Bernanke tells Senate: Focus on growth now, deficit cuts later

February 7, 2012

Federal Reserve Chairman Ben Bernanke kept to his message of caution on Tuesday, warning a Senate panel that sharp spending cuts and tax increases scheduled to take effect in early 2013 could slow the nation’s economic recovery if federal officials do not take further action.

Despite the recent upturn in the jobs market, Bernanke said while testifying before the Senate Budget Committee on the state of the economy, “the pace of the recovery has been frustratingly slow.” He cautioned the lawmakers not to impede near-term growth in the name of cutting the long-term deficit, reiterating the arguments he made to the House Budget Committee last week.

In his testimony, Bernanke repeated his modestly optimistic outlook for 2012, saying that Fed officials “expect somewhat stronger growth this year than in 2011.” According to the Labor Department’s monthly unemployment report released Friday, the United Staters added 243,000 jobs in January, bringing the jobless rate down to 8.3 percent, defying many less positive forecasts.

Bernanke did not refer to the upbeat jobs data, but he singled out the revival of manufacturing as a significant engine in the recovery. “U.S. manufacturers have become increasingly competitive on global stage,” he said, crediting the country’s leadership in education, research and technology for the boost.

But the Fed chief continued to stress that a sharp, immediate push to reduce the deficit could harm the recovery in the upcoming months. In January 2013, he pointed out, the George W. Bush tax cuts will expire, and the major spending cuts triggered by the Budget Control Act will take effect, absent any further action by Congress. As a result, “there will be sharp change in fiscal stance of the federal government. Without compensating action, it would indeed slow the recovery,” Bernanke told the committee members.

Sen. Jeff Sessions (Ala.), the highest-ranking Republican on the committee, however, asked Bernanke whether the country’s current deficit was itself holding back the recovery and discouraging key market players.

Bernanke responded that the markets are “not reacting to the current level of debt” but are eyeing how the federal government reduces that debt and maintains the nation’s economic recovery. He pointed to the uncertainty triggered by the standoff between the White House and House Republicans last year over a plan to raise the debt ceiling, which eventually led the Standard & Poor’s ratings agency to downgrade the U.S. credit rating.

Bernanke recommended that legislators come up with a deficit reduction plan phased in over a longer period to reduce the risk of immediate shocks to a still-vulnerable economy while promoting a more sustainable fiscal path. “What we want to do is have a credible, strong plan so that the economy doesn’t hit a huge pothole,” he said.

Bernanke also defended the Fed’s policy of keeping interest rates at historically low levels. Last month, the Federal Open Market Committee announced that it expected to keep interest rates at near zero through late 2014.

During Tuesday’s hearing, Republican senators raised concerns that the Fed’s strategy on interest rates would lead to runaway inflation. Bernanke pointed out that inflation had remained relatively low throughout his tenure and that the Fed expected that trend would continue. “Our projections are that inflation will be very subdued—probably below our 2 percent target in 2012 and 2013,” he said.

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