Fed sounds the alarm on effects of European debt crisis

The Federal Reserve on Wednesday signaled strong concern that the deepening European debt crisis could drag down the U.S. economy and moved to prop up growth.

After two weeks of reports showing a rapidly weakening economy in April and May, the Fed’s rate-setting committee voted to extend the central bank’s current easing programs and said it would take further dramatic action if the U.S. economy continues to deteriorate.

Ben S. Bernanke, chairman of the Fed, made it clear at a news conference after the committee meeting that he sees the crisis in Europe as the biggest danger for the U.S. economy, but he said it also is being held back by lingering weakness in the housing market and big cutbacks and layoffs by state and local governments.

“We are prepared to do what is necessary” to ensure the economy keeps growing, he said, although he added that recent reports showing a sharp slowdown in job growth and consumer spending were “not entirely clear” about the extent of the slowdown and the Fed will continue to scrutinize economic reports closely in coming weeks before deciding whether to take further action.

Pessimism about the domestic economy was underscored further with the release Wednesday of a sobering report from the Business Roundtable.

The group’s CEO, John Engler, said the uncertainty facing business owners “is pretty lethal.” Companies are afraid to hire, he said, and are “holding back for some clarity.”

Other businesses and private economists have sounded a similar note, blaming the slowdown this spring on uncertainty created in part by a fiscal crisis looming at the end of the year, when $600 billion of tax increases and spending cuts will take effect.

But Mr. Bernanke said it is too early for that year-end deadline to be having much effect on the U.S. economy.

He attributed the current weakness primarily to the European crisis and lingering aftershocks from the recession.

“The European situation is slowing U.S. economic growth,” he said, noting that many countries in Europe have fallen into recession and “that affects our trade” and demand for U.S. products. Europe is the largest export market for U.S. producers.

Europe’s downturn also has precipitated a major slowdown in China, which is the fast-growing market for U.S. goods, he noted. And the big swoon in the U.S. stock market triggered by the intensification of the European crisis this spring also poses a risk for the U.S. economy, he said.

In light of the Fed’s renewed concerns about the U.S. economy, many Fed-watchers now expect the central bank to launch another of its controversial bond-buying programs later this year, despite the heightened political atmosphere and criticism that is likely to generate from conservatives opposed to such unconventional measures.

Republican presidential candidate Mitt Romney, among others, has criticized such unconventional Fed programs, saying they are ineffective and raise questions about the central bank’s commitment to fighting inflation.

But Mr. Bernanke strongly defended the programs and emphasized several times in his news briefing that the Fed still views them as “ammunition” that it can deploy to get the economy moving faster.

He said that past bond-buying programs were successful not only at reducing interest rates to record lows but at prompting investors and banks to put more of their money into lending to consumers and businesses as the Fed buys up more and more of the Treasury securities and mortgage bonds they are holding.

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