Fed Chairman Bernanke Testifies to the Joint Economic Committee on the Economic Outlook

He went on to review the economic situation, making clear that even with a rescue package, the immediate outlook is bleak. The increasingly restricted availability of credit is hurting the broader economy.

He formally reiterated the Fed's (neutral) stance that both the downside risks to growth and the upside risks to inflation are of "significant concern." However, it is hard to draw the same conclusion from his detailed comments. He gave a long list of reasons to be worried about the growth outlook, while his comments on inflation showed less concern.

On the growth front:

• Consumer spending has slowed and will be "sluggish, at best" in the near term.
• Recent evidence hints at some stabilization of home sales, but there remain large backlogs of unsold homes and house prices are still falling.
• Business investment spending has held up well, but a "considerable" slowdown in commercial and office construction is likely in coming quarters. Equipment and software outlays are also likely to slow with the broader economy.
• Exports have been a huge support, but the outlook for foreign growth has weakened and foreign trade will not make as big a contribution to growth in future.
• Real GDP is likely to grow "appreciably below its potential rate" in the second half of the year and then gradually pick up as financial markets and housing stabilize.

On the inflation front:

• Recent news has been more favorable, as oil and other commodities are off their peaks and the dollar is off its lows. Inflation expectations have eased.
• Add the weak growth outlook, and the result is that inflation should moderate later this year and next year.
• But the inflation outlook is uncertain; oil prices in particular remain highly volatile.

We agree with the general thrust of Bernanke's comments, but take a more pessimistic view on the growth outlook. We see consumer spending as worse than "sluggish," actually declining in the third and fourth quarters. And we expect GDP growth not only to be appreciably below potential, but negative in the fourth quarter and in the first quarter of 2009.

By reiterating the risks to both growth and inflation, Bernanke is formally maintaining the Fed's neutral stance and not giving any hint of an interest rate cut. But his detailed remarks suggest that the growth threat is the greater one, with which we agree. We suspect that the Fed will eventually decide to ease interest rates lower in response. But that is not of crucial importance right now. Whether the Fed cuts 25 or 50 basis points off interest rates is of far less significance for the economic outlook than whether a large rescue package emerges from the present negotiations.