WRAPUP 1-Bernanke warns of catastrophe if debt limit not raised

Thu Feb 3, 2011 9:47pm EST

* Bernanke pushes Congress to raise debt limit

* Delay could lead to 'catastrophic' default

* Bernanke: Recovery not yet established, need job growth

* Kocherlakota: not worried about bubbles

By Mark Felsenthal and Pedro da Costa

WASHINGTON, Feb 3 (Reuters) - Federal Reserve Chairman Ben Bernanke on Thursday issued a stern warning to Republican lawmakers that delays in raising the United States' $14.3 trillion debt limit could have "catastrophic" consequences.

"Beyond a certain point ... the United States would be forced into a position of defaulting on its debt. And the implications of that on our financial system, our fiscal policy and our economy would be catastrophic," he told the National Press Club.

Bernanke coupled his warning with a call for the Obama administration and Congress to put in place a credible plan to curb future budget deficits.

He also offered a moderately more optimistic assessment of the economy's prospects than in other recent remarks, although he made clear the recovery still needs support from the Fed.

Some Republican leaders intend to use the need to raise the statutory debt ceiling as leverage for spending cuts. The Obama administration has said the nation would likely hit the limit between early April and late May. For more, see: [ID:nN02198341]

If Congress does not raise the limit in a timely way, the government could be forced to scale back operations. A failure to lift the limit could raise the specter of a first-ever U.S. debt default and push interest rates up sharply.

Financial markets have not yet shown any nervousness over the debt limit, which has typically been raised after political grumbling, and Bernanke said the chances of a default were "very remote."

<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

For highlights from Bernanke's speech and Q&A, see [ID:nN03272340]

For other stores on Fed policy, see [FED/AHEAD]

For an interactive graphic on Fed officials' policy views, see link.reuters.com/ryv97p

Reuters Insider: link.reuters.com/qud87r

^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>

Still, his comments echoed dire warnings issued by Treasury Secretary Timothy Geithner and other Obama administration officials, who have also said failure to raise the debt ceiling could be "catastrophic."

The Fed chairman called on lawmakers not to hold the issue hostage to the contentious debate over how best to rein in record budget gaps.

"I would very much urge Congress not to focus on the debt limit as being the bargaining chip in this discussion, but rather to address directly the spending and tax issues that we have to deal with in order to make progress on this fiscal situation," Bernanke said.

FED MISSING BOTH MANDATE TARGETS

In discussing the recovery, Bernanke provided a modestly more rosy outlook than he has in other recent appearances, citing gains in household spending, improved consumer and business confidence and stepped-up bank lending as signs 2011 may bring stronger growth than 2010.

But he made clear Fed officials were not yet satisfied.

"Although economic growth will probably increase this year, we expect the unemployment rate to remain stubbornly above, and inflation to remain stubbornly below, the levels that Federal Reserve policymakers have judged to be consistent over the longer term with our mandate," he said.

Bernanke's comments on the economy suggest the Fed believes it has plenty of time to let its policies boost growth and pull down a high unemployment rate before it needs to worry about tightening financial conditions to keep inflation in check.

"We continue to see the Fed as making good on its intent to purchase $600 billion in long-term Treasury securities by the end of the second quarter," Barclays Capital economist Michael Gapen wrote in a note to clients. "We also believe that the chairman has the votes needed to pursue further asset purchases should he think conditions warrant."

The hard-hit job market shows some grounds for optimism, but modest growth and cautious hiring suggest that it will be several years before the jobless rate returns to a more normal level, Bernanke said.

"Until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established," he said.

KOCHERLAKOTA'S VIEW

Minneapolis Fed President Narayana Kocherlakota, who despite his reputation as an inflation hawk has publicly voiced support for the Fed's bond-buying program, said on Thursday the jobless rate will remain "troublingly" high through 2012.

"I do not believe that either unemployment or employment will improve rapidly in 2011," he told an audience at the University of Minnesota, where he headed the economics department before taking the top job at the Fed's smallest regional bank in 2009.

And while he said he is "optimistic" inflation will rise this year, he said he expects it to stay below the central bank's informal 2 percent target.

Asked about the potential that Fed policy is fueling bubbles, he said, "Nothing in the current policy environment makes me worried about that."

Some analysts worry the Fed is underplaying gains in the recovery and is turning a blind eye to inflation pressures that may be building, as evidenced by rising commodity prices around the world.

Economic data on Thursday pointed to stronger growth momentum, as the U.S. services sector grew in January at its fastest pace in more than five years, factory orders picked up and claims for jobless benefits fell off sharply. [ID:nN03256467]

"It seems to me that the chairman seems to be glass half-empty," said Stephen Stanley, chief economist at Pierpont Securities in Stamford, Connecticut. "There are all these inflation concerns that are hitting the long-end of the bond market.

Bernanke played down worries that recent commodity price rises pose an inflation threat in the United States.

"Overall inflation remains quite low," he said, adding that downward pressure on wages and prices was not surprising, given the "substantial slack" in the economy.

He also countered accusations the Fed's easy monetary policy was behind surging prices for food and other raw materials around the globe, saying the increases primarily reflected strong demand in emerging economies. [ID:nN03278190] (With additional reporting by Glenn Somerville, Rachelle Younglai and Richard Leong in New York, and Ann Saphir in St. Paul, Minn. Editing by Chizu Nomiyama, Dan Grebler, Gary Hill)

FILED UNDER:
We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/
Comments (1)
gordo365 wrote:
Bernanke is a tool. US will not default on debt because we have a printing press and can create dollars out of thin air. The real risk is that rates go up and interest payments rise and debt service requirements exceed $1T per year. We’ll stop buying free lunches for poor kids and oxygen for old folks long before we default on debt owed to China etc.

Feb 04, 2011 6:25pm EST  --  Report as abuse
This discussion is now closed. We welcome comments on our articles for a limited period after their publication.