Bernanke says Fed will extend $267B 'Operation Twist' to boost economy

The Federal Reserve on Wednesday announced a $267 billion extension of its effort to boost the economy, with Chairman Ben Bernanke reiterating his warning that Congress must act to prevent a "fiscal cliff" of tax hikes and spending cuts.

The Fed will extend, by six months, an effort to reduce borrowing rates known as “Operation Twist.” The extension will run through the end of the year in an attempt to offset a swoon in the U.S. economy, which is struggling amid a global slowdown largely attributable to the European debt crisis.

Bernanke said the Fed was prepared to do more to boost the economy if the recovery continues to stagger.

“We are prepared to do what's necessary,” he told reporters. “We are prepared to provide support for the economy.”

A third round of quantitative easing — massive bond purchases by the Fed in an effort to lower rates, which has been met with GOP skepticism — remains an option for the central bank, Bernanke said. But he made clear that such unconventional moves should not be taken lightly.

“I don't think they should be launched lightly,” he said. “There should be some conviction that they're needed.”

Operation Twist, in which the Fed reorients its portfolio to load up on longer-term securities while selling ones with shorter terms, was launched in September and was originally intended to end in June.

But with the economy lagging, the Fed has opted to load up on $267 billion of longer-term bonds while selling the same amount in shorter-term bonds over the next six months. The Fed traded $400 billion worth of bonds in the original initiative.

The policy meeting marked the first for the Fed since a dismal jobs report in May. Bernanke acknowledged that recent economic data has been “somewhat disappointing," but said it was still to soon to suss out the true trajectory of the economy and whether the dip in job creation was a serious issue or a seasonal blip.

“Month to month, there’s going to be statistical noise,” he said. “Is the improvement sustainable? Is it long-lasting? That's the kind of thing that we'll be looking at.”

Nonetheless, Bernanke identified the ongoing European debt crisis, the continued struggles of the housing market and the looming fiscal cliff facing Congress as major headwinds that pose threats to the nation's economic comeback.

He cautioned that the combination of expiring tax cuts and automatic spending cuts set to take effect at the beginning of 2013 will begin to weigh on the economy as it draws near, making it vital for Congress to address the nation's fiscal trajectory in a responsible way.

“Financial markets don't like uncertainty, particularly uncertainty of this magnitude,” he warned.

He also cautioned lawmakers that in adjusting fiscal policy, they needed to come up with a substantive plan that protects the ongoing recovery while putting the nation on a sustainable fiscal trajectory.

“Simply kicking the can down the road without any other indication of what might be done … could be a negative for sentiment, because it might lead people to worry more about the seriousness of Congress in addressing our fiscal issues,” he said.

Regarding Europe, Bernanke said the Fed is “hoping for the best,” adding that European policymakers have the resources to deal with the matter themselves. He strongly ruled out the notion that the Fed would ever buy the debt of European nations to support the region.

“At this point, we're mostly just in consultation mode,” he said.

Fed officials downgraded their expectations for economic growth and the nation's unemployment rate. Officials generally expect the economy will grow by less than 3 percent until 2014, down slightly from April expectations.

They also anticipate the unemployment rate will stay stuck above 8 percent for the rest of the year, and expect it to remain above 7 percent through 2014. However, officials also do not see inflation as a major threat. They expect it to hold steady below 2 percent for the foreseeable future.

The Fed also announced that it planned to keep interest rates near zero until the end of 2014, as it had previously stated. All but one Federal Open Market Committee member, Richmond Fed President Jeffrey Lacker, supported the statement. Lacker dissented because he opposed the continuation of Operation Twist.

After the May jobs report, speculation ramped up in financial markets that the Fed would be compelled to take further action to support the economy.

Stock markets took a steep dip after the Fed announced its plans Wednesday, then recovered before heading south again following Bernanke's comments. The Dow Jones Industrial Average ended the day down slightly, dropping 13 points.

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