Bernanke also explained his current view of the economy. While the recovery is slower than the central bankers anticipated earlier in the year, he does not believe a double dip lies ahead. He thinks that growth will pick up in 2011. He also isn't concerned that deflation will become a problem, saying that the price level is under control.
Yet he concedes that he could be wrong, as macroeconomics is not an exact science. In light of that, he explains several tools the Fed can use if the economy deteriorates. He does not anticipate needing to use them, but he wants everyone to know that the central bank won't be powerless. He explains that these options all have benefits and risks.
Additional Longer-Term Security Purchases
The most obvious option that the Fed has if the economy further deteriorates is to ramp up its purchases of long-term debt securities. Currently, it's only purchasing enough to keep its balance sheet steady. But it could buy long-term bonds even more aggressively, increasing the size of its portfolio.
The Benefit: This would reduce long-term rates, which may spur more investment.
The Risks: The Fed has little experience with the tactic, so the effect it will have remains unclear. Increasing the Fed's balance sheet could cause the public to become more wary of the Fed's ability reduce its portfolio, increasing inflation expectations.
Modifying Its Communication
The FOMC could more explicitly proclaim how long interest rate targets will remain near zero, rather than rely on the more qualitative "for an extended period" language. Whatever the market's expectation for that amount of time, the Fed could declare that it will be even longer.
The Benefit: Again, this would reduce long-term rates, which may spur more investment.
The Risk: Being more specific would reduce the Fed's flexibility to change its policy as the economy evolves.
Reducing Interest Rates Paid on Reserves
The Fed currently pays financial institutions interest on some of their reserves. It could reduce that interest rate to as little as zero.
The Benefit: Banks would have less incentive to hold reserves and may lend more.
The Risks: This probably wouldn't do much right now, since short-term rates are already so low. It could also disrupt markets and cause some participants to exit other short-term saving, which would result in a much less liquid market.
Increase Its Inflation Target
Bernanke also mentioned that some economists have suggested that the Fed should increase its inflation target. He made clear, however, that he believes this is a terrible idea and that no one on the FOMC supports it. He said that this strategy could be sensible if a period of long-term deflation was getting underway, but he does not view deflation as a significant threat. He believes that this suggested action would undermine the Fed's ability to keep prices stable.