WASHINGTON, D.C. - Testifying before Congress Tuesday morning, Federal Reserve Chairman Ben Bernanke said the Fed expects the economy to return to growth later this year.  The key elements of the Fed's forecast are expectation that the housing market is stabilizing, that the fall in business investment will slow, and that the actions of the Federal Reserve and the White House's stimulus package will all contribute to growth.  But, crucially, recovery depends on the health of the financial system. "An important caveat is that our forecast assumes continuing gradual repair of the financial system," Bernanke said. "A relapse in financial conditions would be a significant drag on economic activity and could cause the incipient recovery to stall."  Bernanke addressed Congress just two days before a crucial phase in the government effort to stabilize that system. Thursday afternoon, the Federal Reserve will release the results of the "stress tests" in which the largest 19 banks in the U.S. were tested to see how they would weather a deep recession.  The stress-test results seem unlikely to suggest any bank is in immediate trouble. Bernanke emphasized that "following the announcement of the results, bank holding companies will be required to develop comprehensive capital plans for establishing the required buffers. They will then have six months to execute those plans." In follow-up questioning from Congress, he said the tests would not show that any banks needed to raise money imminently and that he was hopeful banks would be able to raise any capital they needed in private markets.  Bernanke said the news on the health of the financial system was still mixed. Although many of America's largest banks reported profits in the first quarter--Bank of America ( BAC - news - people ), Citigroup ( C - news - people ), Wells Fargo ( WFC - news - people )and JPMorgan Chase ( JPM - news - people )--the recipients of $100 billion of TARP money, surprised markets with profits in the first three months of 2009.  Bernanke also noted that demand for several of the Federal Reserve's emergency facilities, such as the term securities lending facility and commercial paper facility, which provide emergency or short-term financing for businesses, are seeing declining demand. "That's a good sign that demand for short-term liquidity is diminishing or being replaced by private-sector liquidity," said Bernanke.  Tempering his optimism, Bernanke noted credit markets indicate that substantial concerns about the banking industry remain. And he said that although mortgage rates are low, mortgage activity depends largely on the massive government support of Fannie Mae ( FNM - news - people ) and Freddie Mac ( FRE - news - people ).  It is welcome news that the Federal Reserve expects a bottoming and return to growth during 2009. But unlike some forecasts, including that of the White House, that predict the economy will return to rapid growth following the deep recession, Bernanke expects a sluggish recovery.  The White House anticipates a V-shaped recovery, where, following a sharp decline, the economy has a quick turnaround and a sharp period of growth. Pessimistic economists predict an L-shaped recovery, in which the decline stops but the economy bumps along at a low level for years. Bernanke seemed to throw his support behind an intermediate scenario: a U-shaped recovery, with a gradual, not swift, return to robust growth.  "We expect that the recovery will only gradually gain momentum and that economic slack will diminish slowly. In particular, businesses are likely to be cautious about hiring, implying that the unemployment rate could remain high for a time, even after economic growth resumes."  The prolonged slack in the job market accompanying a U-shaped recession is also expected to keep inflation under control, Bernanke says. If he's right, the road to recovery is still fraught with land mines. But at least we're moving along.
If the financial system does not relapse, the economy will return to growth this year, Fed chairman says.