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Federal Reserve Chairman Ben Bernanke sounds a warning on growing deficit

By Neil Irwin and Lori Montgomery
Washington Post Staff Writer
Thursday, April 8, 2010; A01

Federal Reserve Chairman Ben S. Bernanke warned Wednesday that Americans may have to accept higher taxes or changes in cherished entitlements such as Medicare and Social Security if the nation is to avoid staggering budget deficits that threaten to choke off economic growth.

"These choices are difficult, and it always seems easier to put them off -- until the day they cannot be put off anymore," Bernanke said in a speech. "But unless we as a nation demonstrate a strong commitment to fiscal responsibility, in the longer run we will have neither financial stability nor healthy economic growth."

His stern lecture came as the economy is emerging from the worst recession in years, sending the stock market up considerably over the past year and raising public hopes for a return to prosperity. But the economic downturn -- with tumbling tax revenue, aggressive stimulus spending and rising safety-net payments such as unemployment insurance -- has driven already large budget deficits to their highest level relative to the economy since the end of World War II. This has fueled public concern over how long the United States can sustain its fiscal policies.

The health-care bill signed by President Obama last month has further stoked the national debate over government entitlement programs, though the non-partisan Congressional Budget Office has projected that the legislation would actually reduce future deficits.

Barely two months after Bernanke was confirmed by Congress for a second term following a bruising fight, he used his bully pulpit to tread into an area of economic policy that is usually the province of the president and Congress. He characterized the budget gap as the biggest long-term economic challenge the nation faces, even as he acknowledged that reducing the deficit immediately would be "neither practical nor advisable" given the still-weak economy.

While the immediate audience for the speech was the Dallas Regional Chamber, his message was intended for Congress and the Obama administration. Officials in both branches have spoken of the need for a more sustainable fiscal policy, but few have proposed concrete plans to achieve it. A deficit commission created by Obama is scheduled to begin meeting at the end of the month.

With his warning about what could be the next economic crisis, Bernanke offered a contrast to Alan Greenspan, his predecessor as Fed chairman. Greenspan did little to sound an alert about the housing and credit bubbles that brought on the financial crisis and was pilloried on Wednesday by a special congressional commission for the Fed's lapses during his tenure.

Bernanke did not endorse any particular approach to reducing the deficit. But he laid out the "difficult choices."

"To avoid large and ultimately unsustainable budget deficits, the nation will ultimately have to choose among higher taxes, modifications to entitlement programs such as Social Security and Medicare, less spending on everything else from education to defense, or some combination of the above," he said.

His remarks highlighted the difficulties posed by funding these entitlement programs over the long term. With the population aging and medical costs rising faster than inflation, Medicare is set to become a major drain on the federal budget in the coming decades, though the recently passed health-care bill has delayed the date when the program will begin to require big infusions of cash.

Social Security is already draining resources from the broader federal budget, as spending on benefits has risen above this year's Social Security tax collections. While that gap is expected to be fleeting, the program, the largest single item in the federal budget, is projected to require sustained support within the next 10 years.

Bernanke argued that if the government develops a "credible plan" to reduce long-term deficits, it could help boost the economy before long. Such a plan could enhance investors' confidence in the financial health of the United States and make them more willing to lend the government money at lower interest rates. That, in turn, could lower long-term interest rates in general, making it cheaper for Americans to get a home mortgage or for companies to borrow money to build a factory.

Investors still view U.S. government debt as among the safest investments in the world. But the perceived creditworthiness of nations depends on fickle market forces -- which can change quickly, as Greece and other several other European countries have learned in recent months. Doubts about Greek debt, for instance, have driven up interest rates there and damaged the economy.

The Obama administration is in the early stages of crafting a strategy to reduce U.S. deficits, which are projected to hover around $1 trillion a year for much of the next decade. The presidentially appointed commission, known as the Commission on Fiscal Responsibility and Reform, has been assigned the task of helping develop that strategy.

Obama has said he expects the commission to look at all options for reining in deficits, including cuts to entitlement programs, reductions in other spending and tax increases.

On Tuesday, White House adviser Paul A. Volcker spoke in favor of higher taxes, telling an audience at a New York Historical Society event that the nation may have to consider a European-style sales tax, known as a value-added tax, to close the persistent budget gap. In answer to a question, Volcker said a VAT "was not as toxic an idea" as it has been in the past, according to Reuters. "If at the end of the day we need to raise taxes, we should raise taxes," he added.

Pointing to Volcker's remarks, Republicans in Congress accused Obama of plotting a big tax hike. "To make up for the largest levels of spending and deficits in modern history, the Administration is laying the foundation for a large, misguided new tax, a first-time American VAT," Sen. Charles E. Grassley (R-Iowa) said in a statement. Administration officials, however, said Volcker was not speaking for the president, who campaigned on a pledge to protect the middle class from higher taxes.

"The president has passed historic tax cuts for middle-class families and continues to push for more tax cuts. The president is not proposing to cut the deficit at the expense of middle-class families," said Kenneth Baer, spokesman for the White House budget office.

Bernanke has urged Congress to address long-term fiscal imbalances in congressional testimony before, but usually only when he is asked about them by lawmakers. His speech Wednesday aimed to reach a broader audience, steering away from technical economic speak and using plain, sometimes wry, language -- a rare thing for a Fed chairman.

"The economist John Maynard Keynes said that in the long run, we are all dead," he said. "If he were around today he might say that, in the long run, we are all on Social Security and Medicare."

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