(Updates with comments from Bernanke and adds further details throughout.)
WASHINGTON -(Dow Jones)- U.S. Federal Reserve Chairman Ben Bernanke Wednesday said he expects short-term interest rates to rise as the economy strengthens and signaled he's wary about keeping them too low for too long.
Speaking to House lawmakers about bank supervision, the Fed chief also pushed back against a Senate proposal to strip from the central bank oversight of smaller banks, warning it would narrow the Fed's focus to giant firms.
But it was Bernanke's brief remarks on the economy and interest rates that were perhaps more interesting, coming a day after the Fed's policy-making arm decided to keep short-term rates at a record low near zero.
"I think that what will happen is that short-term interest rates go up because the economy strengthens and then long term rates might go up as well," the Fed chief said. He was responding to a lawmaker question on whether the U.S. is dependent on carry trades in Japan and China to finance its large debt.
The Fed chief said that keeping short-term interest rates too low for too long may spark inflation, but added the U.S. economy wasn't under such a risk for the time being.
Bernanke was being challenged by long-time Fed critic Ron Paul (R., Texas), who argued the Fed was responsible for the recent financial crisis by leaving rates too low for too long. Paul asked Bernanke what damage could come from ultra-low rates another time.
"One possibility is that... you get inflation," Bernanke replied, adding that "every central banker wants to be sure that prices remain stable." The Fed chairman went on to say, however, that rates were so low right now because the economy remained weak. He said low rates help to spur job creation and lift consumption.
The Fed Tuesday said it expects to keep short-term interest rates close to zero for several months at least due to low inflation and the considerable slack remaining in the economy.
"Central banking is an art and we need to balance our dual mandate" of maximum employment and stable prices, Bernanke said.
Turning to bank supervision, Bernanke said the Fed's oversight of state-chartered and community banks helps the central bank set monetary policy and lend to commercial banks.
Senate Banking Committee Chairman Christopher Dodd (D., Conn.) introduced a broad regulatory overhaul package Monday that includes provisions to strip the Fed of its oversight of state-chartered banks and bank holding companies with less than $50 billion in assets.
"It makes us essentially the too-big-to-fail regulator," Bernanke told the House Financial Services Committee. "We don't want that responsibility. We want to have a connection to Main Street as well as Wall Street."
Bernanke said Fed officials are "quite concerned" by the proposal because they want an understanding of firms of all sizes and at all levels. "Smaller and medium-sized banks are very valuable to us," providing information for monetary policy, for understanding the economy and for financial stability. He reminded lawmakers that small institutions were part of prior financial crises, such as those in the 1930s and in the thrift crisis.
Former Fed Chairman Paul Volcker, also testifying at the hearing, called the $50 billion barrier "arbitrary" and warned of the risks from separating out those firms. "We don't want to single out some institutions as too big to fail. We want a system particularly where non-bank institutions can fail."
Volcker later called the $50 billion threshold "much too low in my opinion" in determining which firms really would need to be saved.
Copyright 2009 Dow Jones Newswires
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