By Ros Krasny
AUSTIN, Texas (Reuters) - Federal Reserve Chairman Ben Bernanke on Monday urged decisive action to protect the U.S. economy and said the Fed could directly buy securities and backstop markets as interest rates approach zero.
"Our nation's economic policy must vigorously address the substantial risks to financial stability and economic growth that we face," Bernanke told the Greater Austin Chamber of Commerce in a luncheon address.
President-elect Barack Obama plans a powerful fiscal stimulus package to lift growth once he takes office on January 20, but he has provided scant details so far and says the plan is still being worked out.
Bernanke said that further interest rate cuts beneath the Fed's current target of 1 percent for its benchmark overnight funds rate were "certainly feasible", but suggested the Fed would also use other unconventional measures to aid growth.
"Although conventional interest rate policy is constrained by the fact that nominal interest rates cannot fall below zero, the second arrow in the Federal Reserve's quiver -- the provision of liquidity -- remains effective," he said.
Bernanke has said in the past that the Fed could use so-called quantitative easing to boost growth once official interest rates had reached zero, as Japanese authorities were forced to do in the 1990s to end a decade of stagnation.
Bernanke said the Fed could directly purchase longer-term securities issued by the U.S. Treasury or government-sponsored agencies, in order to influence yields and stimulate demand.
U.S. Treasury prices rose sharply on his remarks, pushing yields to their lowest in five decades.
Bernanke said the Fed might also take broader measures.
"The Federal Reserve can backstop liquidity not only to financial institutions but also directly to financial markets, as we have recently done for the commercial paper market," he said, referring to recent Fed liquidity measures.
The Fed is widely expected to lower benchmark U.S. interest rates by a half percentage point to 0.50 percent at its next scheduled meeting on December 15-16, and to use quantitative measures to pump up financial market liquidity and limit economic weakness.
At 0.50 percent, the federal funds overnight target rate would be the lowest on records that date back to mid-1948.
The Fed has already used innovative measures to pump liquidity into the financial system that has more than doubled the size of its balance sheet. Some economists say that this already amounts to a policy of quantitative easing.
Despite the action already taken, Bernanke warned not to expect a quick recovery.
"The likely duration of the financial turmoil is difficult to judge, and thus the uncertainty surrounding the economic outlook is unusually large. But even if the functioning of financial markets continues to improve, economic conditions will probably remain weak for a time," he said.
The National Bureau of Economic Research, the official arbiter of the U.S. business cycle, said earlier on Monday that the U.S. economy had entered a recession in December 2007.
This makes the current downturn already the third-longest since the Great Depression after 16-month slowdowns in the mid-1970s and early-1980s.
But Bernanke said there was no comparison between the current bout of economic weakness and the Great Depression, when the U.S. economy contracted for over a decade until World War Two and one in four U.S. workers was unemployed.
"Let's put that out of our minds. There is no comparison in terms of severity. We're very lucky to live in a country as rich and diversified as the one we have, and I hope that we will have a quick and rapid recovery from the current slowdown," he said in response to a question.
(Writing by Alister Bull; Editing by James Dalgleish)
