Federal Reserve Chairman Ben Bernanke warned lawmakers today of threats that could derail an already lagging recovery, including potentially economy-killing policies that come out of Capitol Hill. But the money-master provided few new clues as to what the Fed will to do buoy the nation's economy.
In his semiannual monetary and economic report before the Senate Banking Committee, Bernanke stressed that lawmakers should craft a solution to the impending "fiscal cliff" as soon as possible, but with provisions that will gradually resolve the nation's money woes.
"The most effective way that the Congress could help to support the economy right now would be to work to address the nation's fiscal challenges in a way that takes into account both the need for long-run sustainability and the fragility of the recovery," he said in his testimony. "Doing so earlier rather than later would help reduce uncertainty and boost household and business confidence."
Lawmakers are facing a December 31 deadline before Bush-era tax cuts expire and massive spending cuts go into effect. The Congressional Budget Office projects that, should all of the planned tax increases and spending cuts take effect, the nation could enter a recession in early 2013.
Joining the fiscal cliff as an "important risk" is the ever-present European debt crisis, said Bernanke. Constant turmoil in European nations' finances could have potential "spillover effects" for the global economy, threatening the U.S. recovery, Bernanke said.
That recovery already appears to be weakening. The Fed Chairman painted a picture of a gloomy economy, marked by slowing GDP growth, job creation, manufacturing production, and household spending, as well as an improving but shaky housing market.
Job creation, as Bernanke noted, was nearly 200,000 per month at the end of 2011 and in the first quarter of 2012, but has shrunk to 75,000 per month in the second quarter of 2012.
The slowdown in employment has fueled hopes in the financial sector that the Fed will pump more liquidity into the economy with another round of asset purchases, a policy known as quantitative easing.
New York Democratic Sen. Charles Schumer seems to be among those who would welcome a third round of easing, or "QE3." He advised Bernanke to "take whatever actions are warranted by the economic conditions, regardless of the political pressure."
However, Republican lawmakers have often lambasted the possibility of more easing, criticizing it as ineffective and potentially promoting inflation.
Bernanke said today while "economists differ" on their opinions, he believes the first two rounds of easing and the more recent "Operation Twist" to be successful.
Still, his comments on the prospect of QE3 were limited. The Chairman repeated the Fed's now-common refrain that it is "prepared to take further action as appropriate."
Sizable declines in jobs or prices could spur that action. Should it appear that "we are stuck in the mud, so to speak, in terms of employment," as the Fed Chairman put it, or that deflation is a threat, he said, then the Fed might provide more stimulus—buying up assets from other financial institutions to free up more cash for lending.
The problem facing the Fed is a diminishing menu of policy options. Bernanke listed new communication strategies and adjusting the interest rate that banks pay on excess reserves as two avenues that the central bank might undertake, aside from easing. QE3 might not even have its intended effects, as Bernanke acknowledged in June that "there may be some diminishing returns" to additional rounds of easing.
In the face of the potential damage that the fiscal cliff could do to the economy, the Fed may find itself at a loss, says Greg McBride, senior financial analyst at Bankrate.com.
"All they can do is send the signal that they're going to keep the floodgates of easy monetary policy open," he says. "But at some point, Congress has to pick up the ball and run with it."