The Federal Reserve faces a difficult task ahead in finding he right "exit strategy" from its economic stimulus efforts. But the US Congress may have an even more difficult task: reining in federal budget deficits that could weigh on the US economy for years to come.
That was the sobering message delivered by Fed Chairman Ben Bernanke as he gave his semiannual report to Congress.
Doubts about the Fed’s exit strategy have been one big source of concern in financial markets lately.
Mr. Bernanke acknowledged this is a tricky matter, but in response to lawmaker questions Tuesday, he suggested that the central bank has the tools it needs. The challenge involves choosing the right time, so that the Fed neither acts too soon, choking a recovery, nor too late, fueling inflation.
But he said that other government policies, which are controlled by Congress and the White House, pose their own risks to the economy. It will require tough choices on taxes and spending to control rising federal deficits, he said.
"Otherwise, we might see interest rates rise," hindering economic growth and job creation, Bernanke told members of the House Financial Services Committee. "Unless we demonstrate a strong commitment to fiscal sustainability, we risk having neither financial stability nor durable economic growth."
He said failure to deal with the fiscal issue could crimp job growth. Already, the Fed is forecasting that unemployment will remain above 9 percent next year, even as the economy starts to grow again.
This was not the first time he has expressed concern about fiscal policy or acknowledged the Fed's own policy challenges. But Bernanke's testimony served to temper some of the optimism that has been showing up in financial markets in recent weeks. Broad US stock indexes retreated from early-morning gains – a downshift that may have stemmed in part from his comments.
Bernanke's remarks came as the Congressional Budget Office (CBO) has also been sounding the alarm on fiscal sustainability.
Congress is considering major changes to healthcare policy, which is currently a major driver of rising government spending. And Republicans and Democrats are sparring over whether a $787 billion economic stimulus package, still only partly spent, is effective in creating jobs. Some argue that more will need to be spent, while others would roll back the existing plan.
To prevent the rise in government debt from causing "substantial harm" to the economy will require either big tax hikes, sharp spending cuts, or both, the CBO said in its long-term outlook last month.
Bernanke gave lukewarm praise for the current stimulus, saying "there has been some positive impact." The larger issue, he said, is to agree on a path for longer-term fiscal sustainability, which "could yield considerable near-term economic benefits in the form of lower long-term interest rates and increased consumer and business confidence."
On the Fed's own exit strategy, he pledged vigilance against potential inflation. But he said the Fed's short-term lending rate for banks will remain very low "for an extended period." He said monetary policy is not currently fueling inflation. The economy is so weak that consumer prices have been largely contained in recent months.