Smooth road for Fed chair so far, uncertainties ahead

Bernanke's comments calm markets, but future oil prices and housing values pose fundamental challenges.

Often, a transition in leadership at the Federal Reserve is a rocky time for financial markets. Dips or dives for stock prices are not uncommon.

For Ben Bernanke, it's so far so good.

The new chairman of the Federal Reserve Board, in the post just since the beginning of the month, has sent signals that have done more to calm and encourage Wall Street than to rattle it.

While the path of the economy - and of the Bernanke Fed - has uncertainties, the new chairman used his first semiannual testimony on Capitol Hill Wednesday to reassure policymakers and the public of two points: The economy appears to be doing well, and he will be vigilant in guarding against enemy No. 1, inflationary pressures that could threaten price stability.

"The economic expansion remains on track," Chairman Bernanke told members of the House Financial Services Committee. "Nevertheless, the risk exists that ... output could overshoot its sustainable path, leading ultimately ... to further upward pressure on inflation."

It was the tone he was widely expected to set. The first order of business for any central banker is to establish credentials as a defender of price stability. Observers say Bernanke must preserve the confidence that the Fed has already earned.

But if Bernanke's overall message was unsurprising, it also hinted at the fundamental uncertainty ahead for both Fed policymakers and financial markets.

In its campaign to bring interest rates up to a neutral (noninflationary) level, the Fed has already raised its short-term interest rate at 14 consecutive meetings since mid-2004. Now, many believe the Fed is near the point where it can stop raising rates. Because the impact of the rate hikes is only fully felt after many months, the rate hikes already in place will continue to ripple into the economy throughout the rest of this year.

The danger, some economists believe, is that instead of the economy overshooting its growth potential, the Fed may overshoot. By squelching inflation too forcefully, it could cause the economy to undershoot its potential.

Others believe the Fed is well justified if it moves, as expected, to raise the short-term interest rate one or two more times, pushing the level to 4.75 or 5 percent.

The implications for working Americans are large. Job growth and wage growth in the current expansion has been below historical norms. Tightening monetary policy too far could worsen that trend.

Rep. Barney Frank (D) of Massachusetts expressed such concerns in his questions and comments during the meeting Wednesday.

"We face a problem," Mr. Frank said. "There is a decoupling between growth in the gross domestic product and the economic situation of the average American."

He pressed Bernanke about whether Fed policymakers would see wage increases as worrisome, out of concern about possible inflation. In the past, worker demands for wage hikes have sometimes fueled a "wage-price spiral." But currently, wages have not even been keeping pace with inflation.

"It's a bit of a misunderstanding there," Bernanke replied. He said it is desirable for wages to rise faster than inflation as long as the pay hikes don't drive it up.

Such straightforward replies to a range of questions, on everything from the trade deficit to the housing market, are a contrast with Bernanke's predecessor, the sometimes inscrutable Alan Greenspan.

"I can see you are a former teacher," said Carolyn Maloney (D) of New York. "You are very clear."

A new Fed forecast was also released Wednesday, with projections that the economy will grow by about 3.5 percent a year in both 2006 and 2007, after inflation. The forecast calls for inflation to remain contained (about 2 percent) and unemployment around its current level (4.75 to 5 percent). Wild cards that could affect the outcome include whether oil prices rise and how much the housing market slows - and the Fed's own policies.

For their part, Fed policymakers including Bernanke say they will need to closely watch economic data to determine their next moves.