Bernanke Says Further Rate Cuts Are "Feasible" But Impact Would Be Limited

(RTTNews) - The head of the U.S. Federal Reserve admitted Monday that there was only so much the central bank can accomplish with further interest rate reductions, but he stressed that the Fed could still use other tools to help support the financial markets and stimulate the economy.

Speaking at an event hosted by the Greater Austin Chamber of Commerce in Austin, Texas, Fed Chairman Ben Bernanke said that further rate cuts from already low levels were "certainly feasible," but he warned that the impact from any additional rate cuts would be "limited."

Bernanke said that the financial markets are better off for the moves authorities have taken lately, but he noted that absolute stability would take some time. He also predicted that the economy would likely remain weak for some time.

"Regarding interest rate policy, although further reductions from the current federal funds rate target of 1 percent are certainly feasible, at this point the scope for using conventional interest rate policies to support the economy is obviously limited," Bernanke told the audience.

The Fed has been on an aggressive rate-cutting campaign since last year, taking the benchmark rate down to the 4-year low of 1 percent. While there are only so many more cuts that can take place from that level, Bernanke stressed that the central bank has other options.

"Although conventional interest rate policy is constrained by the fact that nominal interest rates cannot fall below zero, the second arrow in the Federal Reserve's quiver--the provision of liquidity--remains effective," Bernanke said, referring to facilities the Fed has in place to provide liquidity for the markets.

Discussing the other options the Fed has available, Bernanke stated that the central bank could buy longer-term bonds issued by the Treasury Department or mortgage giants Fannie Mae and Freddie Mac, which were taken over by the government earlier this year.

Bernanke said buying these securities in the open market "in substantial quantities" would influence their yields and "spur aggregate demand."

The Fed chief noted that last week it announced plans to buy up to $100 billion of Fannie and Freddie debt and $500 billion of their mortgage-backed securities over the next few quarters - a move Bernanke noted was met by a drop in mortgage rates.

Bernanke noted that it could also provide a liquidity backstop for certain financial markets, much as it has for the commercial paper market.

"Such programs are promising because they sidestep banks and primary dealers to provide liquidity directly to borrowers or investors in key credit markets," Bernanke said.

Bernanke agreed with critics who said that the government should generally stay out of markets and allow them to function on their own, but he argued that under times of great stress, it was up to authorities to step in and stabilize things.

"As a general matter, I agree that preserving market discipline is extremely important, and, accordingly, the government should intervene in markets only in exceptional circumstances," Bernanke said.

However, he added, "The failure of a major financial institution at a time when financial markets are already quite fragile poses too great a threat to financial and economic stability to be ignored."

Noting another criticism that has been targeted at the Fed lately, Bernanke admitted that the recent interventions have led to an extreme expansion of the central bank's balance sheet - a move that could lead to inflation problems down the road.

However, he suggested that this is a problem that the Fed will deal with later, after it has stabilized the economy and put the economy on the road to recovery.

"To avoid inflation in the long run and to allow short-term interest rates ultimately to return to normal levels, the Fed's balance sheet will eventually have to be brought back to a more sustainable level," Bernanke said. "The FOMC will ensure that that is done in a timely way. However, that is an issue for the future; for now, the goal of policy must be to support financial markets and the economy."

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