“The way the current law is set up, we are going to have a very, very sharp contraction in the fiscal situation, increased taxes and cuts [in] spending that are very dramatic and that occur almost simultaneously on January 1 of 2013,” Bernanke told the House Financial Services Committee. “If that all happens, that will no doubt do serious damage to the recovery and probably would cost a significant number of jobs.”
Bernanke defended the central bank’s efforts to stimulate the economy, including buying up U.S. Treasury bonds and maintaining near-zero short-term interest rates.
When Rep. Jeb Hensarling (R-Tex.) pointedly pressed the Fed chief on whether the stimulus actions had done much to help the economy, Bernanke responded that the bond-buying program, called quantitative easing, has triggered improvement.
“I think that the previous efforts did have productive effects,” Bernanke said. “QE 1, for example, was followed a few months later by beginning the recovery. . . . And QE 2 came at a time when we were seeing increased risk of deflation which was eliminated by the QE2.”
But Bernanke added, as he has suggested repeatedly in urging action from Congress and the White House, that the Fed’s role in boosting the economy remains limited, “that monetary policy is not a panacea.”
As Bernanke’s testimony has shown over the last two days, it has become increasingly clear that the greatest concern for the economy is shifting from what’s happening abroad to what’s happening at home.
For much of the year, economists worried about the impact of the slowdown in Europe on the U.S. economy. Now, analysts say anxiety about the impact of the fast-approaching fiscal cliff — the series of federal spending cuts and tax hikes set to take effect at the beginning of 2013 if Congress and the Obama administration do not act — is displacing Europe as the primary threat to the nation’s sputtering economy.
Morgan Stanley said this week that fears about the fiscal cliff are reaching new heights across a wide range of industries. It is already seeing reductions in business orders and hiring, among other areas.
“While our analysts are somewhat less worried about the impact of European bank strains,” a Morgan Stanley report said Monday, “the negative impact of fiscal cliff uncertainty is becoming more widespread.”
The potential economic impact could smother the flickering recovery and further stifle job creation, analysts warn.
A new report commissioned by the aerospace industry says federal budget cuts set to take effect in January could cost the country’s economy more than 2 million jobs and raise the national unemployment rate by 1.5 percentage points over the next year.
“The results are bleak but clear-cut,” said Stephen S. Fuller, the George Mason University professor who wrote the report. “The unemployment rate will climb above 9 percent, pushing the economy toward recession and reducing projected growth in 2013 by two-thirds.”
The report echoes warnings from economists and policymakers who are urging lawmakers to find a way to put the nation on a sustainable fiscal path without derailing short-term growth.
Along with Bernanke, this week other top economic forecasters reduced their expectations for U.S. economic growth, in large part because of the uncertainty about the fiscal cliff. Economists say the automatic actions slated to take place at the end of the year — an increase in payroll taxes and in income tax rates, as well as large cuts in domestic and defense spending — would tip the country back into recession.
Congress could prevent that outcome, but lawmakers are pledging to do so only on their terms, creating fears of added partisan gridlock. Democrats insist that taxes rise for higher-income earners; Republicans want to include the affluent in any renewal of the George W. Bush-era tax cuts.
Meanwhile, the prospect of a government-induced recession is already taking a toll on the economy.
“The most effective way that the Congress could help to support the economy right now would be to work to address the nation’s fiscal challenges in a way that takes into account both the need for long-run sustainability and the fragility of the recovery,” Bernanke said in testimony to the Senate banking committee Tuesday. “Doing so earlier rather than later would help reduce uncertainty and boost household and business confidence.”
He said the economic recovery has lost momentum in recent months, sapping consumer confidence and crimping job creation.
But Bernanke gave no indication as to whether the Fed would take additional steps to try to boost growth at its meeting later this month. He said the central bank’s decision on any further fiscal stimulus would turn on whether it determines that the job market is recovering or is “stuck in the mud.”
Bernanke added that concerns about the fiscal cliff, along with ongoing economic problems in Europe, are a significant drag on U.S. growth. He noted that the Congressional Budget Office has estimated that going over the cliff would trigger a shallow recession early next year.
“These estimates do not incorporate the additional negative effects likely to result from public uncertainty about how these matters will be resolved,” he said.
After strong gains at the end of 2011 and in the first three months of this year, job creation has slowed substantially. The nation’s unemployment rate is 8.2 percent, marking 41 consecutive months that it has hovered above 8 percent.
The manufacturing sector in June contracted for the first time in three years, according to private data released this month. Also, U.S. retail sales fell in June for the third consecutive month as consumers cut spending.
Bill Gross, founder of the investment-management firm Pimco, said on Twitter that the nation is “approaching recession when measured by employment, retail sales, investment, and corporate profits.”