Record-low rates aid struggling economy

Record-low interest rates are still needed to stabilize the economic recovery, Federal Reserve Chairman Ben Bernanke told Congress on Thursday.

He cited still-fragile economic conditions, and noted that inflation is low, which gives the government freedom to keep rates at rock-bottom levels.

Deciding when to tighten credit is the biggest challenge facing Bernanke, whose second term started in February. Moving too soon could stall any recovery and flat line any stress tests. Waiting too long could unleash inflation and sow the seeds for new speculative bubbles in stocks or commodities or other assets. Welcome to the US Economic conundrum.

One of the reasons the Fed is holding rates so low is because of stubbornly high unemployment, Bernanke said. It’s now at 9.7%, a potential restraining force on the economy’s rebound.

The Fed also wants to see more lending by banks before it starts tightening credit. The Fed kept a pledge last week to hold rates at record lows for an “extended period,” a decision that drew one dissent. Does this mean 3 months, 6 months or even longer? That is the million dollar question.

Bernanke said the term “extended period” isn’t a fixed number of months. Rather, it is tied to how economic conditions evolve. If the economy were to rebound more strongly than anticipated, then the Fed would “respond appropriately” and start raising rates, Bernanke explained.

Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, however, expressed concern that keeping rates at record lows could cause a buildup of “financial imbalances” and put the economy’s stability at risk. Analysts took that to mean low rates could spur a new speculative bubble later on that could burst and hurt the economy.

In other observations, Bernanke said the housing market is “still quite weak.”

I don’t believe the US Economy is quiet ready for any planned stress tests.  At least not any with much weight.