JACKSON, Wyo. - Federal Reserve Chairman Ben Bernanke said Friday the financial crisis that has pounded the United States -- coupled with higher inflation -- is taking a toll on the U.S. economy and poses a major challenge to Fed policy-makers as they try to restore stability.
"Although we have seen some improved functioning in some markets, the financial storm that reached gale force" around this time last year "has not yet subsided, and its effects on the broader economy are becoming apparent in the form of softening economic activity and rising unemployment," Bernanke said in a speech to a high-profile economics conference.
Although Bernanke welcomed the recent drops in prices for oil and other commodities, and believes inflation will moderate this year and next, the Fed chief said the inflation outlook remains highly uncertain.
The Fed, he said, would monitor the situation closely and will "act as necessary" to make sure that inflation doesn't get out of hand.
The current financial and economic environment is one of the most challenging to Fed policy-makers "in memory," he acknowledged.
Given those duelling economic cross-currents -- weak economic growth and higher inflation -- many economists believe the Fed will leave rates where they are at its next meeting on Sept. 16 and probably through the rest of this year.
The bulk of Bernanke's speech dealt with the need to bolster oversight of the country's financial system to make it better able in the future to withstand future shocks.
To that end, Bernanke recommended that regulators work on ways to assess the health of the entire financial system, rather than the condition of individual banks, Wall Street investment firms or other financial companies -- as is currently the focus.
"Such an approach would appear well justified as our financial system has become less bank centred," he said. "Some caution is in order, however, as this more comprehensive approach would be technically demanding and possibly very costly both for the regulators and the firms they supervise," he added.
He also said that "stress tests" for a range of financial firms might also be helpful.
Bernanke's remarks come amid renewed worries on Wall Street about the financial health of Fannie Mae and Freddie Mac. The mortgage giants' stock has gotten hammered this week as investors became increasingly convinced a government bailout is inevitable.
Although the Fed chief didn't mention the companies, he said that one of the critical questions facing the country is how to strengthen the financial system and at the same time protect against "moral hazard," where financial companies take extra risks because they believe the Fed or the government will ultimately bail them out.
"Some particularly thorny issues are raised by the existence of financial institutions that may be perceived as `too big to fail' and the moral hazard issues that may arise when governments intervene in a financial crisis," he said.
Mitigating that problem is another challenge facing policy-makers, he said.
