Federal Reserve Chairman Ben Bernanke on Friday stopped short of detailing further action to boost the U.S. recovery but said the central bank would consider what more it could do to fight high unemployment, giving some comfort to investors.
Bernanke said the Fed had marked down its outlook for U.S. economic growth and announced it would extend its September policy meeting to two days to consider its options. However, he also said the onus for boosting long-term growth prospects lay at the feet of the White House and the U.S. Congress.
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"It is clear the recovery from the crisis has been much less robust than we had hoped," he told an annual Fed conference here.
Under Bernanke's leadership, the U.S. central bank launched an unprecedented array of measures to steer the economy away from what could have been a second Great Depression.
A weak raft of data has led analysts to say chances of a new recession could range as high as 50 percent.
The economy grew at a paltry 1 percent annual rate in the second quarter, the government said on Friday, after expanding only 0.4 percent during the first three months of the year. At the same time, Europe is strangled by a debt crisis that is undercutting recovery there.
"The growth fundamentals of the United States do not appear to have been permanently altered by the shocks of the past four years," Bernanke said. "The economic healing will take a while, and there may be setbacks along the way," he added. "However ... the healing process should not leave major scars."
His optimism carried an important caveat. He said if policymakers failed to bring down the "extraordinarily" high level of U.S. long-term unemployment, jobs skills could atrophy, harming the economy's long-run potential.
The jobless rate stood at 9.1 percent in July, with nearly half of the unemployed out of work for 27 weeks or more.
Bernanke's speech met with a volatile reception in financial markets, where some participants had expected fresh details on steps the Fed could take to spur stronger growth.
Stocks initially fell sharply, with the Dow Jones industrial average dropping as much as 220 points, but later recovered as investors saw the door still open for a renewed effort at lifting growth. The dollar rallied then gave up some gains, as did bond prices.
Bernanke made plain the central bank's policy-setting Federal Open Market Committee found recent developments troubling. However, he said most policies that would ensure a solid foundation for long-term growth were outside the Fed's province.
He said Europe's debt struggles, a bruising summer political battle over the U.S. budget and a decision by Standard & Poor's to strip the United States of its coveted AAA credit rating lay behind the gut-wrenching market volatility in recent weeks, which had harmed growth prospects.
"Financial stress has been and continues to be a significant drag on the recovery, both here and abroad," he said.
The Fed chief said the economy could benefit over the long haul by putting the U.S. budget on a sustainable path, and he suggested Washington explore ways to make the budget process less contentious. However, he also warned that tightening fiscal policy too soon could harm the fragile recovery.
Julian Callow, an economist at Barclays Capital in London, said incoming economic data would determine if Bernanke can form a consensus at the central bank to provide further support for the sputtering recovery.
"He was rather boxed in terms of what he could say," Callow said. "The markets have been increasing pressure on him to say more, but he needs to take the FOMC with him."
Earlier this month, the Fed said it expected to hold overnight U.S. interest rates near zero for at least the next two years, a move that elicited three dissents -- something the central bank has not seen since 1992.
As gloomy news on the U.S. economy mounted in recent weeks, stock markets plunged and speculation grew the Fed would crank up its crisis-fighting operation.
Some investors hope the central bank, which has already bought $2.3 trillion in bonds, will launch a fresh round of purchases, although many analysts think more modest steps, such as shifting the Fed's securities holdings into longer maturities, are more likely.
"We continue to think the odds are tilted slightly in favor of the Fed taking further stimulative action at the next FOMC meeting, likely altering the composition of the Fed's balance sheet," JPMorgan economist Michael Feroli said.
Bernanke simply reiterated language from the Fed's latest policy statement that the central bank was examining its options and was prepared to act as needed, while repeating the Fed's view that easing commodity prices should bring inflation into line with the Fed's 2 percent or under goal.
In an interview with CNBC, Philadelphia Federal Reserve Bank President Charles Plosser said further bond purchases by the Fed would do the economy little good.
"I'm not sure it would be beneficial to the problems that we are facing," Philadelphia Federal Reserve Bank President Charles Plosser told CNBC.
Plosser, a noted inflation hawk, was one of the officials who dissented at the Fed's August 9 meeting.
Fed officials have discussed buying more longer-term debt and selling short-term securities, an operation that could increase downward pressures on long-term interest rates without further bloating the central bank's balance sheet.
Long-term Treasury yields are an important benchmark for home and auto loans. In addition, a shift in the Fed's portfolio could push some yield-hungry investors into other assets, such as stocks and corporate bonds, perhaps spurring stronger spending.
But some officials think an effort to "twist" down the longer end of the interest rate curve might do little good.
"A twist operation would not have every much effect. It's been analyzed many times," St. Louis Federal Reserve Bank President James Bullard told Reuters.
(Writing by Mark Felsenthal and Tim Ahmann; additional reporting by Leah Schnurr; Editing by Neil Stempleman)