WASHINGTON (MNI) – The following is the second and final section of
Federal Reserve Chairman Ben Bernanke’s testimony prepared Thursday for
the Joint Economic Committee:
The economy’s performance over the medium and longer term also will
depend importantly on the course of fiscal policy. Fiscal policymakers
confront daunting challenges. As they do so, they should keep three
objectives in mind. First, to promote economic growth and stability, the
federal budget must be put on a sustainable long-run path. The federal
budget deficit, which averaged about 9 percent of GDP during the past
three fiscal years, is likely to narrow in coming years as the economic
recovery leads to higher tax revenues and lower income support payments.
Nevertheless, the Congressional Budget Office (CBO) projects that, if
current policies continue, the budget deficit would be close to 5
percent of GDP in 2017 when the economy is expected to be near full
employment.3 Moreover, under current policies and reasonable economic
assumptions, the CBO projects that the structural budget gap and the
ratio of federal debt to GDP will trend upward thereafter, in large part
reflecting rapidly escalating health expenditures and the aging of the
population. This dynamic is clearly unsustainable. At best, rapidly
rising levels of debt will lead to reduced rates of capital formation,
slower economic growth, and increased foreign indebtedness. At worst,
they will provoke a fiscal crisis that could have severe consequences
for the economy. To avoid such outcomes, fiscal policy must be placed on
a sustainable path that eventually results in a stable or declining
ratio of federal debt to GDP.
Even as fiscal policymakers address the urgent issue of fiscal
sustainability, a second objective should be to avoid unnecessarily
impeding the current economic recovery. Indeed, a severe tightening of
fiscal policy at the beginning of next year that is built into current
law — the so-called fiscal cliff — would, if allowed to occur, pose a
significant threat to the recovery. Moreover, uncertainty about the
resolution of these fiscal issues could itself undermine business and
household confidence. Fortunately, avoiding the fiscal cliff and
achieving long-term fiscal sustainability are fully compatible and
mutually reinforcing objectives. Preventing a sudden and severe
contraction in fiscal policy will support the transition back to full
employment, which should aid long-term fiscal sustainability. At the
same time, a credible fiscal plan to put the federal budget on a
longer-run sustainable path could help keep longer-term interest rates
low and improve household and business confidence, thereby supporting
improved economic performance today.
A third objective for fiscal policy is to promote a stronger
economy in the medium and long term through the careful design of tax
policies and spending programs. To the fullest extent possible, federal
tax and spending policies should increase incentives to work and save,
encourage investments in workforce skills, stimulate private capital
formation, promote research and development, and provide necessary
public infrastructure. Although we cannot expect our economy to grow its
way out of federal budget imbalances without significant adjustment in
fiscal policies, a more productive economy will ease the tradeoffs faced
by fiscal policymakers.
Thank you. I would be glad to take your questions.
——————
1 In particular, the unusually warm weather this past winter may
have brought forward some hiring in sectors such as construction where
activity normally is subdued during the coldest months; thus, some of
the slower pace of job gains this spring may have represented a payback
for that earlier hiring. In addition, the estimated seasonal factors for
some economic indicators may have been influenced by the timing of the
steepest part of the decline in activity during the 2008-09 winter
months; if so, the seasonal adjustment process may have resulted in an
overstatement of economic activity this past winter and the
understatement of activity in other months.
2 For further discussion, see Ben S. Bernanke (2012), “Recent
Developments in the Labor Market,” speech delivered at the National
Association for Business Economics Annual Conference, Washington, March
26, www.federalreserve.gov/newsevents/speech/bernanke20120326a.htm.
3 This projection is the alternative fiscal scenario in the
Congressional Budget Office (2012), Updated Budget Projections: Fiscal
Years 2012 to 2022 (Washington: CBO, March), available at
www.cbo.gov/publication/43119
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** MNI Washington Bureau: 202-371-2121 **
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