The Federal Reserve chairman, Ben S. Bernanke, said Friday that the central bank was determined to prevent the economy from slipping into a cycle of falling prices, even as he emphasized that he believed growth would continue in the second half of the year, “albeit at a relatively modest pace.”

To help sustain the economy, Mr. Bernanke gave his strongest indication yet that the Fed was ready to resume its large purchases of longer-term debt if the economy worsened, a move that would add to the Fed’s already substantial holdings.

“We have come a long way, but there is still some way to travel,” Mr. Bernanke said.

“I believe that additional purchases of longer-term securities, should the F.O.M.C. choose to take them, would be effective in further easing financial conditions,” Mr. Bernanke told a Fed policy symposium here. He was referring to the Federal Open Market Committee, the panel that sets interest rates, which Mr. Bernanke leads; some members have expressed unease over the prospect of the Fed pursuing any further monetary accommodation.

“Central bankers alone cannot solve the world’s economic problems,” he said.

While Mr. Bernanke emphasized that deflation was “not a significant risk for the United States at this time,” he said “the F.O.M.C. will strongly resist deviations from price stability in the downward direction.”

It was his most robust statement to date that the Fed would do its part to avoid a Japanese-style deflation from taking hold.

And he said the “preconditions for a pickup of growth in 2011 appear to remain in place,” as banks increase lending, worries over the European sovereign debt crisis abate and consumers increase their savings.

“Stronger household finances, rising incomes, and some easing of credit conditions will provide the basis for more-rapid growth in household spending next year,” Mr. Bernanke said.

Indeed, the new report finding that the gross domestic product grew 1.6 percent in the second quarter nearly seemed to draw a collective sigh of relief from Mr. Bernanke and others gathered here — including the head of the European Central Bank, top officials from the International Monetary Fund and the World Bank, and most of the Fed’s top leaders.

The figure, which was revised down from 2.4 percent, came in higher than estimates by government and market economists.

Mr. Bernanke acknowledged that inflation had recently fallen “slightly below” the level that policy makers believe is consistent with a healthy economy. But he added, “At this juncture, the risk of either an undesirable rise in inflation or of significant further disinflation seems low.”

In his 19-page speech, Mr. Bernanke outlined his views of the economy and explained the Fed’s recent action to prevent monetary policy from tightening by reinvesting the proceeds from mortgage bonds in longer-term Treasury securities.

Strikingly, Mr. Bernanke acknowledged that the traditional trade-off between inflation and employment had become all but obsolete, at least for now.

“Consistent with our mandate, the Federal Reserve is committed to promoting growth in employment and reducing resource slack more generally,” Mr. Bernanke said. “Because a significant further weakening in the economic outlook would likely be associated with further disinflation, in the current environment there is little or no potential conflict between the goals of supporting growth and employment and of maintaining price stability.”

Mr. Bernanke outlined in detail four approaches the Fed might use to further ward off the threat of deflation.

First, he said, the Fed’s purchases of longer-term securities had helped bring down long-term interest rates and lower the cost of borrowing, contributing to the economic stabilization and recovery that began in the spring of 2009.

However, such purchases seemed to be most effective in time of financial stress, he said. It was an oblique acknowledgment that the Fed might have to purchase trillions of dollars’ worth of additional assets if it decides that additional quantitative easing — the strategy of buying financial assets to put downward pressure on long-term interest rates — is needed.

Second, Mr. Bernanke opened the door to lowering inflation expectations beyond its current stances that “exceptionally low” short-term rates would be warranted for “an extended period.”

In Canada, the central bank committed to keeping a low policy rate until a specific time; in Japan, the central bank promised to keep low rates until consumer prices stabilized or rose. Mr. Bernanke said that in the United States, it might be “difficult to convey the committee’s policy intentions with sufficient precision and conditionality.”

Third, the Fed could lower the rate it pays on excess reserves — the $1 trillion that banks have been keeping at the Fed. But Mr. Bernanke said that cutting the rate even to zero would be unlikely to lower the federal funds rate — the benchmark short-term rate — by more than 0.10 to 0.15 percentage points. And doing so risked making short-term money markets “much less liquid.”

Fourth, Mr. Bernanke discussed a controversial proposal, advanced by some economists, for the Fed to set a medium-term inflation target “above levels consistent with price stability.” But he dismissed that strategy as “inappropriate for the United States in current circumstances.”

Inflation would likely be higher and more volatile under such a policy, he said, while inflation expectations would become less stable.

Mr. Bernanke acknowledged that the recovery had “slowed somewhat in recent months” because consumer spending had grown at a slower pace than expected and because of continuing weakness in housing and nonresidential construction.

“Despite this recent slowing, however, it is reasonable to expect some pickup in growth in 2011 and in subsequent years,” Mr. Bernanke said, while cautioning that “the economy remains vulnerable to unexpected developments.”

By SEWELL CHAN

Tags: ben bernanke, borrowers, central bank, economists, european central bank, Federal Reserve, IMF, interest rates

This entry was posted on Friday, August 27th, 2010 at 11:36 am and is filed under Global Economy, Global Financial, Market Finance, US Finance. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.