US should slow down deficit reduction, says Bernanke

23 May 13
The US government's drastic deficit reduction is damaging growth and should be replaced with a longer-term approach, the chair of the Federal Reserve has said.

Ben Bernanke told the Congressional Joint Economic Committee that US fiscal policy at a federal level had become ‘significantly more restrictive’ in recent years. Spending cuts and tax increases that have come into effect so far in 2013 will create a ‘substantial drag’ on the economy this year, he said.

Bernanke cited the Congressional Budget Office's estimates that current deficit reduction policies would slow US economy growth by as much as 1.5 percentage points this year.

‘In present circumstances, with short-term interest rates already close to zero, monetary policy does not have the capacity to fully offset an economic headwind of this magnitude,’ he warned.

Despite the short-term deficit reduction, Bernanke claimed that much less had been done to address the federal government’s long-term fiscal policies. CBO figures showed both the federal debt and deficit rising again in the latter part of this decade, he noted.

In light of this, Bernanke stressed that politicians should put the federal budget on a ‘sustainable’ long-term path.

‘The objectives of effectively addressing longer-term fiscal imbalances and of minimising the near-term fiscal headwinds facing the economic recovery are not incompatible,’ he said.

‘To achieve both goals simultaneously, the Congress and the administration could consider replacing some of the near-term fiscal restraint now in law with policies that reduce the federal deficit more gradually in the near term but more substantially in the longer run.’

During his testimony to the committee, Bernanke also addressed the potential to cut back on the Federal Reserve’s quantitative easing programme, under which it buys billions of dollars’ worth of mortgage debt every month in a bid to reduce borrowing costs and stimulate the economy.

A long period of low interest rates contained ‘costs and risks’, he acknowledged, in particular by reducing the income of those who relies on interest from savings accounts or government bonds.

But he added: ‘A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further.

‘Such outcomes tend to be associated with extended periods of lower, not higher, interest rates, as well as poor returns on other assets. Moreover, renewed economic weakness would pose its own risks to financial stability.’

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