U.S. Must Start to Rein In Deficit, Fed Chief Says

April 15, 2010

New York Times

SEWELL CHAN

WASHINGTON - The Federal Reserve chairman said Wednesday that the government had to make “difficult choices” to address its gaping deficits and warned that “postponing them will only make them more difficult.”

The chairman, Ben S. Bernanke, said that a credible plan for reining in federal deficits could help lower long-term interest rates. “Although sizable deficits are unavoidable in the near term, maintaining the confidence of the public and financial markets requires that policy makers move decisively to set the federal budget on a trajectory toward sustainable fiscal balance,” he said.

In testimony to the Joint Economic Committee of Congress, Mr. Bernanke said that a moderate recovery had begun, but that it would take “a significant amount of time” to restore the 8.5 million jobs lost in the last two years. Of particular concern, he said, was that 44 percent of the unemployed in March had been jobless for at least six months.

Inflation, the other side of Mr. Bernanke’s mandate as Fed chairman, remains low. Personal consumption spending, the index of inflation the Fed uses the most, has been rising at an annual rate of 1.25 percent. Excluding the more volatile prices of food and energy, core inflation has slowed to an annual rate of 0.5 percent.

Mr. Bernanke did not provide new details on the Fed’s policy stance that short-term interest rates would remain near zero for “an extended period.” He said that time frame was contingent on high unemployment, subdued inflation and stable inflation expectations.

“If those conditions cease to hold, and we anticipate changes in the outlook, then of course we will respond to that,” he told the committee’s chairwoman, Representative Carolyn B. Maloney, Democrat of New York.

Mr. Bernanke’s fiscal admonitions came a week after he gave a speech in Dallas warning that the country must prepare for the aging of the population. They could give momentum to the bipartisan fiscal commission created by President Obama. He did not specify whether he believed the government should raise taxes, make cuts to Social Security and other benefits programs, or do something else.

He did warn the nation’s debts and deficits could at some point alarm investors and raise the government’s borrowing costs.

“At some point, the markets will make a judgment about, really, not our economic capacity but our political ability, our political will, to achieve longer-term sustainability,” Mr. Bernanke told Senator Sam Brownback, Republican of Kansas. “At that point interest rates could go up and that would be, of course, a negative for economic growth and recovery.”

Could it happen now? Mr. Bernanke replied, “It’s absolutely possible, certainly.”

Later, he told Senator Amy Klobuchar, Democrat of Minnesota, that “right now the markets are essentially signaling a lot of confidence that our political system will deliver a sustainable trajectory of fiscal policy” over the next few decades.

“If we don’t do it, or we give a strong indication that we’re not going to be able to do it,” he warned, “then it would not be something that we have to worry about in 2040; it could be something we have to worry about on Wednesday.”

The deficit will start to “recede somewhat” over the next two years as the stimulus winds down and the recovery brings in more revenue, but is projected to remain around 4 to 5 percent of gross domestic product through 2020, Mr. Bernanke said.

Under a more gloomy situation — one that assumes 60,000 American troops in overseas operations by 2015, discretionary spending growing at the rate of nominal gross domestic product, the extension of expiring tax cuts and an inflation-indexed alternative minimum tax — the deficit could reach 9 percent of G.D.P. by 2020, he said.

Mr. Bernanke also addressed the politically heated issue of China’s currency. He told Senator Charles E. Schumer, Democrat of New York, that “most economists agree the Chinese currency is undervalued and has been used to promote a more export-oriented economy. I think it would be good for the Chinese to allow more flexibility in their exchange rate.”

Letting its currency, the renminbi, appreciate would give China’s central bank more flexibility in monetary policy and help stimulate domestic demand and consumption, Mr. Bernanke said.

He also told Representative Kevin Brady, Republican of Texas, that the Fed would not try to monetize debts by increasing the money and credit supply and stimulating inflation.

“Given that so many of our obligations are either short-term or indexed or are real obligations, such as medical obligations or Social Security obligations, which are indexed, it wouldn’t have a substantial effect, even if there were a willingness to do that, which, of course, there is not,” he said. “Inflation is just not an answer, either for economic reasons and just because it wouldn’t affect the balance very much.”

Mr. Bernanke said the economy had begun to recover in the second half of 2009, as companies worked down excess inventories and expanded production.

Since the middle of last year, consumer spending has been rising at a rate of about 2.5 percent a year, and car sales picked up in March. Manufacturing in the eight months ending in February grew at an annual rate of 8 percent, in part because of stronger demand from foreign markets.

But Mr. Bernanke also described “significant restraints on the pace of the recovery.” Sales of new and existing homes fell in January and February, the pace of housing starts is sluggish, and the commercial real estate market is still shrinking, he said. State and local governments, he added, have cut back on jobs and construction spending.

Mr. Bernanke said that banks and financial markets had recovered since the 2008 crisis, in part because of the Fed’s extraordinary lending programs and “stress tests” that bolstered investor confidence.

However, lending to households and businesses has continued to fall, a result of a sluggish demand and a fall in creditworthy borrowers, he said.

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