–Bernanke: Recent Evidence Self-sustaining Recovry Taking Hold

WASHINGTON (MNI) – The following is the second and final part of
the full text of Federal Reserve Chairman Ben Bernanke’s testimony
Friday before the U.S. Senate Budget Committee:

In light of this experience, and with the economic outlook still
unsatisfactory, late last summer the FOMC began to signal to financial
markets that it was considering providing additional monetary policy
accommodation by conducting further asset purchases. At its meeting in
early November, the FOMC formally announced its intention to purchase an
additional $600 billion in Treasury securities by the end of the second
quarter of 2011, about one-third of the value of securities purchased in
its earlier programs. The FOMC also maintained its policy, adopted at
its August meeting, of reinvesting principal received on the Federal
Reserve’s holdings of securities.

The FOMC stated that it will review its asset purchase program
regularly in light of incoming information and will adjust the program
as needed to meet its objectives. Importantly, the Committee remains
unwaveringly committed to price stability and, in particular, to
maintaining inflation at a level consistent with the Federal Reserve’s
mandate from the Congress. In that regard, it bears emphasizing that the
Federal Reserve has all the tools it needs to ensure that it will be
able to smoothly and effectively exit from this program at the
appropriate time. Importantly, the Federal Reserve’s ability to pay
interest on reserve balances held at the Federal Reserve Banks will
allow it to put upward pressure on short-term market interest rates and
thus to tighten monetary policy when needed, even if bank reserves
remain high. Moreover, the Fed has invested considerable effort in
developing methods to drain or immobilize bank reserves as needed to
facilitate the smooth withdrawal of policy accommodation when conditions
warrant. If necessary, the Committee could also tighten policy by
redeeming or selling securities on the open market.

As I am appearing before the Budget Committee, it is worth
emphasizing that the Fed’s purchases of longer-term securities are not
comparable to ordinary government spending. In executing these
transactions, the Federal Reserve acquires financial assets, not goods
and services. Ultimately, at the appropriate time, the Federal Reserve
will normalize its balance sheet by selling these assets back into the
market or by allowing them to mature. In the interim, the interest that
the Federal Reserve earns from its securities holdings adds to the Fed’s
remittances to the Treasury; in 2009 and 2010, those remittances totaled
about $120 billion.

Fiscal Policy

Fiscal policymakers also face a challenging policy environment. Our
nation’s fiscal position has deteriorated appreciably since the onset of
the financial crisis and the recession. To a significant extent, this
deterioration is the result of the effects of the weak economy on
revenues and outlays, along with the actions that were taken to ease the
recession and steady financial markets. In their planning for the near
term, fiscal policymakers will need to continue to take into account the
low level of economic activity and the still-fragile nature of the
economic recovery.

However, an important part of the federal budget deficit appears to
be structural rather than cyclical; that is, the deficit is expected to
remain unsustainably elevated even after economic conditions have
returned to normal. For example, under the Congressional Budget Office’s
(CBO) so-called alternative fiscal scenario, which assumes that most of
the tax cuts enacted in 2001 and 2003 are made permanent and that
discretionary spending rises at the same rate as the gross domestic
product (GDP), the deficit is projected to fall from its current level
of about 9 percent of GDP to 5 percent of GDP by 2015, but then to rise
to about 6-1/2 percent of GDP by the end of the decade. In subsequent
years, the budget outlook is projected to deteriorate even more rapidly,
as the aging of the population and continued growth in health spending
boost federal outlays on entitlement programs. Under this scenario,
federal debt held by the public is projected to reach 185 percent of the
GDP by 2035, up from about 60 percent at the end of fiscal year 2010.

The CBO projections, by design, ignore the adverse effects that
such high debt and deficits would likely have on our economy. But if
government debt and deficits were actually to grow at the pace
envisioned in this scenario, the economic and financial effects would be
severe. Diminishing confidence on the part of investors that deficits
will be brought under control would likely lead to sharply rising
interest rates on government debt and, potentially, to broader financial
turmoil. Moreover, high rates of government borrowing would both drain
funds away from private capital formation and increase our foreign
indebtedness, with adverse long-run effects on U.S. output, incomes, and
standards of living.

It is widely understood that the federal government is on an
unsustainable fiscal path. Yet, as a nation, we have done little to
address this critical threat to our economy. Doing nothing will not be
an option indefinitely; the longer we wait to act, the greater the risks
and the more wrenching the inevitable changes to the budget will be. By
contrast, the prompt adoption of a credible program to reduce future
deficits would not only enhance economic growth and stability in the
long run, but could also yield substantial near-term benefits in terms
of lower long-term interest rates and increased consumer and business
confidence. Plans recently put forward by the President’s National
Commission on Fiscal Responsibility and Reform and other prominent
groups provide useful starting points for a much-needed national
conversation about our medium- and long-term fiscal situation. Although
these various proposals differ on many details, each gives a sobering
perspective on the size of the problem and offers some potential

Of course, economic growth is affected not only by the levels of
taxes and spending, but also by their composition and structure. I hope
that, in addressing our long-term fiscal challenges, the Congress will
seek reforms to the government’s tax policies and spending priorities
that serve not only to reduce the deficit but also to enhance the
long-term growth potential of our economy–for example, by encouraging
investment in physical and human capital, by promoting research and
development, by providing necessary public infrastructure, and by
reducing disincentives to work and to save. We cannot grow out of our
fiscal imbalances, but a more productive economy would ease the
tradeoffs that we face.

Thank you. I would be pleased to take your questions.

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** Market News International Washington Bureau: 202-371-2121 **