By Steven K. Beckner
(MNI) – Federal Reserve Chairman Ben Bernanke Monday night
displayed a growing degree of alarm about record federal budget deficits
and called for action to reduce them over time.
Bernanke said there is “little scope” for reducing the $1.4
trillion budget deficit over the next year or two. Indeed he warned that
“premature fiscal tightening could put the recovery at risk” in remarks
prepared for delivery to the Rhode Island Public Expenditure Council in
Providence.
But longer term, he declared it “crucially important” to put fiscal
policy “on a sustainable path.”
If steps are not taken to curb deficit spending, he warned that
deficits will continue to grow as a percent of national income and
become more and more difficult to finance. Just paying interest on the
national debt will become increasingly costly and render the United
States even more dependent on foreign creditors, he predicted.
Calling the budgetary threat to the economy “real and growing,”
Bernanke said a “credible plan” is needed to reduce it — possibly
employing some kind of fiscal policy rule.
Failure to do so, he said, “would endanger” America’s economic
future.
“For now, the budget deficit has stabilized and, so long as the
economy and financial markets continue to recover, it should narrow
relative to national income over the next few years,” the Fed chief
said.
“Economic conditions provide little scope for reducing deficits
significantly further over the next year or two; indeed, premature
fiscal tightening could put the recovery at risk,” he added.
However, Bernanke said that “over the medium- and long-term,
however, the story is quite different.”
“If current policy settings are maintained, and under reasonable
assumptions about economic growth, the federal budget will be on an
unsustainable path in coming years, with the ratio of federal debt held
by the public to national income rising at an increasing pace,” he
warned.
“Moreover, as the national debt grows, so will the associated
interest payments, which in turn will lead to further increases in
projected deficits.”
Bernanke said “expectations of large and increasing deficits in the
future could inhibit current household and business spending–for
example, by reducing confidence in the longer-term prospects for the
economy or by increasing uncertainty about future tax burdens and
government spending–and thus restrain the recovery.”
What’s more, “concerns about the government’s long-run fiscal
position may also constrain the flexibility of fiscal policy to respond
to current economic conditions,” he went on. “Accordingly, steps taken
today to improve the country’s longer term fiscal position would not
only help secure longer-term economic and financial stability, they
could also improve the near-term economic outlook.”
Being “unsustainable,” adjustments of the federal deficit will
inevitably occur at some point “because creditors would never be willing
to lend to a country in which the fiscal debt relative to the national
income is rising without limit,” he said.
“The only real question is whether these adjustments will take
place through a careful and deliberative process that weighs priorities
and gives people plenty of time to adjust to changes in government
programs or tax policies, or whether the needed fiscal adjustments will
be a rapid and painful response to a looming or actual fiscal crisis.”
Bernanke has been much more reluctant than predecessor Alan
Greenspan to make fiscal policy recommendations, but he has become
increasingly vocal in recent months about the sheer magnitude of the
budget deficit and its economic consequences.
“Failing to address our unsustainable fiscal situation exposes our
country to serious economic costs and risks,” he said. “In the short
run, … concerns and uncertainty about exploding future deficits could
make households, businesses, and investors more cautious about spending,
capital investment, and hiring.”
“In the longer term, a rising level of government debt relative to
national income is likely to put upward pressure on interest rates and
thus inhibit capital formation, productivity, and economic growth,” he
continued. “Larger government deficits increase our reliance on foreign
lenders, all else being equal, implying that the share of U.S. national
income devoted to paying interest to foreign investors will increase
over time.”
“Income paid to foreign investors is not available for domestic
consumption or investment,” he went on. “And an increasingly large cost
of servicing a growing national debt means that the adjustments, when
they come, could be sharp and disruptive.”
“For example, large tax increases that might be imposed to cover
the rising interest on the debt would slow potential growth by reducing
incentives to work, save, hire, and invest,” he added.
Bernanke said there is no precise threshold or tipping point at
which the U.S. budget deficit causes major problems, but said, “What we
do know, however, is that the threat to our economy is real and growing,
which should be sufficient reason for fiscal policymakers to put in
place a credible plan for bringing deficits down to sustainable levels
over the medium term.”
After reviewing “PAYGO” and other rules that might be used to rein
in deficits, Bernanke noted that those have been tried in the past
without success in the United States.
Ultimately, what is required is “political will,” he said.
** Market News International Washington Bureau: 202-371-2121 **
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