Bernanke admits US is contracting but plays down 'Great Depression'

Ben Bernanke, the chairman of the Federal Reserve, has admitted for the first time that the US economy may be contracting, but he said suggestions that the country was heading into a new Great Depression were unlikely to prove true.

Assailed by references to the economic catastrophe of the 1930s during his testimony before Congress yesterday, Mr Bernanke – one of the world's foremost scholars of the causes of the Depression – said the modern-day Fed was pursuing "creative" actions to shore up confidence in the financial system.

His comments were the first public references to the Fed's role in the bail-out of Bear Stearns, whose failure last month would have had consequences that "could have been severe and extremely difficult to contain", he told the joint economic committee.

The Fed stepped in with a $29bn loan to support JPMorgan's takeover of Bear Stearns and ripped up decades of previous central banking policy to promise that it would act as lender of last resort not just to retail banks but also now to Wall Street. "We think we have been pretty creative," Mr Bernanke said.

The Fed chairman batted away suggestions that it would have been better to let Bear Stearns go into liquidation, to punish it for poor investments in sub-prime mortgages. He said that, "with the very glaring exception of the 1930s, the Fed has been an eff-ective market stability regul-ator".He added: "At the time of the Depression, liquidationist theory was supported by the Treasury, and it was partly on the basis of that theory that the Fed stood by and let a third of the banks in the country fail. The financial stability that was not addressed was a major contributor to the Depression, not just in the US but abroad. Today we will not let prices fall at 10 per cent a year, we will act to keep the economy growing and stable. There are very great differences between the 1930s and today."

Mr Bernanke repeated his prediction of a rebound in the US economy later this year but conceded: "It now appears likely that real gross domestic product will not grow much, if at all, over the first half of 2008, and could even contract slightly". It was before the joint economic committee a year ago that Mr Bernanke predicted "the impact on the broader economy and financial markets of the problems in the sub-prime market seem likely to be contained" – a prediction that proved not to be the case.

The International Monetary Fund has again cut its forecast for global growth this year, it emerged yesterday. The world economy will grow at the slowest pace since 2002, according to an IMF document obtained by Bloomberg News, and there is a one-in-four chance of an all-out global recession.

"Global expansion is losing momentum in the face of what has become the largest financial crisis in the US since the Great Depression," the IMF says.