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Fed Chairman Delivers Semi-Annual Testimony and Monetary Policy Report to Congress15 Jul 08In his semi-annual testimony to Congress on July 15, Fed chairman Bernanke indicated that the Fed is caught in a quandary, as downside risks to growth are balanced by upside risks to inflation. However, uncertainty about the outlook is a major threat to the financial sector, and recent instability in the U.S. financial system indicates that the Fed needs to take a more proactive approach. Chairman Bernanke told Congress that the Federal Reserve's job has become extremely difficult, given the greater uncertainties about the outlooks for both GDP growth and inflation. With respect to the revised FOMC economic outlook, the Fed did revise up 2008 growth in light of a relatively strong first half. However, the outlook for 2009 growth remains unchanged, and the central tendency range has an unusually wide band of 2.0–2.8%. Indeed, the chairman stated emphatically that higher energy prices, tighter credit conditions, and a deeper contraction in housing markets all represent significant downside risks to growth. It is worthy of note that the Fed's growth outlook is considerably more optimistic than Global Insight’s. We are forecasting GDP growth of just under 1.0% in 2008 and near 2.0% in 2009. Our forecasts sit at the bottom of the Fed's central tendency range. With respect to inflation, in view of severe upward pressure on crude oil prices, it is no surprise that the Fed has raised its top-line inflation forecasts for 2008 and 2009. Bernanke reiterated that upside risks to the inflation outlook have intensified lately. The main concern is that inflationary impulses from commodity prices become embedded in the domestic wage and price setting process. On the subject of financial stability, the chairman indicated support for the Treasury plan to stabilize Fannie Mae and Freddie Mac. The Board of Governors unanimously approved the extension of the Fed's discount window facility to Fannie Mae and Freddie Mac over the weekend. That is a very effective and elegant solution to their short-term liquidity problems, and recent debt-funding events for Freddie and Fannie have reportedly gone smoothly. Nevertheless, Bernanke admitted that many financial markets and institutions remain under considerable stress due to significant uncertainties about the outlooks for the economy and credit quality. While the chairman’s testimony adequately addressed the major issues that the Federal Reserve is grappling with, we get the impression that the Fed is once again underestimating the systemic risk to the financial system, and the economy, from the recent escalation of pressures on financial market and major financial intermediaries. Pressures on financial stocks and the financial markets continue unabated, and negative contagion has spread not only through the U.S. financial system, but also into global financial markets. We have moved into the early phases of a full-blown financial crisis, and the currents are moving swiftly. Bernanke and the Fed need to step up to the plate and fight this menace proactively with all of the resources at their disposal. by Brian Bethune
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