Bernanke: Fed Wrestles With Size Of Aid Program

In town Friday morning, Federal Reserve Chairman Ben Bernanke said the central bank is prepared to take further steps to rejuvenate the economy by buying Treasury bonds but is wrestling with how big the program should be.

Bernanke also indicated that Fed policymakers are trying to craft a plan to lift inflation from super-low levels. He made his remarks in a speech delivered to a Fed conference here.

The conference is focused on monetary policy in a low-inflation environment. The Fed has basically run out of room to lower short-term interest rates — the main way it encourages business and consumer spending. So Bernanke’s speech outlined advantages and disadvantages of different strategies to stimulate the economy with other, less-well-understood tools.

Bernanke said the Fed must weigh the risks of a Treasury-buying program and determine how the debt purchases would be paced. The Fed's bond purchases would be intended to lower long-term interest rates to stimulate buying and spending and help lower unemployment.

"There would appear - all else being equal - to be a case for further action," Bernanke said.

The Fed tried doing this recently. “Empirical evidence suggests that our previous program of securities purchases was successful in bringing down longer-term interest rates, and thereby supporting the economic recovery,” he said.

Bernanke highlighted the risks of such a move that would leave its balance sheet “considerably larger than normal.” He said investors may not be confident in the Fed’s exit strategy.

“To address such concerns, and to ensure that it can withdrawal monetary accommodation smoothly and at the appropriate time, the Federal Reserve has developed an array of new tools,” Bernanke said.

Fed policymakers would have to decide on a Treasury buying program at their next meeting Nov. 2-3. Bernanke’s highly-anticipated remarks indicate that the program is very likely.

World stocks rose after Bernanke's remarks. But the prospect of more dollars swirling around the financial system did nothing to help the dollar itself, which slid further after the Fed chief spoke.

The economy is growing at a pace "less vigorous than we would like," Bernanke acknowledged.

Unemployment, now at 9.6 percent, has been stuck near double digits for more than a year. Bernanke indicated that the Fed is concerned that economic growth is likely to remain lackluster and that unemployment will decline only slowly next year. High unemployment is likely to keep consumers cautious in their spending.

“More broadly, prolonged high unemployment would pose a risk to consumer spending and hence to the sustainability of the recovery,” Bernanke said.

During the recession, the Fed launched a $1.7 trillion program, buying a mix of mortgage securities and government debt. The effort was credited with forcing down mortgages rates and providing support to the weakened housing market. The new program is likely to be smaller. One Fed official has suggested a $500 billion program, while another has suggested it be $100 billion or less.

The Fed is again resorting to such unconventional methods - called quantitative easing - to stimulate the economy because it has already sliced its key interest rate to a record low near zero. The anticipated second round is being dubbed quantitative easing two.

"Bernanke gives green light for QEII," TJ Marta, a market strategist at Marta on the Markets, said after Bernanke's speech.

For now, the Fed is more interested in seeing prices rise- rather than fall.

Because the economy is weak, "the risk of deflation is higher than desirable," Bernanke said. Deflation is a widespread drop in prices, wages and the values of stocks and homes.

As Bernanke was speaking, the government issued a report that pointed to why a new Treasury-buying program may be necessary to ward off deflation. Consumer prices excluding the volatile categories of food and energy were flat or a second straight month.

A prolonged drop in prices for goods, for wages and in the values of homes and stocks is dangerous for the economy and Americans' pocketbooks. It makes paying on debt much harder, causing more people to fall into foreclosures, default on credit card bills and companies to slide into bankruptcy.

Bernanke's comments come as the Fed is weighing steps to try to raise people's expectations of where they think inflation is heading in the months ahead.

If the Fed were to communicate that it will tolerate a higher-than-normal rate of inflation, that could make companies feel more inclined to nudge up their prices. Shoppers, thinking prices would be rising even further in the future, would be more inclined to make purchases sooner. That would lift inflation from worrisome low levels.

Such a move would push "real" or inflation-adjusted interest rates, down, which could spur more spending. Fed officials at the September meeting noted that it has ways to try to influence people's expectations of inflation. One way was to include information in the minutes of the Fed meetings to try to shape people's expectations about inflation.

Addressing the nation's high unemployment, Bernanke believed much of that problem was due to the sharp contraction in business activity that occurred in the wake of the financial crisis and a lack of customer demand since then.

Some economists have argued that unemployment is high because of two primary factors. Workers face difficulties moving to new cities where jobs may be available, mostly because they worry about being able to sell their homes in depressed housing markets. They also note a mismatch between the skills workers have and the ones companies want.

WBUR's Curt Nickisch contributed to this report.