Federal Reserve Chairman Ben S. Bernanke warned Congress on Tuesday morning that $85 billion of across-the-board spending cuts due to start Friday will dampen economic growth this year.
In his first public testimony to the newly elected Congress, the Fed chairman urged lawmakers to replace the cuts with spending cuts and revenue increases that will reduce the nation’s debt over the long term but have a gentler impact on the U.S. economy as it struggles to recover this year.
The nation’s debt and deficit problems are primarily long-term, driven by rising health care costs and the aging population, Mr. Bernanke said, so Congress needs to focus on making adjustments in spending programs and revenues that would address those long-term problems.
“There’s a mismatch with the timing of the spending cuts,” he told the Senate Banking Committee. “The problem is long-term, but the cuts are short-term and do harm to the recovery.”
Austerity measures enacted this year, including $650 billion of tax increases passed in January, will lower economic growth by about 1.5 percentage points this year, with the so-called sequestration cuts accounting for one-third of that decline, Mr. Bernanke estimated.
The spending cuts and furloughs of federal employees may not have a big impact at first, but they will accumulate over time and hold back economic growth, he said.
With the economy growing at about 2 percent on average in recent years, the combined austerity measures could have a sizable impact on growth, although the Fed expects growth to continue at a moderate pace, he said.
Despite the impact on growth, Mr. Bernanke commended Congress for making progress on taming the deficit, which he said will fall from 7 percent of economic output last year to about 2.5 percent in 2015. The accumulated stock of public debt will stop growing and hover at around 75 percent of economic output for the next decade as a result, he said.
But the measures have not gone far enough to solve the long-term fiscal problems looming in health care and retirement programs as more and more baby boomers retire, he said.
The U.S. economy slowed sharply in the fourth quarter after a period of solid but modest growth. The unemployment rate was 7.9 percent in January.
Mr. Bernanke suggested that in negotiating more debt-reduction measures, Congress should strive to reduce the stock of public debt to somewhere closer to the historic average of 40 percent of economic output in the United States.
Budget analysts said to achieve stabilization of the debt at a level that low will require another $2.5 trillion of spending cuts and tax increases beyond what Congress already has enacted.
In an intriguing footnote in his testimony, Mr. Bernanke said the Fed likely will contribute less in the future to reducing the deficit with the copious profits it has earned on its purchases of Treasury bonds and mortgage-backed securities since 2008.
The Fed has turned over $290 billion of profits from the investments to the Treasury in the past five years, helping to reduce the deficit. But as interest rates rise in the future and cut into the value of the central bank’s holdings, it will have fewer profits to turn over, Mr. Bernanke said.
The Fed chairman returns to Capitol Hill on Wednesday to testify before the House Financial Services Committee.
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