Bernanke says recovery on track despite headwinds

The European debt crisis is likely to have only a "modest" impact on the U.S. economic recovery as long as Wall Street stabilizes, Federal Reserve Chairman Ben Bernanke told Congress on Wednesday.

Testifying before the House Budget Committee, Bernanke struck a more confident tone that the recovery will remain intact despite problems in Europe as well stubbornly high unemployment and a fragile housing market here at home.

"The economy ... appears to be on track to continue to expand through this year and next," Bernanke said.

However, the pace of the expansion - 3.5 percent this year by the Fed's estimate - won't be strong enough to quickly bring relief to the 15 million Americans who are unemployed. The unemployment rate now at 9.7 percent would likely see only a "slow reduction," Bernanke warned.

Fears have grown in recent weeks that the recovery could be derailed.

One worry is if Europe's debt crisis turns into a broader financial contagion, crimping lending in the United States and around the globe. The situation has spooked investors, sending Wall Street into periodic nosedives.

Another worry is that hiring in the United States by private companies could stall. That fear was stoked by a government report last Friday, showing that job creation at private companies in May slowed sharply, with businesses adding only 41,000 new jobs, the fewest since the start of the year.

However, Bernanke said signals suggest that the economy will keep on plodding ahead as massive government stimulus fades. Consumers and businesses have picked up the baton from the government and are spending sufficiently to keep the recovery on track, he said. Still, spending by consumers is much more subdued than in the early stages of past economic recoveries. That's why economic growth is expected to be only modest this year, rather than blistering.

"It appears ... that the recovery has made an important transition," Bernanke told lawmakers. While it can't be entirely ruled out that the country could slide back into a "double dip" recession, Bernanke predicted that the "economy will continue to recover at a moderate pace."

Channeling the anxiety many ordinary people feel about the recovery, the panel's chairman, Rep. John Spratt, D-S.C., said: "Too many Americans continue to feel the effects of this recession and wonder when ... relief is going to come."

Discussing the European crisis, Bernanke also struck a confident tone that the United States would get through the fallout without much damage.

"If markets continue to stabilize, then the effects of the crisis on economic growth in the United States seem likely to be modest," Bernanke said.

Stock portfolios are taking a hit from a rattled Wall Street and weaker economic prospects in Europe probably will sap demand for U.S. exports.

Although such negative forces "will leave some imprint on the U.S. economy," Bernanke said there are other more positive forces that will help out the United States. They include low mortgage rates as investors flock to the safety of U.S. Treasurys, and lower prices for oil and other globally traded commodities, Bernanke said.

The Fed has pledged to hold rates at record lows to nurture the recovery. Many economists believe the Fed will hold rates near zero when it meets next on June 22-23. And, economists viewed Bernanke's remarks on Wednesday as bolstering their beliefs that the Fed won't start to boost rates until next year - or possibly 2012- given the European crisis and high unemployment.

"We will take the actions necessary to ensure stability and continued economic recovery," Bernanke said.

Bernanke said European leaders are showing a firm resolve to fight the crisis and restore confidence in financial markets. The Fed will remain "highly attentive" to developments abroad and their potential impact on the U.S. economy, Bernanke said.

On another topic, Bernanke said the Fed and other regulators intend in the next few weeks to tell banks to take steps to make sure their pay practices aren't spurring excessive risk-taking by executives and other employees. A Fed review found that many banks have not modified their compensation practices in the wake of the 2008 financial crisis, Bernanke said. One of the problems that contributed to the crisis was compensation practices that emboldened reckless behavior.

The Fed chief also urged Congress and the White House to come up with a plan to whittle down record federal budget deficits.

Failing to do so could hurt the economy in the long run, Bernanke said. That's because it can lead to higher interest rates for Americans to buy homes, cars and other things, and make it more expensive for Uncle Sam to service its debt payments.

At some point, "things will come apart," he warned.

"We should be planning now" for a deficit-reduction blueprint, Bernanke said, adding that Europe's debt problem is a sobering reminder of the need for countries to get their fiscal houses in order.

But he added that radical reductions in spending or big hikes in taxes right now wouldn't be prudent because the U.S. recovery is fragile. And, "more assistance" may be needed, he said. Bernanke didn't provide details, although Congress is moving closer to extending unemployment benefits.

The nation's red ink hit a record $1.4 trillion last year. The recession took a big bite out of tax revenues, while spending rose to stimulate the economy and provide relief to struggling Americans.