Bloomberg News

Bernanke Says Tighter Budget May Hurt Growth as Fed Weighs Aid

September 09, 2011

Sept. 9 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke warned that quick deficit reduction may hurt the recovery and said the central bank this month will consider steps to bolster growth and spur hiring.

“A substantial fiscal consolidation in the shorter term could add to the headwinds facing economic growth and hiring,” Bernanke said in a speech yesterday in Minneapolis, repeating many points in his address last month in Jackson Hole, Wyoming.

The Fed chief, in a speech to economists, said policy makers have measures at hand and are “prepared to employ these tools as appropriate.” As in Jackson Hole, he stopped short of signaling what he believes is the central bank’s best option to aid the economy, sending stocks lower.

Bernanke has previously said that possible steps include buying more government bonds and lengthening the duration of securities in its $1.65 trillion Treasury portfolio. Michael Gapen, senior U.S. economist at Barclays Capital and a former Fed economist, said policy makers at their Sept. 20-21 will probably decide to extend the average maturity of the Fed’s bond holdings.

Just hours after Bernanke’s speech, President Barack Obama called on Congress to pass a jobs plan that would inject $447 billion into the economy through infrastructure spending, by cutting in half the payroll taxes paid by workers and small- business owners and by providing subsidies to local governments to stem teacher layoffs.

Most of the economic impact from the infrastructure spending would be next year, though some of it would come in 2013, an administration official said.

Housing Slump

Bernanke warned in his Jackson Hole speech that the Fed alone can’t lift sagging home prices, mitigate a wave of home foreclosures, or put 14 million unemployed Americans back to work.

“He’s been pretty careful all along to argue for some stimulus in the short run because of the need to get the economy growing,” said Robert Eisenbeis, a former Atlanta Fed research director and now chief monetary economist at Cumberland Advisors Inc. of Sarasota, Florida.

“He would not want to see austerity put in place because that would be counter to what he sees as important to the short- run growth of the economy,” Eisenbeis said.

The Standard & Poor’s 500 Index fell 1.1 percent to 1,185.90 at 4 p.m. in New York as Bernanke disappointed investors by refraining from detailing plans to boost growth. Yields on 10-year Treasuries declined seven basis points to 1.98 percent, according to Bloomberg Bond Trader prices.

Fragile Economy

Bernanke said Obama and Congress must put the federal government’s finances on a “sustainable trajectory” over the long term, while warning that policy makers should not “disregard the fragility of the economic recovery” by pushing short-term fiscal austerity.

Answering audience questions, Bernanke didn’t say how much the government should cut spending to put the country on a stable fiscal path. He also didn’t detail how he believes the U.S. should reduce long-term deficits.

On inflation, Bernanke said, “we see little indication that the higher rate of inflation experienced so far this year has become ingrained in the economy.”

The speech marks Bernanke’s first comments on the economy since a government report last week showed that hiring unexpectedly stalled in August and the unemployment rate remained stuck at 9.1 percent.

“The weakness of the housing sector and continued financial volatility are two key reasons for the frustratingly slow pace of the recovery,” Bernanke said.

Budget Shortfalls

Other impediments to growth include cost-cutting by state and local governments confronting budget shortfalls and waning federal fiscal stimulus, he said.

The Fed at its September meeting will probably announce plans to replace short-term Treasury securities in its portfolio with long-term bonds in an effort to lower rates on everything from mortgages to car loans, according to economists at Barclay’s Capital Inc., Wells Fargo & Co., and T. Rowe Price Associates Inc.

“We see the relatively downbeat nature of the chairmen’s comments on the growth outlook as confirming our view that the FOMC is inclined to take further accommodative steps at its September meeting,” said Gapen at Barclays.

Among its additional measures for easing, the Fed could cut the 0.25 percent interest rate it pays banks on the $1.6 trillion in excess reserves they have parked at the Fed. It could also pledge to keep record monetary stimulus in place until unemployment drops to a certain level or inflation rises to a specific threshold.

Reduce Unemployment

That’s similar to the suggestion made this week by Chicago Fed President Charles Evans in a speech in London. He said the Fed’s commitment to low interest rates should be made contingent on pushing down the unemployment rate to 7 percent or 7.5 percent, as long as inflation stays below 3 percent.

The U.S. economy is flagging more than two years after the recession ended. The Fed reported Sept. 7 that the recovery slowed in some regions of the country during July and August as factories curbed production and consumers limited their spending.

The economy barely grew in the first six months of this year. The 0.7 percent growth rate for that period was the weakest stretch since the recovery began in June 2009.

Even though Bernanke said the Fed has lowered its projection for economic growth over the coming quarters, policy makers still expect the economy to “strengthen over time,” he said.

--With assistance from Prashant Gopal and Scott Lanman in New York, and Shobhana Chandra and Bob Willis in Washington. Editors: James Tyson, Christopher Wellisz

To contact the reporter on this story: Jeannine Aversa in Washington at javersa@bloomberg.net; Joshua Zumbrun in Minneapolis at jzumbrun@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net


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