Bernanke warns against steep budget cuts

WASHINGTON Wed Feb 9, 2011 5:50pm EST

Chairman of the Federal Reserve Ben Bernanke testifies on the state of the U.S. economy before the House Budget Committee on Capitol Hill, February 9, 2011. REUTERS/Kevin Lamarque

Chairman of the Federal Reserve Ben Bernanke testifies on the state of the U.S. economy before the House Budget Committee on Capitol Hill, February 9, 2011.

Credit: Reuters/Kevin Lamarque

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Bernanke defends Fed policy

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WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke on Wednesday warned against sharp cuts in U.S. spending at a time when the economic recovery is still fragile enough to require extraordinary support from the central bank.

Even as he warned about the need for a long-term plan to address "unsustainable" budget deficits, Bernanke said steep reductions in government outlays could compromise growth at a time when employment is just beginning to rebound.

"The cost to the recovery would outweigh the benefits in terms of fiscal discipline," Bernanke told the House of Representatives' Budget Committee. "I think we really need to take a long-term view."

Bernanke offered few clues into whether the Fed might extend its controversial policy of buying $600 billion in government bonds beyond its June deadline, but nor did he signal any inclination to cut the program short.

The Fed launched the bond-buying plan in November in an attempt to keep long-term borrowing costs down and support a fragile economic rebound.

Acknowledging renewed momentum in the economy, Bernanke said a drop in the jobless rate to 9 percent in January from 9.8 percent in November, the biggest two-month decline since 1958, was "grounds for optimism."

However, he said hiring is still anemic and noted that the economy has made up just over one million of the more than eight million jobs lost during the recession.

"This gain was ... not enough to significantly erode the wide margin of slack that remains in our labor market," he said. "Until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established.

DEFENDING THE PROGRAM

The Fed's aggressive bond-buying program drew ire from many policymakers in emerging markets, who accused the United States of unfairly driving down the value of the U.S. dollar to boost exports.

At home, many Republicans attacked the policy as potentially inflationary, concerns on display again Wednesday as Bernanke made his first appearance before a House committee since Republicans assumed control of the chamber last month.

The discourse was generally civil, although some of the questions were pointed.

The panel's chairman, Republican Rep. Paul Ryan of Wisconsin, opened the hearing by criticizing the Fed for providing the fuel for future bubbles and inflation, suggesting the bond purchases were eroding the dollar's value.

"There is nothing more insidious that a country can do to its citizens than debase its currency," Ryan said.

Pressed by skeptical lawmakers, Bernanke said the Fed regularly reviews its bond buying, but also indicated he feels it is still needed. He repeated that it would take four to five years for unemployment to return to more "normal" levels closer to 5 percent.

"The chairman continues to deliver the same message of caution and patience despite the better-than-expected data flow observed in recent months," said Michael Gapen, economist at Barclays Capital in New York.

Bernanke said U.S. inflation remains quite low, a tough message to deliver amid headlines of rising food and commodity costs across the globe. He also said expectations of future inflation had remained "stable," suggesting little worry that an inflationary psychology was building.

BERNANKE PING-PONG

Both Democrats and Republicans tried to get Bernanke to back their views on how best to attack a budget deficit that is expected to hit a record $1.5 trillion this year. Republicans want to rein in outlays and ward off any tax increases; Democrats are wary of cutting spending too deeply now.

Bernanke offered a fig leaf to both sides, supporting lower taxes on the one hand while maintaining that short-term budget reductions should not be too radical.

"It's really a question of convincing the market that there's a long-term plan here," Bernanke said, adding that budget cuts should be done in a "growth-friendly" way.

He said Congress should consider closing corporate tax loopholes to broaden the tax base so that the corporate tax rate could be reduced. He also repeated a warning about the dire consequences of not lifting the country's debt ceiling.

Asked about the future of government-sponsored enterprises like Fannie Mae and Freddie Mac, Bernanke said government backing for the mortgage sector should be a last resort, not common practice.

(Editing by Dan Grebler)

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