WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke on Wednesday warned against sharp cuts in 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, 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.
In separate remarks, Atlanta Fed President Dennis Lockhart indicated the bar will be relatively high for extending the Fed’s bond purchases beyond June, even if he appeared to think the economy is still relatively vulnerable.
“It depends entirely on the state of the economy and if I take my base case forecast, which continues the moderate rate of growth through 2011 and for 2012, I‘m not sure it will be necessary,” Lockhart told reporters after a speech to a group of professional accountants.
Brian Sack, head of the powerful New York Fed markets group charged with implementing Fed policy, sounded a similar note. “The issue for the prospect of an additional round of asset purchases would need to be calibrated with whether it is appropriate given the shift in the economic outlook.”
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.
Just across the street, Fed nemesis Ron Paul, who has called for the central bank to be abolished, was holding his first hearing as chairman of a House committee on monetary affairs.
Paul reiterated some of his unvarnished criticism of Bernanke and, after the hearing, took the time to sign copies of his book, called “End the Fed”. Paul said Bernanke “is really cocky” about plans to unwind the toxic assets the Fed took on from troubled banks during the height of the 2007-2009 crisis.
Part of the skepticism from Congress comes from the Fed’s aggressive bond-buying program, which many Republicans have argued is potentially inflationary. These concerns were again on display 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.
Editing by Dan Grebler, Gary Hill