Bernanke Presses For Fiscal Restraint

Federal Reserve Chairman Ben S. Bernanke testifies before the House Budget Committee. Bernanke said large deficits threaten financial stability.
Federal Reserve Chairman Ben S. Bernanke testifies before the House Budget Committee. Bernanke said large deficits threaten financial stability. (By Joshua Roberts -- Bloomberg News)
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By Neil Irwin
Washington Post Staff Writer
Thursday, June 4, 2009

The nation needs to begin planning now to eventually bring taxes and spending in line, Federal Reserve Chairman Ben S. Bernanke said yesterday, arguing that large budget deficits, if sustained, could deepen the financial crisis and choke off the economy.

Bernanke's testimony to Congress reflected growing concern among economists and investors that the nation's long-term fiscal imbalances could stand in the way of economic recovery by driving up the interest rates that the government, businesses and consumers pay to borrow money. The rate the government pays has already risen in recent weeks.

The Fed chairman argued that even as the government spends massive amounts of money to contain the financial crisis, it must be prepared to move toward fiscal balance.

"Congress and the administration face formidable near-term challenges that must be addressed," Bernanke told the House Budget Committee. But "unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth."

The financial crisis is driving the country deeply into the red, with the national debt projected to double from about 41 percent of the economy last year to more than 82 percent by the end of the next decade. Thereafter, things will only get worse, budget analysts say, as the baby boom generation lays claim to benefits from Social Security and costly federal health programs. So far, President Obama has offered no plan to rein in those costs, though he has stressed the importance of reducing the deficit generally.

Bernanke frequently delivers messages on the need for fiscal responsibility to congressional budget committees. But his comments yesterday carried more weight given recent swings in the market for Treasury bonds. In particular, the global investors who finance the nation's large budget deficits have grown more antsy.

The U.S. Treasury must now pay 3.5 percent to borrow money for 10 years -- low by historical standards, but up from about 3.1 percent a month ago and 2.9 percent three months ago. The increase has come even as the Fed has launched a program to buy up to $300 billion in Treasury bonds -- purchases designed to push down rates and did, when the program was rolled out in March.

The higher rates for government borrowing have many likely causes, and some of those reflect improvement in financial markets. For example, as investors have become more comfortable investing in risky assets such as stocks, they have been willing to move money out of safe U.S. Treasury bonds and into other investments.

But other reasons for the shift are less positive. Investors are also worried that Congress and the Obama administration will continue to rely heavily on borrowed money to fund the government and thus are demanding a higher premium to lend it money.

"These increases appear to reflect concerns about large federal deficits," Bernanke said in his testimony, before naming other causes that are also playing a role.

Some analysts worry that the Fed will succumb to political pressure in the future to effectively print money to fund government borrowing -- a process known as monetizing the debt. Two congressmen raised that possibility explicitly in yesterday's hearing.

"This can be a dangerous policy mix. The Treasury is issuing debt. And the central bank is buying it," said Rep. Paul D. Ryan (R-Wis.). "It gives the alarming impression that the U.S. one day might begin to meet its financial obligations by simply printing money. And we all know what happens to a country that chooses to monetize its debt. It gets runaway inflation, a gradual erosion of workers' paychecks and family savings."

Bernanke said that the Fed takes its political independence seriously, and while it is now focused on using all the tools at its disposal to ease the pain of the recession, it will respond aggressively if inflation becomes a problem.

The Fed has given no strong indication of whether it will expand its purchases of Treasury bonds. Without doing so, though, the Fed would have less flexibility to stimulate the economy. It has already cut a key interest rate it controls to nearly zero.

"They definitely have less leeway" to buy more Treasury bonds, said Michael Feroli, an economist at J.P. Morgan Chase. "The Fed hasn't done a stellar job of communicating its strategy" with the bond purchases, which, he argued, has allowed the discussion to be dominated by people who argue that the Fed's actions are effectively monetizing the debt. Doing so would increase the money supply, thereby weakening the dollar and leading to high inflation.

One thing that would help assuage those fears would be for government leaders to signal that they will manage the nation's finances well in the long run. That would tend to keep long-term interest rates low, which in turn would help encourage an economic recovery.

Bernanke, as is his habit, did not recommend specific ways that Congress should aim to reduce long-term budget deficits; he views tax and spending decisions as the domain of elected officials.

"In the end, the fundamental decision that the Congress, the administration and the American people must confront is how large a share of the nation's economic resources to devote to federal government programs, including entitlement programs," Bernanke said. "Crucially, whatever size of government is chosen, tax rates must ultimately be set at a level sufficient to achieve an appropriate balance of spending and revenues in the long run."


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