Economy pleases Fed chief

Times Staff Writer

Federal Reserve Chairman Ben S. Bernanke on Wednesday painted a portrait of an economy that was carefully -- and successfully -- balanced to produce healthy growth and low inflation.

A prolonged slump in the housing market could cut into overall economic growth, Bernanke told the House Financial Services Committee in his semiannual report on the state of the economy. And a resurgence in consumer spending could rekindle inflation.

But Bernanke suggested that the Fed had sized up the economy correctly in halting its series of increases in short-term interest rates last summer and in leaving them alone ever since. The Fed’s strategy moved interest rates high enough to ward off inflation without raising them so high that they crushed economic growth, he said, adding that resurgent inflation remained the greater risk to the economy.

“It was a steady-as-she-goes message,” said Mark Zandi, chief economist for Moody’s


“I don’t see how they can resist smirking at the Fed,” said David Kelly, chief economist for Putnam Investments in Boston. “This economy is working out exactly the way they wanted.”

Kelly said he was struck at how well Bernanke’s Fed was staying “on message.” In the chairman’s first months in office early last year, Fed members sometimes contradicted each other and even themselves.

Bernanke was careful Wednesday to acknowledge that the Fed’s twin goals were maximum economic growth with minimum inflation. That was a nod to congressional Democrats, who complain that the Fed often sacrifices growth on the altar of low inflation.

At the same time, Bernanke, determined to show his stripes as an inflation hawk, reiterated his frequent assertion that higher prices represented a greater threat than weak growth.


The Fed chief predicted that the economy would enjoy moderate growth of 2.25% to 2.5% this year and 2.5% to 2.75% next year. The 2007 forecast range is about a quarter of a point lower than what the Fed predicted in February, reflecting a slowdown that reduced the annual growth rate to 0.7% in the first quarter of this year.

Bernanke attributed that slowdown largely to “the ongoing adjustment of the housing sector.” He added that declines in residential construction would probably continue to weigh on growth “over coming quarters, although the magnitude of the drag on growth should diminish over time.”

The Commerce Department said Wednesday that housing construction rose 2.3% in June to a seasonally adjusted annual rate of 1.467 million units. Analysts discounted the unexpected increase, noting that applications for building permits fell 7.5%. Permits are considered a better indicator of future trends.

Recent reports on overall inflation, Bernanke acknowledged, showed “unwelcome” price increases. One measure of consumer inflation that the Fed carefully watches, called the personal consumption expenditures index, rose at an annual rate of 4.4% for the first five months of the year.


But that figure was propelled by rising food and energy costs. Without those two volatile sectors, Bernanke said, core inflation is only about 2%, and he called that figure a better gauge of overall future inflation.

So he stuck by the Fed’s February forecast for core inflation of 2% to 2.25% in 2007 and 1.75% to 2% in 2008.

Another inflation gauge, the consumer price index, rose 0.2% in June, much less than May’s 0.7% surge, the Labor Department reported Wednesday. The core index also rose 0.2% in June.

Members of the House panel generally welcomed Bernanke’s testimony. But committee Chairman Barney Frank (D-Mass.) said the Fed chairman failed to address growing income inequality, which Frank called “the single most pressing economic issue facing the country today.”


Frank said resentment felt by the working class had left Congress unable to pass immigration legislation or extend President Bush’s broad authority to negotiate trade agreements with other countries.

Bernanke, who has been criticized by Congress for failing to address the sub-prime mortgage crisis, also told the House panel that the central bank would write new lending regulations to strengthen consumer protections. He didn’t give specifics.