Federal Reserve Chairman Ben S. Bernanke is trying to make sure the U.S. central bank doesn’t become a scapegoat for fiscal profligacy.
Fed officials are warning that Congress needs to balance the nation’s budget, showing that policy makers are concerned about a loss of confidence in U.S. finances and want lawmakers to help prevent it, according to Dean Maki, chief U.S. economist at Barclays Capital Inc. Bernanke extended his campaign yesterday, telling the House Budget Committee “anything that can be done now to change that path” would have a “good impact on the current economy” and interest rates.
“There is this tremendous fiscal problem looming, and Congress has to do something about it,” said Mark Gertler, a professor of economics at New York University who has co- authored research with Bernanke. “If they have a fixed amount of time, spend it solving” that problem, rather than “grandstanding about the Fed.” The central bank’s plan to buy $600 billion in Treasury securities through June is “a relatively modest policy undertaking” compared with balancing the $3.7 trillion budget, he said.
The Fed sparked the harshest political backlash in three decades after announcing a second round of so-called quantitative easing on Nov. 3. Republicans, including House Speaker John Boehner of Ohio, said QE2 risks accelerating inflation, weakening the dollar and fueling asset bubbles.
“What is needed is very clear communication to the Congress at large and the American public,” that the program isn’t “crazy or highly unusual and that it made sense, but that it does involve some risk and that’s being managed,” said Alfred Broaddus, former president of the Federal Reserve Bank of Richmond. “You’ve got to be careful about turning this thing around.”
‘Can Be Overdone’
By acknowledging that buying government debt “can be overdone,” the Fed may bolster confidence that it will withdraw its record stimulus in time to avoid a surge in inflation, said Broaddus, who was president of the Richmond Fed from 1993 to 2004.
Bernanke defended the bond-purchase program yesterday in his first House testimony since Republicans took control of the lower chamber last month. He repeated that Congress should adopt a long-term plan to control a federal budget deficit that’s projected to reach a record $1.5 trillion this year.
The Fed isn’t monetizing the nation’s debt because “what we’re doing here is a temporary measure, which will be reversed,” Bernanke said. QE2 is “providing significant support to job creation and economic growth.”
The unemployment rate fell to 9 percent in January from 9.8 percent in November, the biggest two-month drop since 1958, and gross domestic product rose at a 3.2 percent annual rate in the fourth quarter, compared with 2.6 percent in the third and 1.7 percent in the second.
At the same time, “our nation’s fiscal position has deteriorated appreciably,” and adjustments “must occur at some point,” Bernanke said yesterday.
“The Fed wants to make clear it’s not going to underwrite large deficits in the medium term,” Maki said in a telephone interview from his New York office. The central bank is responding to critics who’ve said it “is allowing the Congress and the administration to run less-responsible fiscal policy,” he said.
One such critic is Sarah Palin, the 2008 Republican vice- presidential nominee, who says she’s considering a run for president in 2012.
“It’s time for us to ‘refudiate’ the notion that this dangerous experiment in printing $600 billion out of thin air, with nothing to back it up, will magically fix economic problems,” she wrote in a letter to the Wall Street Journal published Nov. 18.
So far, buyers of Treasury securities haven’t forced Congress to curb its spending by making it expensive for the nation to borrow. The yield on the 10-year Treasury note was 3.65 percent late yesterday in New York, lower than its average of 5.25 percent during the last decade, according to data compiled by Bloomberg.
“Unfortunately, there’s no sense of urgency right now,” said John Lonski, chief economist at Moody’s Capital Markets Group in New York. “Once you reach the point where concerns about the federal budget deficit render financial markets dysfunctional, then Congress will take action pronto.”
Representative Paul Ryan, the Wisconsin Republican who chairs the budget panel and offered his own plan last year for cutting spending, asked Bernanke during his testimony if Congress could aid short-term economic growth with a plan to control spending. “That’s correct,” Bernanke said.
Bernanke may not have won Ryan over on QE2, though. Ryan said during the hearing he’s concerned that “you’re going to see inflation after it’s already been launched.”
Representative Ron Paul, a Texas Republican who has advocated abolishing the central bank, said yesterday that the Fed’s policies aren’t working.
“They haven’t been very efficient in producing jobs,” and prices “really aren’t all that stable,” Paul said at a hearing he held titled “Can Monetary Policy Really Create Jobs?”
Since Bernanke fueled speculation about additional asset purchases during an Aug. 27 speech in Jackson Hole, Wyoming, inflation expectations have climbed. The breakeven rate for 10- year Treasury Inflation Protected Securities, the yield difference between the inflation-linked debt and comparable- maturity Treasuries, has risen to 2.33 percentage points from 1.63 percentage points, Bloomberg data show. The central bank prefers an inflation rate of about 2 percent.
“Deficits and the unfunded liabilities of Medicare and Social Security are not created by the Federal Reserve; they are the legacy of Congress,” Dallas Fed President Richard Fisher said in a Feb. 8 speech. Fisher has expressed doubts about the efficacy of quantitative easing and said this week he’ll oppose further asset purchases after the planned $600 billion is completed.
The Fed “would be more comfortable running a very easy monetary policy if it could see firm evidence that a more- sustainable fiscal situation was being put in place on a long- term basis,” Maki said. Most Fed officials aren’t seeking “sharp, immediate” cutbacks, given that they want the economic recovery to gain traction, he said.
Quantitative easing is “hardly a panacea” and would benefit from fiscal support, Fed Vice Chairman Janet Yellen said in New York speech Dec. 1. “We would be wise to heed the abundant empirical evidence of the superiority of taking action before a fiscal crisis is upon us,” Richmond Fed President Jeffrey Lacker said Feb. 8 in a speech in Newark, Delaware.
$35 Billion in Cuts
House Republicans have started looking at reducing some expenditures, announcing last week that they will seek $35 billion in cuts.
Washington’s spending spree is over,” Ryan said in a Feb. 3 statement.
While Bernanke and other Fed officials have voiced concern that the nation’s financial situation is unsustainable, they have stopped short of prescribing how lawmakers should fix it.
“The composition of spending and taxes is a Congressional prerogative,” Bernanke said yesterday.
Policy makers must “be very careful about getting into” too much detail with fiscal recommendations because that also could politicize the Fed, Broaddus said. Bernanke’s predecessor, Alan Greenspan, was criticized for expressing his opinions on matters such as Social Security, he said.
“Chairman Bernanke has set a different tone than Chairman Greenspan in that he has consistently avoided making near-term fiscal-policy recommendations,” Maki said. “He’s taking this approach in part to preserve the Fed’s independence and avoid an image of partisanship.”
Congress shouldn’t become too involved in monetary policy, either, because that could damage the credibility and effectiveness of the Fed, Lonski of Moody’s said.
“Their primary focus ought to be on fiscal policy, not on monetary policy,” Lonski said. “You have to worry about what you have direct control over.”
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