Bernanke says low rates won't stoke inflation

By Pedro Nicolaci da Costa

WASHINGTON | Wed Nov 3, 2010 8:45pm EDT

WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke, fresh from announcing new measures to support the U.S. economy, said the central bank's aggressive monetary policy will not spark unwanted inflation in the future.

Bernanke, in an opinion piece to be published on Thursday in the Washington Post, argued that the bigger risks facing the country right now are an unemployment rate that remains too high and inflation readings that are uncomfortably low.

"Inflation that is too low can pose risks to the economy -- especially when the economy is struggling. In the most extreme case, very low inflation can morph into deflation, which can contribute to long periods of economic stagnation," Bernanke wrote.

The Fed on Wednesday announced it would buy an additional $600 billion in government bonds through the middle of next year, a widely telegraphed decision that has been accompanied by some doubts about its likely effectiveness.

Opponents of the measure say it is only sowing the seeds of future inflation, a concern Bernanke said was "overstated" because the economy was currently operating so far below its full potential.

"Even absent (deflation) risks, low and falling inflation indicate that the economy has considerable spare capacity, implying that there is scope for monetary policy to support further gains in employment without risking economic overheating," the Fed chief said.

Bernanke also beat back worries about whether asset purchases and their effect on financial markets can have a discernible positive effect on U.S. economic activity, which expanded at a meager 2 percent annualized clip in the third quarter.

By boosting the prices of stocks and corporate bonds, he said, the Fed's bond buying can -- and already has to some extent -- stimulate the sort of investment that will begin to put a dent on the nation's 9.6 percent unemployment rate.

"Easier financial conditions will promote economic growth," he said. "Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending."

Still, Bernanke acknowledged that the idea of conducting monetary policy through longer-dated asset buying is relatively unfamiliar, adding that this has caused the Fed to proceed cautiously.

He reiterated the notion that the central bank has the tools it needs to withdraw monetary stimulus if inflation looks to be rising too rapidly.