Fed chief: Economy might not slip much

But housing slump, energy costs threaten

CHATHAM - Despite the recent jump in the national unemployment rate, chances have improved that the United States will avoid a "substantial downturn," Federal Reserve chairman Ben S. Bernanke said last night.

Bernanke, speaking at a conference sponsored by the Federal Reserve Bank of Boston, said a number of factors, including low interest rates, federal tax rebate checks, strong exports, and stabilizing financial markets, should lift the economy during the rest of the year. He warned, however, that soaring energy prices and the continued housing slump remain threats.

"Although activity during the current quarter is likely to be weak," he said, "the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so." Bernanke's speech came just days after the Labor Department reported on Friday that the national jobless rate jumped a half-percentage point to 5.5 percent in May, the biggest monthly increase in more than two decades. The unexpected surge in joblessness sent shock waves through financial, currency, and commodity markets, with the Dow Jones industrial average plunging nearly 400 points and oil surging nearly $11 a barrel to a record $138.54.

Yesterday, the Dow recovered 70.51 to close at 12,280.32. Oil retreated, losing more than $4 a barrel to close in New York at $134.35. Bernanke spoke after US markets had closed.

Bernanke's assessment of the economy appears to be the latest indication that the Fed has turned its attention to inflation after making deep cuts in interest rates and taking extraordinary actions to keep financial and credit markets functioning, including engineering the sale of a failing Wall Street firm, Bear Stearns Cos., to prevent a 1930s-type meltdown. Mounting inflation concerns, many economists say, will keep the Fed from cutting rates when policy makers meet later this month.

Bernanke has emphasized inflation in recent speeches, including one at Harvard University last week. Last night, he said rapidly rising prices of oil and other commodities, such as food crops, have kept inflation high.

While the full extent of these increases has not passed through to other products or wages, he said, the Fed is carefully monitoring the impact of higher raw materials costs in the broader economy. He suggested the Fed will, if necessary, act decisively to prevent inflation from gaining a long-term foothold. The Fed typically fights inflation by raising interest rates.

"The latest round of increases in energy prices has added to the upside risks to inflation and inflation expectations," Bernanke said. The Fed, he added, "will strongly resist an erosion of longer-term inflation expectations, as an unanchoring of those expectations would be destabilizing for growth as well as inflation."

Inflation expectations are critical because if workers believe prices will keep going up they demand higher wages, which in turn puts pressure on employers to raise prices more. This so-called "wage-price spiral" was a key contributor to runaway inflation, high unemployment, and stagnant growth of the 1970s, which became known as "stagflation."

The Boston Fed conference, which attracts top academic and business economists, is examining the relationship between inflation and unemployment. Bernanke called on researchers to further investigate the dynamics of commodity prices, labor costs, and inflation, and ways to get more precise data, to help central bankers develop more effective polices.

Robert Gavin can be reached at rgavin@globe.com.