Fed chief: Cuts won't derail recovery

Federal Reserve Chairman Ben Bernanke says a plan from House Republicans to cut $61 billion in spending this year would not harm economic growth. 

The GOP's proposed spending cuts, passed as part of a continuing resolution, would probably reduce "growth on the margins" and lower gross domestic product by only one- or two-tenths of a percent, Bernanke told the Senate Banking Committee.

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The Fed chairman's estimate contrasts with recent reports from Goldman Sachs and Moody's Analytics that predicted economic harm from a $61 billion spending reduction.

The Goldman Sachs report released last week predicted that the Republican spending cuts would slow growth by as much as 2 percentage points in the second and third quarters of this year. Senate Democrats pounced on the analysis to argue that Republicans were trying to "drag our economy back into a recession."

But Bernanke said that analysis is off the mark.

"Two percent [reduction in growth] is enormous and would be based on $300 billion in cuts," Bernanke told the panel in his semiannual report to Congress. "Sixty billion to $100 billion isn't sufficient to create that kind of effect."

Although Bernanke didn't provide a projection of possible jobs losses from the spending bill, he said the proposed spending cuts aren't likely to lead to the 700,000 job losses predicted by Moody's Analytics chief economist Mark Zandi. 


He reiterated previous statements that, while the debt and deficits are major issues for the nation, Congress needs to tackle the issue of long-term budget imbalances. 

"Sixty billion won't have much impact on the long run," he said. "Congress needs to address the budget deficit over a 5- to 10-year window."

Bernanke said he would like to see the nation's structural budget deficit reduced by 2 to 3 percentage points in the next decade. 

Zandi said the Republican plan to trim $61 billion from federal spending through the next seven months would wipe out 700,000 jobs through 2012 and reduce economic growth by 0.5 percentage points this year.

As the economy continues to improve, Bernanke said the central bank is paying "close attention" to rising commodity prices, specifically the cost of gasoline, that has increased sharply with the political turmoil in the Middle East and North Africa.

Increasing prices could raise inflation expectations, reduce confidence and sap consumers of some spending power as the recovery picks up pace.

So far, Bernanke isn't seeing any signs that rising gas prices are posing a significant risk to the nation's economic recovery but the Fed is taking the issue "very seriously" as part of its job to ensure inflation remains low.

He said that “sustained rises in the prices of oil or other commodities would represent a threat both to economic growth and to overall price stability, particularly if they were to cause inflation expectations to become less well anchored" but said the price increases could create a “temporary and relatively modest increase in consumer prices inflation.”

Republicans attempted to dismantle Bernanke's arguments that the central bank's quantitative easing policy, known as QE2, isn't working but he strongly defended the plan saying the proof of its effectiveness is evident in the improving financial and labor markets. In addition, inflation has remained low, the threat of deflation has faded and the long-term outlook for inflation expectations, about 2 percent, is on track, he said.

Senate Banking ranking member Richard Shelby (R-Ala.) questioned whether QE2 -- using $600 billion to buy up government debt -- may risk "sparking inflation" while failing to help the nation address its fundamental problems.

"We take the inflation issue very very seriously and there's no illusion about allowing inflation to get high," Bernanke assured lawmakers, reassuring policymakers that ultimately the Fed's balance sheet would eventually return to a more normal level. The balance sheet has expanded to more than $2 trillion as the Fed bought up bad mortgage debt.

Bernanke called $600 billion a "strong statement and a powerful move" it's not outside the "range of historical experience."

"Instead of unemployment stagnating or going up we're seeing some improvement," Bernanke said.

He also called concerns that QE2 has caused the dollar's value to diminish as "way overstated" saying it's about the same as before the crisis across world markets. 

Besides the Fed's monetary policy, Bernanke credited an $858 billion package of tax cuts for contributing to the nation's economic growth this year and in 2012.

While lawmakers peppered Bernanke with questions over the effects of $14 trillion in debt and a projected $1.5 trillion deficit this year, he argued that the tax code could be make more efficient but while lawmakers need to control spending they should look to invest in research and development, education, infrastructure "and other things that help the economy grow and "allows the private sector to bring the economy forward."
 
He urged lawmakers "not to lose sight that money spent is spent effectively with attention to long-term growth."

"I support a program to improve long-term fiscal sustainability," he said. 

Mostly, he reiterated previous statements that while the economy is improving the job market is weak and the housing market is the biggest drag on the recovery.

“Until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established,” he said.

-- This story was updated at 3:26 p.m.

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