Fed chief calls for deficit control. Why now?

Bernanke warned Wednesday that federal debt as a share of GDP is approaching highest levels since the early 1950s, after the massive borrowing of World War II.

By , Staff writer

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    Federal Reserve Chairman Ben Bernanke testifies before the House Budget Committee Wednesday.
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For Washington, fighting the recession has become the financial equivalent of waging a major war.

Think that comparison is exaggerated? Look at the numbers in Federal Reserve Board Chairman Ben Bernanke’s June 3 testimony to the House Budget Committee.

The federal deficit is soaring, as it did when America’s enemy was Nazis, not unemployment. Prior to the onset of the current crisis, federal debt held by the public was about 40 percent of US gross domestic product (GDP). By 2011 it’s likely to hit 70 percent, noted Chairman Bernanke.

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Debt levels reminiscent of post-war days

This development “would leave the debt-to-GDP ratio at its highest level since the early 1950s, the years following the massive debt buildup during World War II,” Bernanke told committee members.

Bernanke’s main point here is that the US government cannot just keep borrowing and borrowing to pay for its stimulus and financial stability programs.

Eventually, Uncle Sam is going to have to pay the piper. And it won’t be too long until the piper has finished his playlist.

Wave of retirees will exacerbate budget woes

Deficit reduction efforts are particularly important in light of the budgetary challenges posed by the retirement of the baby-boom generation and the continued increases in medical costs, said the Fed chief.

“Maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance,” said Bernanke.

So, why is Bernanke raising the profile of the deficit issue at this particular moment? After all, he and other US officials have long known it was a potential problem. They’ve warned that the nation would have to deal with it at some point.

It’s possible that the Fed chief has simply decided it is time. There is some evidence that the recession may be bottoming out, and if Congress and the administration are going to start looking for places to rein in spending further, they may need to get started.

Veteran budget expert Stan Collender, a managing director for Qorvis Communications, writes on the blog “Capital Gains and Games” that 2011 will be the first full fiscal year for which cutting deficits below current projections will be the correct economic policy.

And planning-wise, 2011 is not that far away. The Obama administration will be sending its 2011 budget to Congress in seven months, writes Mr. Collender.

Potential perils of deficit spending

It is also possible that Benanke has simply become more concerned about the deficit’s potential pernicious financial effects.

In his testimony Wednesday, the Fed chief noted that in recent weeks the interest rates on longer-term Treasury securities and fixed-rate mortgages have risen, in part due to concerns that large federal deficits may lead to future inflation.

This jump in rates already has cut into demand for home refinancings and house purchases, according to a Wachovia Economics Group analysis.

Applications for refinancing have fallen 24 percent over the past month, according to the analysis. Demand for commercial loans has also weakened.

“Higher long-term interest rates today are a roadblock to recovery, not a milepost,” concluds Wachovia.

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