The following are highlights of Federal Reserve Chairman Ben Bernanke's prepared remarks on Wednesday to the House of Representatives Financial Services Committee as part of his semi-annual testimony on the U.S. economy and monetary policy.

For a text of Bernanke's prepared remarks, see http://financialservices.house.gov/UploadedFiles/071311MPR.pdf

BERNANKE ON ECONOMIC OUTLOOK:

Once the temporary shocks that have been holding down economic activity pass, we expect to again see the effects of policy accommodation reflected in stronger economic activity and job creation. However, given the range of uncertainties about the strength of the recovery and prospects for inflation over the medium term, the Federal Reserve remains prepared to respond should economic developments indicate that an adjustment in the stance of monetary policy would be appropriate.

BERNANKE ON FED POLICY OPTIONS:

On the one hand, the possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support. Even with the federal funds rate close to zero, we have a number of ways in which we could act to ease financial conditions further. One option would be to provide more explicit guidance about the period over which the federal funds rate and the balance sheet would remain at their current levels. Another approach would be to initiate more securities purchases or to increase the average maturity of our holdings. The Federal Reserve could also reduce the 25 basis point rate of interest it pays to banks on their reserves, thereby putting downward pressure on short-term rates more generally.

BERNANKE ON TEMPORARY ECONOMIC HEADWINDS:

In part, the recent weaker-than-expected economic performance appears to have been the result of several factors that are likely to be temporary. Notably, the run-up in prices of energy, especially gasoline, and food has reduced consumer purchasing power. In addition, the supply chain disruptions that occurred following the earthquake in Japan caused U.S. motor vehicle producers to sharply curtail assemblies and limited the availability of some models. Looking forward, however, the apparent stabilization in the prices of oil and other commodities should ease the pressure on household budgets, and vehicle manufacturers report that they are making significant progress in overcoming the parts shortages and expect to increase production substantially this summer.

BERNANKE ON EFFECTS OF LONG-TERM UNEMPLOYMENT:

Importantly, nearly half of those currently unemployed have been out of work for more than six months, by far the highest ratio in the post-World War II period. Long-term unemployment imposes severe economic hardships on the unemployed and their families, and, by leading to an erosion of skills of those without work, it both impairs their lifetime employment prospects and reduces the productive potential of our economy as a whole.

BERNANKE ON EXPECTED PICKUP IN THE ECONOMY:

Much of the slowdown in aggregate demand this year has been centered in the household sector, and the ability and willingness of consumers to spend will be an important determinant of the pace of the recovery in coming quarters. ... On the positive side, household debt burdens are declining, delinquency rates on credit card and auto loans are down significantly, and the number of homeowners missing a mortgage payment for the first time is decreasing. The anticipated pickups in economic activity and job creation, together with the expected easing of price pressures, should bolster real household income, confidence, and spending in the medium run.

BERNANKE ON INFLATION PICKUP:

Much of the acceleration was the result of higher prices for oil and other commodities and for imported goods. In addition, prices of motor vehicles increased sharply when supplies of new models were curtailed by parts shortages associated with the earthquake in Japan. Most of the recent rise in inflation appears likely to be transitory, and FOMC participants expected inflation to subside in coming quarters to rates at or below the level of 2 percent or a bit less that participants view as consistent with our dual mandate of maximum employment and price stability.

BERNANKE ON WHY INFLATION WILL SUBSIDE:

Reasons to expect inflation to moderate include the apparent stabilization in the prices of oil and other commodities, which is already showing through to retail gasoline and food prices; the still-substantial slack in U.S. labor and product markets, which has made it difficult for workers to obtain wage gains and for firms to pass through their higher costs; and the stability of longer-term inflation expectations, as measured by surveys of households, the forecasts of professional private-sector economists, and financial market indicators.

BERNANKE ON QE2:

Estimates based on a number of recent studies as well as Federal Reserve analyses suggest that, all else being equal, the second round of asset purchases probably lowered longer-term interest rates approximately 10 to 30 basis points.

Our analysis further indicates that a reduction in longer-term interest rates of this magnitude would be roughly equivalent in terms of its effect on the economy to a 40 to 120 basis point reduction in the federal funds rate. ... Thus, even with the end of net new purchases, maintaining our holdings of these securities should continue to put downward pressure on market interest rates and foster more accommodative financial conditions than would otherwise be the case. ... The experience to date with the round of securities purchases that just ended suggests that the program had the intended effects of reducing the risk of deflation and shoring up economic activity.

BERNANKE ON FED EXIT STRATEGY:

In brief, when economic conditions warrant, the Committee would begin the normalization process by ceasing the reinvestment of principal payments on its securities, thereby allowing the Federal Reserve's balance sheet to begin shrinking. At the same time or sometime thereafter, the Committee would modify the forward guidance in its statement. Subsequent steps would include the initiation of temporary reserve-draining operations and, when conditions warrant, increases in the federal funds rate target. From that point on, changing the level or range of the federal funds rate target would be our primary means of adjusting the stance of monetary policy in response to economic developments.

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