Friday, February 17, 2006

In many respects, Federal Reserve Chairman Ben Bernanke was impressively straightforward Wednesday in his inaugural congressional testimony as head of the nation’s central bank. In particular, we found his analysis of America’s soaring budget and current-account deficits, both of which have contributed to the collapse of national saving, to be both sobering and on the mark.

On the other hand, Mr. Bernanke was disappointing in his steadfast refusal to express an opinion on the proposed restoration of PAYGO budget rules, which expired in 2002. In the absence of 60 votes in the Senate, PAYGO (i.e., pay as you go) would require Congress to find offsetting revenue increases or spending cuts in order to fund either tax relief or programmatic increases in entitlement spending.

Having chaired the White House Council of Economic Advisers for the previous seven months, Mr. Bernanke nonetheless held no punches in warning about the implications of the nation’s rising federal budget deficit. According to White House projections released Feb. 6, six days after he formally departed the council, the fiscal 2006 budget deficit will total $423 billion, reflecting a 33 percent increase over 2005. “Increased [budget] deficits are a negative for the economy, certainly,” Mr. Bernanke candidly acknowledged. Earlier, he explained that he was “concerned about the prospective path of deficits” because “it does reduce national saving and therefore imperils, to some extent, the prosperity, the future prosperity of our country.” Noting that the share of gross domestic product spent on Social Security, Medicare and Medicaid will increase from 8 percent today to 16 percent by the time his college-attending children will be contemplating retirement, he declared that it was “appropriate for me to talk about long-term government spending, taxes and deficits” because “that bears on economic stability and financial stability.” Unlike Mr. Bernanke, we believe that discussion should include his views on PAYGO, whose restoration his predecessor, Alan Greenspan, strongly embraced.

Regarding the record-setting current account deficit, about 90 percent of which is the trade deficit, Mr. Bernanke observed: “The immediate implication is that the U.S. economy is consuming more than it’s producing, and the difference is being made up by imports from abroad, which in turn are being financed by borrowing from abroad.” The 2005 current-account deficit will closely approach 7 percent of GDP, reflecting the huge extent by which U.S. consumption exceeds its output. This buildup of foreign debt will eventually “lower national wealth and lower our ability to consume in the future.”

Later, Mr. Bernanke warned that there may come a time “when foreigners are not willing to continue to add to their holdings of U.S. dollar assets, and that, in turn, will lead to perhaps an uncomfortable adjustment in the current account.” If foreigners do continue financing America’s excess consumption and budget deficits, Mr. Bernanke hypothesized, they would likely charge higher prices (i.e., higher interest rates), which “would feed back on the U.S. economy in ways that might be uncomfortable” — to say the least. As the Fed’s Monetary Policy Report to Congress argued, “If not reversed over the longer haul, persistent low levels of [national] saving will necessitate either slower capital formation or continued heavy borrowing from abroad.” Indeed, either scenario would hurt America’s ability to reckon with Baby Boomers’ retirement needs and the nation’s overall standard of living.

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