The Baltimore Sun

WASHINGTON -- Troubled subprime mortgages and falling new-home construction numbers are likely to bog down the U.S. economy over the next six months, but it could rebound by spring, Federal Reserve Chairman Ben S. Bernanke said yesterday.

Testifying before the Joint Economic Committee of Congress, the Fed chief also acknowledged that he's caught between contradictory pulls: If he cuts interest rates more to spark the economy, that could worsen the threat of rising inflation from a weakening dollar and sky-high energy prices. The Fed's dual mission is to thwart rising prices, or inflation, while keeping the economy growing.

"We assess the risks to these objectives roughly balanced at this time," the Fed chairman said, signaling that the Fed doesn't expect to reduce interest rates again when it next meets, Dec. 11.

Bernanke also said lenders must do more to restructure problem mortgages to help end the protracted housing slump.

Bernanke shrugged off the dollar's slide in currency markets, and said it was unlikely that the U.S. economy would return to 1970s-style stagflation, when growth was almost stagnant even as inflation ran uncomfortably high.

The Fed announced a half-point rate cut Sept. 18 and followed it with a quarter-point cut in the benchmark federal funds rate Oct. 31. But that's probably it for a while.

Even if it wants to help ease the effects of the housing downturn by lowering borrowing costs, the falling dollar makes imports more expensive and oil prices are near $100 a barrel. Both fuel inflation.

"The Fed's really in a bit of a box here," said Gary Bigg, an economist with Bank of America in New York.

Energy prices could send inflation up to a 5 percent annual rate in the final three months of the year, Bigg said.

"You've had a pretty large run-up in [oil] prices. That's starting to feed through to gasoline and energy prices," he said.

Aware that jittery financial markets would parse his every word, Bernanke left the door open for a rate reduction if economic conditions worsen significantly.

"We are not dogmatic," he said.

The U.S. economy grew at almost 4 percent annual rates over the past two quarters despite the deep slide in housing and a credit crunch on Wall Street that's almost paralyzed routine lending in short-term debt markets.

"The broader economy outside housing has been remarkably resilient over the past couple of years," Bernanke said. "The numbers we have seen over the past couple of weeks haven't changed the view that the spillover [into the broader economy] ... has been limited."

Still, high oil prices are troubling. Oil is being driven up partly by the dollar's slide against major currencies. Since oil is traded in dollar contracts, a sinking dollar means that oil-producing nations demand higher prices to compensate for the dollar's lost value.

When the vice chairman of China's parliament suggested Wednesday that his nation - the holder of huge U.S. debt in dollars - may consider shifting its investments into other currencies, foreign-exchange markets trembled.

But Bernanke said he wasn't overly worried. As long as the U.S. economy grows, stays open to foreign investment and trade keeps flowing, the dollar will rebound, he said.

"I'm an optimist on those fronts, and I do believe that will lead to a sound dollar in the medium term," the Fed chief said.

The weak dollar makes U.S. exports less expensive overseas, and booming exports are offsetting the weakness that's spreading from housing, helping to sustain U.S. economic growth.

Acknowledging that he underestimated the depth of the housing downturn, Bernanke said he expected new-home construction to stabilize soon.

"Our current calculation is that things will begin to flatten out in the second quarter of next year," he said.

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