Bernanke optimistic on recovery; worried over inflation

Federal Reserve chairman Ben Bernanke has called the current crisis ''one of the most difficult financial and economic episodes in modern history'', but said he is ''fundamentally optimistic'' about the economy.

''I am fundamentally optimistic about our economy. Today's economic conditions are difficult, but the foundations of our economy are strong, and we face no problems that cannot be overcome with insight, patience and persistence," Bernanke said.

 He was addressing the economics students at a seminar last night at the Morehouse College in Atlanta, Georgia.

''Recently we have seen tentative signs that the sharp decline in economic activity may be slowing, for example, in data on home sales, homebuilding and consumer spending, including sales of new motor vehicles, '' Bernanke said.

''A leveling out of economic activity is the first step toward recovery. To be sure, we will not have a sustainable recovery without a stabilisation of our financial system and credit markets,'' Bernanke said.

While some recent reports have also suggested a moderating of the economy's downturn, data on Tuesday was less encouraging.

The US commerce department reported that retail sales fell sharply in March by 1.1 per cent after two months of small gains.

The unexpected March drop, led by still-falling auto sales, sent stock prices down, with the Dow Jones Industrial Average losing 137.63 points, or 1.7 per cent, to close at 7920.18. Other market indexes fell similarly.

Bernanke also stressed that despite the extraordinary efforts the Fed is taking to support financial markets and the economy, it hasn't taken its eye off inflation, saying that most Fed officials would like to see annual inflation of around 2 per cent over the long term.

"We have a number of effective tools that will allow us to drain excess liquidity and begin to raise rates at the appropriate time," he noted. ''That said, unwinding or scaling down some of our special lending programs will almost certainly have to be part of our strategy for removing policy stimulus once the recovery is under way."

Bernanke did not specify what areas he had in mind, but analysts believe it would include bonds backed by commercial real estate, a sector that has been deteriorating quickly in recent months.

In a question-and-answer session after the speech, Bernanke said the Fed's response to the financial crisis has been "extraordinary ... because we're in extraordinary times."

The private sector will at some point take the lead again in allocating capital, he said, and when that happens the Fed will have to unwind its credit-support programmes.

"It will be a tough calculation" to gauge the right time to do so, Bernanke added. Similarly, the Fed needs to make sure it raises interest rates at the appropriate time, he said, and not keep rates too low for too long.

Bernanke also acknowledged that the job market for graduates is the most difficult in decades.

"People ought to go into a profession based on what they enjoy, what is valuable to them, what they think is valuable to their society," Bernanke said.

Bernanke also addressed the inequities in wealth between whites and minorities.

"Part of it has to do I think with financial education," Bernanke told students at the historically black college. "There needs to be broader understanding in minority communities … about the importance of saving and building a credit record."

Though the US economy likely contracted sharply again in the first quarter, economists expect a smaller decline in the second quarter, followed by stabilisation later this year.

But risks remain, especially from the labor market. The US is currently shedding jobs at a rate of about 650,000 per month. If that continues, it could stamp out a consumer-driven recovery before it takes hold.

The Fed is also considering holding regular press conferences, a move that would mark a significant step toward increased openness for the central bank, in line with the policy followed by the European Central Bank, which holds regular press conferences.

Federal Reserve policymakers currently disclose economic forecasts four times a year, and the Fed chairman gives detailed reports on the economy to congressional committees twice a year.

The Fed has been gradually becoming more open since 1994, when it began announcing when it moved its target for short-term interest rates.