04:48 - Source: CNN
Forced budget cuts: GOP vs. Democrats

Story highlights

Bernanke: The economy has picked up after a flat fourth quarter 2012

He warns Congress that automatic budget cuts could slow growth

He strongly defended the Fed's "highly accommodative monetary policy"

The economy is expanding again, Federal Reserve Chairman Ben Bernanke told Congress Tuesday, but he warned that what lawmakers do about the looming forced budget cuts could slow the upward trend.

The economy has picked up after an unexpected fourth quarter 2012 when growth was close to zero, he said in his twice-a-year report on monetary policy.

He also strongly defended the Fed’s “highly accommodative monetary policy” known as quantitative easing, which has been criticized by congressional Republicans who worry that too much easing of monetary policy – what some call “printing money” – risks creating high inflation. They also fear it could bring more asset bubbles like the dot-com bust at the turn of the century and the housing and real estate collapse that prompted the worldwide financial crisis of 2008 and 2009.

Finally, the Fed chairman warned Congress that major near-term budget changes, like automatic budget cuts, risk slowing growth by about 1.5% this year, off what the chairman already calls “moderate but somewhat uneven pace.”

In prepared testimony, Bernanke told the Senate Banking Committee that the zero-growth fourth quarter reflected “weather-related disruptions” and temporary declines in a few volatile categories of spending. And he emphasized the available data “suggests that economic growth has picked up again this year.”

Fed chariman Bernanke plays down concerns over easing

On the employment front, he said the labor market keeps improving, but only gradually, and he worries that the long periods of unemployment erode worker skills and keep many young people from even getting jobs in the first place.

Bernanke seemed to come prepared to defend the Fed’s aggressively loose monetary policy, saying that under normal circumstances the Fed could just lower interest rates to spur economic growth. But with short-term rates near zero, Bernanke said the Fed has to use alternative policy tools.

He put those tools in two categories. The first is the forward guidance that the Fed has been using in its periodic statements, supporting a stronger recovery by assuring the markets about longer-term interest rates. This encourages borrowing by business and individuals who can use the money for investment in production and hiring and by families who can use low rates to buy homes, which strengthens the housing sector of the economy, he said.

The second and more controversial tool is aggressive purchasing of mortgage-backed securities and long-term Treasury bonds, which puts more money into the system. This worries many observers who wonder if the Federal Reserve will be able to pull back that policy when the economy eventually gets going again at a robust pace.

Bernanke said it’s a cost-benefit situation and countered those who worry about excessive risk-taking with easy money creating asset bubbles. He said the Fed believes the benefits of promoting a stronger recovery and more rapid job creation outweigh the dangers of risk-taking.

And the chairman said the Fed “remains confident that it has the tools necessary to tighten monetary policy when the time comes to do so.” Bernanke said the Fed has sharply expanded monitoring of banks and the financial system overall, along with tougher supervision of financial firms.

He noted that “significant progress” has been made recently toward reducing the federal deficit over the next few years. But he cited Congressional Budget Office figures as he warned Congress about cutting too much too fast, saying the harm to the economy would be a significant short-term burden.

And he said that slowing down the economy could have the perverse effect of cutting tax revenue and actually hurting the short-term effort to hold down annual deficits.

Bernanke suggested that Congress replace the short-term and front-loaded spending cuts of the forced budget cuts with gradual cuts now and substantial cuts “in the longer run.”