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.
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.
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.