NEW YORK CITY-Although the economy has been buffeted by headwinds that have hindered “what otherwise might have been a stronger cyclical rebound,” Federal Reserve chairman Ben Bernanke sees a couple of reasons to expect faster GDP growth in the future. “First, the effects of the crisis on potential output should fade as the economy continues to heal,” Bernanke said in a speech Tuesday at the New York Economic Club here. “And second, if the headwinds begin to dissipate, as I expect, growth should pick up further as many who are currently unemployed or out of the labor force find work.”
Those headwinds, though, are blowing in from all corners of the US as well as from Europe, and range from the slow recovery in housing to a financial sector that’s still on the mend. “Banks’ capital positions and overall asset quality have improved substantially over the past several years, and, over time, these balance sheet improvements will position banks to extend considerably more credit to bank-dependent borrowers,” Bernanke said in prepared remarks. “Indeed, some types of bank credit, such as commercial and industrial loans, have expanded notably in recent quarters.” Nonetheless, he continued, “banks have been conservative in extending loans to many consumers and some businesses,” a caution he said stems from lenders’ “continued desire to guard against the risks of further economic weakness.”
The still-volatile fiscal and financial situation in Europe only adds to the risks “that US financial institutions, businesses, and households must consider when making lending and investment decisions,” said Bernanke. He noted that European policymakers have taken “some important steps recently,” but added that further improvement in global financial conditions will depend partly on how the policymakers follow through on these initiatives.
Then there’s the so-called fiscal cliff, against which Congress and the Obama administration will need to protect the economy, Bernanke said. “The realization of all of the automatic tax increases and spending cuts that make up the fiscal cliff, absent offsetting changes, would pose a substantial threat to the recovery,” he said. Bernanke warned that failure to reach a timely agreement on raising the debt ceiling could mean “even heavier economic and financial costs” than in the summer of 2011. He said “delay and discord” on these issues could further aggravate business and consumer uncertainty.
Although it’s still to early to gauge the effects of QE3, Bernanke said, “yields on corporate bonds and agency MBS have fallen significantly” since the Federal Open Market Committee’s announcement in September that it would implement another round of quantitative easing. “More generally, research suggests that our previous asset purchases have eased overall financial conditions and provided meaningful support to the economic recovery in recent years.”
He reiterated that keeping the federal funds rate at “exceptionally low levels” likely will be called for at least through the middle of 2015. However, Bernanke added, “we are not saying that we expect the economy to remain weak until mid-2015.” Instead, he said, the FOMC expects that “a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens. In other words, we will want to be sure that the recovery is established before we begin to normalize policy.”