Federal Reserve Chairman Ben Bernanke delivered a stark warning to lawmakers in a high-profile speech Tuesday, saying that the U.S. economy is at risk if they bungle negotiations over the looming austerity crisis.
Bernanke’s remarks are notable less for their substance than for their tone and timing. In his most prominent public speech in almost three months, Bernanke made clear that he sees grave risks should the bargaining over the “fiscal cliff” — a phrase he coined — lead to either steep, immediate fiscal austerity or prolonged, confidence-rattling brinksmanship. And he suggested that 2013 could be a good year for the U.S. economy if lawmakers reach a deal quickly and amicably.
Uncertainty over U.S. fiscal policy “appears already to be affecting private spending and investment decisions and may be contributing to an increased sense of caution in financial markets, with adverse effects on the economy,” Bernanke told an audience of the Economic Club of New York, according to a prepared text. And the nation’s future prospects may be shaped in part by whether policymakers act in ways that instill confidence in the stability of U.S. policy.
The economy is already bearing the weight of that anxiety, Bernanke said, and “such uncertainties will only be increased by discord and delay. In contrast, cooperation and creativity to deliver fiscal clarity . . . could help make the new year a very good one for the American economy.”
As he has before, Bernanke warned that the tax increases and spending cuts now scheduled to take effect Jan. 1 would harm the economy. “The Congress and the Administration will need to protect the economy from the full brunt of the severe fiscal tightening at the beginning of next year that is built into current law,” Bernanke said. A failure to act “would pose a substantial threat to the recovery” and would, by the reckoning of analysts at the Congressional Budget Office and elsewhere, “send the economy toppling back into recession.”
As is his habit, Bernanke did not publicly endorse specific tax and spending policies as part of a deal. Rather, he called generally for policymakers to “think creatively and work together constructively,” working to find a “credible plan to put the federal budget on a path that will be sustainable in the long run” while also taking actions that “avoid unnecessarily adding to the headwinds that are already holding back the economic recovery” by introducing austerity policies too quickly.
But he left no doubt that a negotiation process like that over raising the debt ceiling in the summer of 2011 could be destabilizing for a fragile economy. “The economic confidence of both market participants and the general public likely will also be influenced by the extent to which our political system proves able to deliver a reasonable solution with a minimum of uncertainty and delay.”
Other points to note from Bernanke’s first major speech on the economy since the end of August:
Monetary policy: Bernanke affirmed the Fed’s intention to continue low-interest-rate policies to try to stimulate growth, but he gave no hints that the central bank would announce “thresholds” for unemployment and inflation that might prompt a rise in interest rates. Several of his colleagues, including Fed vice chairwoman Janet Yellen, have advocated that new approach. In a question-and-answer session following the speech, he signaled openness to the approach, however. "This is a very promising direction, and we are continuing to look at it," Bernanke said, adding that "I don't want to front-run those discussions which are still ongoing."
Housing: Bernanke seemed optimistic on the housing sector, saying that "it seems likely that, on net, residential investment will be a source of economic growth and new jobs over the next couple of years." But he added that tight credit and other factors may "prevent the sort of powerful housing recovery that has typically occurred in the past."
Structural unemployment: Bernanke seemed a bit more open than in the past to arguments that the deep crisis and recession of 2008-2009 may have reduced the nation's economic potential. Echoing a Congressional Budget Office study last week, the Fed chief noted that "potential output may have grown more slowly than expected in recent years," though he added that this "seems at best a partial explanation of the disappointing pace of the economic recovery." The U.S. economy's productive potential may be lower in part because workers who have been out of work for extended periods of time may have had their skills atrophy, and as businesses have invested in fewer new machines.