The US economy is likely to worsen significantly over the next year, said Ben S Bernanke, the Federal Reserve chairman, in his testimony at the Senate Banking, Housing and Urban Affairs Committee in Washington on Tuesday.
However he assured the committee that although the economy was suffering through a 'severe contraction' and could get even worse than recent forecasts, the Federal Reserve would take all necessary steps to thaw the credit markets.
He urged support for the significant fiscal and monetary measures adopted by the Obama administration to revive the sagging credit market.
''If actions taken by the administration, the Congress, and the Federal Reserve are successful in restoring some measure of financial stability - and only if that is the case, in my view - there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery,'' Bernanke said.
"If there is one message that I'd like to leave you with, if we're going to have a strong recovery, it has got to be on the back of a stabilisation of the financial system. It is black and white," Bernanke said in his first biannual report to both houses of Congress on the state of the economy.
The top US central banker said the Obama administration was following the right track in stimulating the economy. He expressed his hope that the stimulus package should work, though it may take some time.
Bernanke's speech also quelled fears that the government is moving to nationalise the country's financial system.
"We don't need majority ownership to work with the banks," Bernanke said. "We have very strong supervisory oversight. We can work with them now to do whatever is necessary," he said.
On Monday, the Treasury, the Fed and federal bank regulatory agencies issued a joint statement announcing that the government might demand direct ownership in major banks after they undergo a 'stress test' to determine their viability.
The test, which will be applied to the 20 biggest banks, will be used to measure whether banks have enough capital to survive a worsening downturn.
"If financial conditions improve, the economy will be increasingly supported by fiscal and monetary stimulus, the salutary effects of the steep decline in energy prices since last summer, and the better alignment of business inventories and final sales, as well as the increased availability of credit," Bernanke said.
As required by law, Bernanke addressed both halves of the Fed's dual mandate: stable prices and maximum employment. The former part of the mission has largely been met, with prices more or less unchanged from their level a year ago, and inflation is expected to glide under 1 percent during 2009.
Labour market gloomy
But labour market conditions continue to deteriorate. Citing projections by the Fed's Open Market Committee in January, he said the unemployment rate, which soared to 7.6 per cent in January, is likely to reach 8.5 to 8.75 per cent in the last quarter of 2009. The country's gross domestic product is projected to decline 0.5 to 1.25 per cent this year, he said, and foreclosure rates remain at high levels.
But Bernanke said, ''This outlook for economic activity is subject to considerable uncertainty, and I believe that, over all, the downside risks probably outweigh those on the upside.''
The recession is already well over a year old, making it longer than the average recession. So far, 3.6 million jobs have been lost.
The international nature of the economic slowdown delays recovery, he said.
The Fed has taken some extraordinary steps in recent months in the hopes of increasing the flow of credit to businesses and households. In December, the Federal Open Market Committee lowered its key interest rate to virtually zero.
The Fed has been buying mortgage-backed securities - considered the leading cause of the meltdown after the housing bubble burst - that have been guaranteed by the federal government. It has also begun unprecedented programmes as a lender.
In his testimony, Bernanke addressed criticisms regarding the lack of transparency in the administration of these and other programmes.
Analysts are, however,l worried about the state of affairs. They say the US economy is in the throes of its worst economic and financial crisis in the post-war period and the Fed is not proactive to prevent the US economy from falling into a deflationary trap.
Some criticise Bernanke saying that throughout his three-year tenure at the helm of the Federal Reserve, he has been painfully slow to do the right thing.
For even taking into account the recently announced $800 billion fiscal stimulus package, the Federal Reserve is now forecasting that US economic output will decline significantly in 2009, before recovering only very gradually thereafter. It also anticipates unemployment will rise to 8.5 per cent, and that it will remain elevated for many years to come, one analyst at a banking firm opined.