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Bernanke: Fed would supply more stimulus if needed

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WASHINGTON (AP) — Federal Reserve Chairman Ben Bernanke said

Wednesday that the central bank is prepared to provide additional

stimulus if the economic lull persists.

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Delivering his twice-a-year economic report to Congress, Bernanke

laid out three options the central bank would consider. One

possibility, he said, was another round of Treasury bond buying.

That would make the third such effort since 2009.

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The Fed chief’s reassurances helped drive stock prices higher, but

it also underscored the fragile state of the economy more than two

years after economists said the recession had ended. Unemployment

has risen for three straight months and a debt crisis in Greece and

other European countries threatens to weaken the global

economy.

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Bernanke warned U.S. lawmakers that their failure to raise the

nation’s borrowing limit by Aug. 2 could trigger a major financial

crisis. He said that if government defaults on its debt, it would

throw “shock waves through the entire financial system.”

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Bernanke said more stimulus would only be necessary if economic

conditions worsened and deflation re-emerged as a threat. Deflation

is a destabilizing period of falling prices.

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He also said the Fed was nimble enough to respond if the opposite

happened. He said the Fed was ready to raise interest rates that

have been held at record lows for nearly three years, should the

central bank fear a greater risk of inflation.

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“We have to keep all options on the table,” Bernanke told the House

Financial Services Committee on the first of two days of Capitol

Hill testimony. “If we get to the point where the recovery is

faltering” and inflation is dropping toward zero, then the central

bank would consider the additional stimulus options, he

said.

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The Dow Jones industrial average rose more than 93 points in

afternoon trading. Broader indexes also increased.

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In addition to purchasing Treasury bonds, Bernanke said the Fed

could help the economy by:

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– Cutting the interest paid to banks on the reserves they hold as a

way to encourage them to lend more.

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– Communicating in more explicit terms how long it planned to keep

rates at record-low levels. That would give investors confidence

about the Fed’s efforts to continue supporting the

economy.

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The Fed last month agreed to end on schedule its program to boost

the economy through the purchase of $600 billion in Treasury bonds.

But the central bank also acknowledged that the economy had slowed

in the first half of the year. As a result, it lowered its economic

growth forecast for 2011 and said unemployment wouldn’t fall below

8.6 percent this year.

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Since then, the government reported a second straight month of

dismal hiring in June. The economy added just 18,000 jobs last

month, the fewest in nine months. The unemployment rate rose to 9.2

percent – the highest rate this year.

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Companies pulled back sharply on hiring after adding an average of

215,000 jobs per month from February through April. The economy

typically needs to add 125,000 jobs per month just to keep up with

population growth. And at least twice that many jobs are needed to

bring down the unemployment rate.

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The Fed has said that temporary factors, such as high gas prices

and supply chain disruptions caused by the Japan crisis, are partly

to blame for the sluggish period.

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Bernanke told Congress that the Fed believes those impediments

should ease in the second half of the year. But if that forecast

proves wrong, he said the Fed is prepared to do more.

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“The possibility remains that the recent economic weakness may

prove more persistent than expected and that deflationary risks

might re-emerge, implying a need for additional policy support,”

Bernanke said.

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Economists noted that Bernanke was careful to balance the

possibility of further Fed stimulus with the possibility that

inflation could become a problem.

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Paul Ashworth, chief U.S. economist at Capital Economics, said the

Fed would likely hold off on further steps unless deflation emerges

as a threat again. Ashworth said any decision would not come until

next year.

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“The Fed wants to wait and see if the drop off in economic growth

was due to transitory factors and whether inflation drops back,”

Ashworth said.

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The Fed launched its last round of bond buying last when deflation

worries were increasing. The bond-buying program was the Fed’s

second round of “quantitative easing.” That’s a term economists use

for a tool the Fed can use to drive down long-term interest rates

by purchasing Treasury bonds.

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The topic of new stimulus was raised at the same June meeting in

which Fed policymakers agreed to end the last program. Some members

said the Fed should be open to additional measures if growth failed

to pick up enough to “meaningfully” reduce the unemployment rate,

according to minutes of the June 21-22 meeting.

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Others expressed concerns about inflation and said the central bank

would need to take steps to begin removing its low-interest rate

policies “sooner than currently anticipated.”

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The minutes highlighted a division at the Fed between officials who

are most worried that the economy is growing too slowly, including

Bernanke, and some regional bank presidents who are concerned that

the Fed’s policies could spark high inflation.

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Bernanke spoke to the minority’s concerns in his testimony. He said

that the central bank would be prepared to start raising interest

rates faster than currently contemplated, if prices don’t

moderate.

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The Fed has kept its key interest rate at a record low near zero

since December 2008. Most private economists believe the Fed will

not start raising interest rates until next summer. And some say

the Fed won’t increase rates until 2013, based on the slumping

economy.

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