel Thursday that the economy still needs some help, but acknowledged the need to begin to tighten credit to prevent inflation at some point.

"The economy continues to require the support of accommodative monetary policies," Bernanke said Thursday. "However, we have been working to ensure that we have the tools to reverse, at the appropriate time, the currently very high degree of monetary stimulus."

In prepared testimony, Bernanke explained to the House Financial Services Committee how the Fed intends to roll back emergency liquidity programs. He repeated some points made last month in remarks the Fed released after his scheduled appearance was postponed due to a snowstorm.

Bernanke re-affirmed Thursday that the Federal Open Markets Committee expects conditions are "likely to warrant exceptionally low levels of the federal funds rate for an extended period."

He added that the Fed has tools to counter inflation "at the appropriate time," he said, although he didn't suggest when the appropriate time might be.

For the last 18 months, the Fed has bought mortgages, long-term Treasurys and the debt of mortgage finance firms Fannie Mae (FNM, Fortune 500) and Freddie Mac. (FRE, Fortune 500)

Bernanke laid out a plan to sell some of those mortgages, Treasurys and debt, by offering what's called reverse repurchasing agreements. Under those agreements, the Fed sells its securities to a third party while agreeing to rebuy them at some point in the future.

The second way the Fed plans to soak up money is to sell banks and financial firms the equivalent of certificates of deposit. In this case, the Fed gets a chunk of the bank's reserves in exchange for paying interest at a steady rate.

These deposits would be auctioned off and banks couldn't count their investment in the Fed as cash or reserves.

One such exit that the Fed has begun is unwinding certain credit programs, including the Fed's purchase of mortgage-backed securities, one of several credit markets that froze up at the start of the crisis.

Expressing concerns that the market for mortgage-backed securities won't return, several lawmakers asked Bernanke if ending such a program will lead to problems in the housing industry, including hikes in mortgage interest rates.

Bernanke acknowledged that "mortgage rates might pop back up," but that, so far, "there seems to be very little negative reaction."

"While that market has not completely returned to normal, we've seen considerable improvement," he said.