- The Washington Times - Wednesday, June 22, 2011

Federal Reserve Chairman Ben S. Bernanke on Wednesday rejected an argument frequently made by Republican deficit hawks that immediate, deep cuts in federal spending will help produce jobs.

The Fed chairman said at a news conference that — to the contrary — cuts in spending at the state and local level, combined with the withdrawal of stimulus spending at the federal level, contributed to the slowdown in job growth and economic growth seen this year.

“I don’t think that sharp, immediate cuts in the deficit would create more jobs,” he said. “Deficit reduction is at best neutral for job-creation.”

State and local governments have eliminated close to a half-million jobs since the recession, according to the Bureau of Labor Statistics. Those job losses originally were fed by gaping budget gaps in most states and now are being fed in part by the loss of federal stimulus funding. The government job cuts have partially offset robust job growth in the private sector this year of close to 200,000 a month on average.

To avoid generating more job losses, Mr. Bernanke stressed that Congress and the White House should aim to reduce the deficit gradually over several years particularly through reforms in entitlement-spending programs such as Medicare and Medicaid which have been growing rapidly and pose the greatest threat of destabilizing the government’s finances.

“The most effective way to address fiscal problems is to take a long-range perspective,” he said.

Republicans have argued that slashing federal spending will create jobs by reducing the government burden on the private economy. That argument has resonated in opinion polls which show public support for taking that approach. But the party dogma runs counter not only to Mr. Bernanke’s advice, but the counsel of most economists.

In his second-ever public press briefing following a meeting of the Fed’s monetary policy committee, Mr. Bernanke also said for the first time that an explosion of the European debt crisis could trigger another global financial rout that would pull down the U.S. economy. He said the Fed is prepared to react with more easing measures if that happens.

“An disorderly default [by Greece] would no doubt roil financial markets globally and would have a significant effect on the U.S.,” he said.

Greece’s parliament on Tuesday averted the possibility of an immediate default by upholding the Socialist government and its economic-austerity program in a vote of confidence. That enables the International Monetary Fund and the European Union to continue lending to the country.

But analysts say Greece most likely is headed toward a debt restructuring at some point, because its debts have become unsustainable while the austerity program has thrown the country into a deep recession.

Mr. Bernanke called Greece’s troubles a “very difficult situation.” The Fed has surveyed U.S. banks to determine how exposed they would be to a default by Greece, he said, and found that most U.S. banks have little direct exposure.

However, both U.S. banks and U.S. money market funds have “significant exposure” indirectly through their extensive relations with European banks that hold most of Greece’s bonds, he said.

There is “some concern to money market mutual funds,” he said. His assessment on widely used money market funds is ominous because it could mean the same kind of devastating chain reaction in financial markets would occur after a Greek default as happened after Lehman Brothers defaulted on its debt obligations in September 2008. The Lehman incident was a key factor triggering the global financial crisis nearly three years ago.

Despite these vulnerabilities in the U.S. economy, Mr. Bernanke said the Fed thinks that European authorities wiill handle the crisis well and avoid any world-shaking financial fallout.

The Fed has reduced its forecast for U.S. economic growth this year from slightly more than 3 percent to slightly less than 3 percent. Assuming all goes well, Mr. Bernanke said, the Fed is proceeding with its plans to gradually withdraw stimulus from the U.S. economy in coming months.

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