Bernanke: Give Me Balanced Budgets, But Not Yet


Ben Bernanke smells like a man should.

Chairman of the U.S. Federal Reserve Bank Ben Bernanke took a break from enabling deficits in order to pose as a deficit hawk in his audience with the Joint Economic Committee yesterday. In his prepared comments, Bernanke warned about federal budget shortfalls that are projected to grow for as long as grass grows and birds fly:

In particular, the Administration and the Congressional Budget Office (CBO) project that the deficit will recede somewhat over the next two years as the temporary stimulus measures wind down and as economic recovery leads to higher revenues. Thereafter, however, the annual deficit is expected to remain high through 2020, in the neighborhood of 4 to 5 percent of GDP. Deficits at that level would lead the ratio of federal debt held by the public to the GDP, already expected to be greater than 70 percent at the end of fiscal 2012, to rise considerably further. This baseline projection assumes that most discretionary spending grows more slowly than nominal GDP, that no expiring tax cuts are extended, and that current provisions that provide most taxpayers relief from the alternative minimum tax are not further extended. Under an alternative scenario that drops those assumptions, the deficit at the end of 2020 would be 9 percent of GDP and the federal debt would balloon to more than 100 percent of GDP.

Although sizable deficits are unavoidable in the near term, maintaining the confidence of the public and financial markets requires that policymakers move decisively to set the federal budget on a trajectory toward sustainable fiscal balance. A credible plan for fiscal sustainability could yield substantial near-term benefits in terms of lower long-term interest rates and increased consumer and business confidence. Timely attention to these issues is important, not only for maintaining credibility, but because budgetary changes are less likely to create hardship or dislocations when the individuals affected are given adequate time to plan and adjust. In other words, addressing the country's fiscal problems will require difficult choices, but postponing them will only make them more difficult.

During the questions period, Sen. Tom Coburn (R-Oklahoma) asked Bernanke to expand on the Congressional Budget Office's deficit projections. Bernanke:

Well Senator, first let me just say that those numbers are based on CBO analysis, and as you say, those assume that AMT fixes continue to be extended, which they have been; and that expiring tax cuts are extended and that non-military spending grows as fast as GDP. So there are some assumptions about policy.

I think it's fair to say that deficits, structural deficits, longer-term deficits, at anywhere between 4 and 9 percent, anywhere in that range, is not sustainable because it leads to a debt-to-GDP ratio that grows essentially indefinitely and does not stabilize, which leads to higher interest rate payments which in turn feed back into the deficit. So I think it's very important that we consider how, looking forward—not this year, because of many economic conditions that are moving toward higher spending and lower revenues—but over the medium term as we try to plan our fiscal policy going forward, we need to find a sustainable path, and that would require lower deficits than we are currently projecting, or at least CBO is projecting.

[Coburn compares the United States with PIIGS economies]

Well we are a much larger, diversified, advanced economy than Greece and some of the other countries. But clearly at some point we need to address those balances, we need to make sure we have a sustainable fiscal program that will not lead to indefinite growth in the debt relative to GDP.

[On international lenders' potential skepticism of the U.S. government's seriousness]

Senator, that's inherently very hard to say. At some point, the markets will make a judgment about, really not our economic capacity, but our political ability and will to achieve longer term sustainability, and at that point interest rates could go up and that would be, of course, a negative for economic growth and recovery. So we don't know when that point will be reached, and for that reason I think it's important, even if we cannot balance the budget immediately that we begin to think about how in the immediate to long term, we can put the federal budget on a sustainable trajectory.

Bernanke seemed unconcerned with details about the proposed Consumer Financial Protection Agency, which is envisioned as part of the Federal Reserve Bank:

I'd like to understand better how it would work. My current understanding is that the agency would not be within the Fed in any kind of accountability sense, that the agency would not be reporting to the board or to the chairman. It would essentially be freestanding. So that means being within the Fed is kind of a vague idea at this point.

It is true that the current proposal would involve the Federal Reserve financing this agency. That of course doesn't make it any less costly to the taxpayer. It just means there would be less revenue remitted from the Federal Reserve to Treasury. So it's really up to Congress how you want to account for and finance the agency. But that particular way of doing it would lead to less seigniorage or revenue being remitted from the Fed to the Treasury, because that would be used to support the agency.

You may also want to stick around for Sen. Charles Schumer's (D-New York) Hearst-worthy demagoguery against China, which he blames for layoffs at an upstate environmental ceramic maker in a tirade so logic-free it will convince you New Yorkers are the most provincial yokels in this benighted country.

We're bankrupt.

This kind of bogarting was common among lawmakers on the JEC, which includes members from both the legislative bodies former President Lyndon Johnson once defined for future President George H. W. Bush as, respectively, "chicken salad and chicken shit." Rep. Ron Paul (R-Texas) broached proposed expansion of the U.S. commitment to the International Monetary Fund (from $10 billion to $105 billion) and questioned what emergency the IMF's projected $560 billion war chest is designed to address. But Paul too was unwilling to let Bernanke hang himself:

Ben Bernanke: The source of this was going back to the G20 meeting in the crisis, and I think one of the agreements the G20 leaders made was mutual commitment to put more money in the IMF as a way of addressing the financial crisis around the world. And that's why it happened. The Federal Reserve wasn't involved in those meetings.

So that was before Greece. If money is put out to any country, it'll be done first of all with specific approval from our, from the executive board which of course includes the U.S. in a veto position, with conditionality that the country has to meet certain conditions. So the G20 leadership apparently has agreed that this is a way to provide credit to avoid fiscal or exchange rate crises in countries around the world.

Ron Paul: But do you think this is a good idea? Do you agree that we should make these commitments?

Ben Bernanke: I think in general that having the IMF available to avoid crises is a good idea, yes.

Ron Paul: And again where will the money come from? This is our problem in this country. We're bankrupt too. And also along this line, do you feel like, you go along with this commitment, what are we going to do when a state gets under the gun? Like California and others. They're approaching the state that Greece is in. We can't turn down California. I mean if we can bail out all these banks, and they get off the hook and now they're making billions and their executive officers are cleaning up, do you think we would ever turn down California or any other state that gets into the same situation?

Ben Bernanke: Well that's Congress' decision.

Ron Paul: You've bailed out a lot of people from the IMF. You know, you have the capability of buying up some debt and doing all this kind of thing. We can't even audit you to find out what you do. So you can do anything you want. And you can create as much money as you want.

Ben Bernanke: You can see any transaction or loan we make. We'll be happy to provide that information to you. And we're not involved in lending to the IMF. The IMF is a separate institution which has American executives as part of the executive branch.

Ron Paul: Where would the money come from?

Ben Bernanke: It's a loan.

Ron Paul: Out of thin air?

Ben Bernanke: Well, it's a loan. If it's not paid back we would take our share of the loss.

Professor Laurence Ball, mon semblable, mon frere!

Rep. Kevin Brady (R-Texas) asked about Professor Laurence Ball's recommendation of a 4 percent inflation target. Bernanke's response:

His argument is that at a higher inflation rate, nominal interest rates would also be higher on average. And that would give more space to cut during a recession and perhaps more ability to create impetus.

So that's not an illogical argument but it has substantial risks, which are: The Federal Reserve over a long period of time has established a great deal of credibility by keeping inflation low—around 2 percent, roughly speaking. You can see that for example in inflation-indexed Treasury debt, which shows that people expect over the next 10 years about 2.2 percent inflation, on average, over that ten-year period.

If we were to go to 4 percent, say we're going to 4 percent, we would risk losing a lot of that hard-won credibility because folks would say, well if we go to four why not go to six, and if we go to six why not go to eight? It would be very difficult to tie down credibly expectations at four. Beyond which, in the longer term low inflation is good for the economy, and 4 percent is already getting up there a bit and would probably have detrimental effects on the functioning of our markets and so on.

So I understand the argument but that's not a direction we're interested in pursuing. We're going to keep our inflation objectives where they are, about 2 percent, which we think is appropriate given biases in the measurement of inflation and given the need to have a little space between the average inflation rate and the risk of having deflation or falling prices. So that's the path we're going to be following.

As always with the Fed, the more you think about it the less sense it makes. If you're not going to inflate your way out of debt, and the best deficit-reduction argument you can make is a variant of Saint Augustine's chastity prayer, and—as suggested by the massive IMF commitment—the best grey eminences see more hard times ahead, and global buyers of U.S. debt (or at least Fed officials disguised in Mao jackets and turbans) are still supporting the American habit of overspending, then where, other than in Bernanke's rhetoric, is this fiscal restraint going to come from? I guess Bernanke would say that's for Congress to decide.

NEXT: Wrong Address

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  1. I guess Bernanke would say that’s for Congress to decide.

    It’s a pretty cost-free thing for him to say.

    Surely he knows that unsustainable deficits are unsustainable. Surely he knows that Congress generates the unsustainable deficits. He’s simply telling the truth.

    Oh, and also freaking out world markets by screaming that Congress needs to massively increase fiscal liquidity or there will be a worldwide economic catastrophe.

    But that’s for Congress to decide.

  2. Give me the proper link for the Bishop’s chastity prayer – but not just yet.

  3. Ron Paul: Where would the money come from?

    Ben Bernanke: It’s a loan.

    Ron Paul: Out of thin air?

    Ben Bernanke: Well, it’s a loan. If it’s not paid back we would take our share of the loss.

    Apparently BB doesnt understand the difference between P/L and cash flow. Ron Paul is asking a cash flow type question (where does the money come from) and he answers with a profit/loss statement. Its all well and good if the loan gets repaid, but WHERE DOES THE MONEY COME FROM? Many a company (or country) has gone under not due to profit problems, but due to cash flow problems.

    1. It is instructive to read Bernanke’s nd Mishkin’s book on “Inflation Targeting”. He says that he thinks the Fed should have “Tool Independence” while being “goal dependent” on Congress or the political authoritys whoever that may be.

      He also goes into why he thinks 7 percent inflation is a ok target if that is what congress decides. These opinions that he wrote about explicitly helped discredit all his rehtoric about “maintaining independence” that he used to try and keep the Fed secrets.

      Bernanke loves the power so did Greenspan, they don’t care about the long term results of the system they are managing, they don’t care to question the theory behind what they are doing…the simple explanation that “every other country is doing it” is all they need…why question things that give you HUGE amounts of power…if it weren’t for this gig his middling talents would have him writing textbooks…think that sounds fun to him now? hell no…once he has worn the ring he craves it more than ever.

  4. Here is my review of the book written back in 2005 when it became clear he was a front runner to replace the “interest rate czar” aka “bubblespan”.

    Bernanke’s deflation fighting credentials have been written about many times. Bernanke has stated himself that he is, “what some would consider obsessed with the Great Depression”. He has convinced himself of what should have been done to prevent the depression and I believe he hopes to be a hero at some point in the future and use his knowledge to prevent a deflationary depression in the future.

    Book review of:
    “Inflation Targeting”

    The reason I wrote this essay was to examine a more mysterious side of Ben Bernanke. Is Bernanke Really An Inflation Hawk? I have painstakingly read some of his previous work in order to examine his mindset with regards to inflation. In 1999, before he got so involved in “public service”, he co-published a 382 page book called “Inflation Targeting”. I haven’t seen any mention of this book in the thousands of financial articles I have read over the last few years. There are many nuggets in the book that have already foreshadowed some of the actions of the Fed. At the time he felt free to discuss things that he apparently doesn’t feel appropriate are to discuss now that he is the big cheese. Luckily for him, thus far the US Financial press has been far too lazy to read a 382 page book on inflation targeting. Luckily for you, I have dissected this obtuse book with the tenacity of a four year old boy searching for bugs under rocks in the back yard.

    One of the most intriguing things I found in the book is Bernanke’s discussion of M-3 statistics and the negative affects on public perception. It is a fact some central banks have targeted inflation by making public announcements targeting M-3 data as well as some version of the CPI. In theory this has some appeal because it is understood by many economists that an increase in the money supply will eventually lead to an increase in over all prices. (Common sense right!?). Bernanke explains that in the second half of 1991, the German Bundesbank was faced with an inverted yield curve at the same time as “GDP growth began to slacken”(sound familiar?!). The “problem”, as Bernanke described it, was that M-3 growth accelerated as people shifted funds into time deposits to take advantage of lower short term rates. Bernanke notices that although the Bundesbank has been pretty successful in meeting its CPI targets over the past 15 years, it has consistently missed its M-3 targets. Bernanke reasons that “changes in the demand for money” make M-3 targeting a misleading distraction when trying to control CPI inflation while also managing the other goals (unemployment and growth). His takeaway from past central bank experiences is to not make public goals for M-3 growth. He says the relationships between M-3 growth and central bank goals are statistically insignificant. One of his main lessons that he takes away from other inflation targeting regimes is to not confuse the public by targeting money supply stats in conjunction with CPI stats.

    Bernanke leaves no doubt that he thinks the public has to have faith that the Fed is serious about controlling inflation. He repeatedly emphasizes the importance of conveying to the public that they are serious about inflation. He has thought of dozens of different methods to convey this to the public. It has apparently never crossed his mind that to really convince us that he is against inflation he has to actually be against inflation.

    In his book Bernanke talks about two reasons for targeting inflation at greater than 0%.

    1. “Simulations” done in a study by Akerlof, Dickens and Perry(1996) showed that “inflation rates close to zero might increase the natural rate of unemployment”, mostly because “it is difficult to move wages downward in nominal terms so reductions in real wages can only occur through inflation”. Well I don’t know what you think, but that is one hell of a sales pitch. It is a good thing old Bernanke never had to go door to door selling knives like I did one summer in college.

    Even Bernanke knows that some monopoly game simulation done on a 133 megahertz computer in 1996 by some pot-smoking-grad-school eggheads is not a very good reason to destroy the world’s premier currency at some arbitrary minimum rate. For he says on page 29 of his book “A more persuasive argument against aiming for an inflation rate of zero is that such policy risks tipping the economy into deflation”. Note that for Bernanke the word deflation is like the phrase “broccoli and mushroom casserole” to my 3 year old. Even worse he equates deflation unequivocally with 1930’s US depression and 1990’s Japan. He has no use for declining prices and the gradual working off of bad debt. In his world all debt is paid in full with devalued currency. Later in the book Bernanke admits that a targeted inflation of 5% or 7% may be ok. He doesn’t want to pass judgment on this until more econometric studies have been done. Maybe I am biased, but my interpretation of this kind of statement is that he is not really that worried about inflation.

    Bernanke repeatedly asserts that it is the central banks job to address the goals of the public (read the political powers). One of the big selling points of the central bank for the advocates of it is that it is an independent. Bernanke gives lip service to the great value of this independence but then he starts chipping away at it. He implicitly supports thinking about two types of independence:”goal independence” and “instrument independence”. He advocates giving the central bank instrument independence, but not goal independence. On page 35 Bernanke says “this strategy [his strategy] calls for inflation targets themselves to be set by the political process in which central bankers consult with the appropriate legislators or ministers. The execution of the policy is then left completely to the central bank.” Wow! So when Bernanke thinks of independence he thinks of a private in the army digging a hole exactly the depth his sergeant tells him to(goal independence for the sergeant)), but the private gets to pick whichever tool(instrument independence) he wants to do it. Aren’t academics great! This guy can walk around and feel like he is really an honest person when he says he supports and independent Fed, yet he has defined independence to mean pretty much the exact opposite of what it really means! Good god! My maid has instrument independence!

    There are lots more boring details in this book that bore most of my acquaintances to tears, but let me give you one last clarification for all of you folks who are worried about the integrity of the CPI. Bernanke succinctly and quickly points out that any inflation targeting regime is entirely dependent on what measure of inflation you are targeting. Bernanke go straight to the point and says he thinks the old measures of inflation overstate real inflation. Thus you need to make sure and use a index that uses hedonics to adjust for changes in quality, such as bigger TV screens or sharper pictures or more megahertz in the computer or better emissions equipment on a car, maybe he’d even use hedonics to adjust down the price of college education. After all aren’t today’s students learning a lot more about economics now that he has improved our knowledge of economics so vastly. So he wants to make sure that all improvements in quality are stripped out of any inflation index the Fed is targeting. He is clear about this goal in his book.

    He also clearly states that substitution of goods should be included in the index so that if pork goes up in price and people switch to buying chicken then the change in habits should be reflected in the index. Yes this means if steak goes up in price and my family switches to eating cat food for dinner then that should be reflected, because our cost of living hasn’t actually gone up. Bernanke also emphasizes that “at least the first round effects” of “supply shocks” should be insulated form the inflation index of interest. He repeatedly uses “oil price spikes” as examples of “supply shocks”. Bernanke supports all the adjustments to the CPI and doesn’t seem shy about adding new innovations to these indexes if he could insulate first round effects of “supply shocks” more effectively

    So if there was any doubt about the Fed understanding how the CPI is manipulated then this should make it crystal clear that they understand and they support it. Bernanke intends to consult with “appropriate ministers”[the guy who appointed him] about the Fed’s goals [low unemployment and higher GDP growth and don’t let the housing bubble crash]. Does anyone have any question what the legislative branch will have for goals?

    This policy is not the end of the world for us, it is refreshingly clear what you need to do. With Greenspan you had to worry that he was doctor evil who knew that government had to fear gold even more than hecklers who wear distasteful t-shirts. With Bernanke his goals are clear:”slowly inflate the debt away, but never ever ever ever ever let the economy slip into Deflation.”

    1. Interesting, Gabe. I read that book too, and was impressed to find that nobody ever actually has an inflation target. They just have these particular numbers they aim at, which are always higher than zero.

  5. If you’re not going to inflate your way out of debt

    The government does not want to get out of debt as a certain amount of long-term cheap debt is desirable. The idea is to keep it manageable.

  6. “project that the deficit will recede somewhat over the next two years as the temporary stimulus measures wind down and as economic recovery leads to higher revenues.”

    But what if it doesn’t? What if the recession goes on another two years? What if, instead, there are more bailouts, say for California?

    1. Then we will be forced to raise taxes…it’s a win/win

  7. Ben Bernanke: …. And we’re not involved in lending to the IMF. The IMF is a separate institution which has American executives as part of the executive branch.

    Ron Paul: Where would the money come from?

    Ben Bernanke: It’s a loan(to IMF).

    Ron Paul: Out of thin air?

    Ben Bernanke: Well, it’s a loan. If it’s not paid back we would take our share of the loss.

    Anyone catch Bernanke lying right there in under a minute?

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