Ben Bernanke’s mission for his trip to Congress on Tuesday was to explain why the benefits of the Fed’s third, $85bn-a-month round of quantitative easing still outweigh its costs and risks.
The majority of an unusually combative performance was focused on those costs and risks of QE3. At one point he told Republican senator Bob Corker that “none of the things you said are accurate”.
But Mr Bernanke also needed to get across the benefits of continuing the Fed’s asset purchases in a economic environment that is still weak and uncertain.
The Fed chairman sounded a cautiously upbeat note on the economy, saying that it “continued to expand at a moderate if somewhat uneven pace”, and that “available information suggests that economic growth has picked up again this year”.
Risks to the economy have not gone away, however, and Mr Bernanke touched on three: petrol prices; turmoil in the eurozone; and automatic “sequester” cuts to government spending that will start on Friday.
All of these risks threaten the Fed’s projections for growth in 2013, which as of last December were an optimistic 3 per cent, well in advance of market forecasts.
In the last couple of months, US oil markets have given a reminder of their potential for economic mischief, as the price of West Texas Intermediate rose from $85 to nearly $100. In the last few days, it has fallen back to $92.
“The recent increase in gasoline prices – which reflects both higher crude oil prices and wider refining margins – is hitting family budgets,” said Mr Bernanke. That is a particular concern because the expiry of a payroll tax break at the start of the year is already squeezing what consumers have to spend.
Another risk is sequestration. When the Fed made its forecasts last December, it was assuming a compromise about the fiscal cliff – which it got. But like most other forecasters the Fed did not separately allow for sequestration – which imposes immediate, across-the-board spending cuts – to take place.
Mr Bernanke said that the Fed agreed with estimates that it would knock about 0.6 percentage points off growth this year if it were to take full effect. “Given the still-moderate underlying pace of economic growth, this additional near-term burden [upon] the recovery is significant,” he said.
The Fed chairman warned Congress that the scale of short-term cuts is what matters for the economy and it cannot escape damage by rejigging them. “I have no input there other than to say that I think the near-term effect on growth would probably not be substantially different if you did it that way,” Mr Bernanke said.
A third risk, which has popped up again like an unkillable horror-movie monster, is the eurozone. The hearing took place in the shadow of market turmoil after Italy’s inconclusive election. Senators wanted Mr Bernanke’s opinion.
The Fed chairman said that Europe posed a risk although mainly through the financial sector. “The market’s reacting first and foremost to uncertainty,” said Mr Bernanke. “It doesn’t know which way the Italian government’s going to go and how those policies will be affected.”
He said, hypothetically, that if concern were ever to arise about Italy’s ability to stay in the eurozone then there could be much broader effects on stocks and bonds worldwide. “Those effects would be more unpredictable and more concerning, probably, than the direct losses on exposures in terms of Italian debt holdings,” said Mr Bernanke.
The Fed has to weigh those risks against healthier signs from some parts of the economy. There was more good news from the housing sector on Tuesday with the S&P Case-Shiller price index up by 0.9 per cent on the previous month and the inventory of new homes relative to sales at its lowest level since April 2005.
But while the economy remains fragile, and Mr Bernanke is satisfied that the risks of QE3 are not too great, then he is likely to argue that the benefits of continued asset purchases outweigh the costs.
“Notably, keeping longer-term interest rates low has helped spark recovery in the housing market and [has] led to increased sales and production of automobiles and other durable goods,” he said.