With the outlook for the economy “unusually uncertain,” Federal Reserve Chairman Ben S. Bernanke advised Congress on Wednesday not to precipitously cut stimulus spending in a drive to rein in the deficit, but rather focus on longer-range budget reforms that will reduce the deficit in the next five years but not immediately threaten economic growth.
Mr. Bernanke told the Senate Banking, Housing and Urban Affairs Committee that the central bank is reviewing its own options for further stimulating economic growth “if the recovery seems to be faltering,” although he insisted that he still expects moderate growth of 3 percent to 3.5 percent for the rest of the year.
His remarks confirmed fears in financial markets that the economy recently took a turn for the worse, and sent the Dow Jones Industrial Average down by more than 100 points. Just before he spoke, President Obama signed into law a financial reform bill giving major new powers to the Fed and other regulators to impose restrictions on credit and banks, adding to the uncertainty overhanging the markets.
Because of concerns about the economy, the Fed chairman took the unusual step of weighing in on what he described as the “very contentious” debate over stimulus spending versus deficit reduction that has been raging on Capitol Hill.
After weeks of partisan wrangling, the Senate on Wednesday extended further aid to the long-term unemployed over the objections of Republicans and conservative Democrats who had insisted on immediate cuts in spending to offset the stimulus.
Mr. Bernanke stressed that both goals are important: Congress should continue to support the still-fragile recovery with some stimulus, but it also must lay plans for dramatic reductions in the deficit to prevent the government debt from getting out of control and precipitating a financial crisis in coming years.
He said the goals could be married by focusing deficit reduction efforts on the “medium term,” meaning the next four or five years, when the burgeoning public debt poses the biggest threat of precipitating a crisis.
“There’s not much need to reduce the 2010 deficit” of about $1.4 trillion, he said, noting that the Treasury has been able to easily finance it this year because of a rush into safe-haven investments when the European debt crisis erupted.
“At the current moment, large deficits, as unattractive as they are, are important for restoring economic activity and stability. I would be reluctant to withdraw spending too precipitously,” he said.
“I would much prefer to see consolidation or cuts over the medium term as opposed to immediately,” he added.
Mr. Bernanke said Congress‘ goal should be to cut the yearly budget deficit to a “sustainable” level of about 3 percent of economic output or $450 billion by the middle of the decade - the goal set by a presidential commission that will recommend anti-deficit measures later this year.
Congress should focus on resolving “structural” budget problems - such as the government’s increasingly insolvent retirement programs - rather than “cyclical” problems like the loss of revenues or increase in unemployment benefit spending that resulted from the deep recession, he said.
“Anything we can do to reduce the structural deficit would be positive for the markets, and would make it easier to maintain stimulus,” he said.
Failing to address the longer-term deficit risks bringing on a sharp rise in interest rates and jarring financial crisis that would pose serious problems for the U.S. economy, he said.
But while Mr. Bernanke urged major efforts to reduce the spiraling deficit and stave off a debt crisis like the one engulfing Europe, he was characteristically short on recommending specific program changes to Congress.