Bernanke warns fiscal standoff already taking toll on the economy

Federal Reserve Chairman Ben Bernanke issued his final warning Wednesday to the White House and Congress to strike a deal to avoid the "fiscal cliff," cautioning that concerns over the pending tax hikes and spending cuts were already taking a toll on the economy.

Bernanke was adamant that policymakers could not let the economy go over the cliff, even briefly, because it would wreak havoc on a still tenuous recovery. In fact, he said the continued standoff was already doing damage.

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“Why are markets volatile? Why is business investment among its weakest levels during the recovery?” he told reporters. “All of these things, at least to some extent, can be traced to the anticipation and concern over the fiscal cliff.”

His latest comments mark Bernanke’s final attempt to press President Obama and lawmakers toward an agreement before tax rates rise and sequestration cuts go into effect in January.

Bernanke famously coined the term “fiscal cliff” back in February, and while some have suggested the term is overly dramatic, the government’s chief economic steward still found it apropos.

“If fiscal policy becomes very contractionary, the economy, I think, will go off a cliff,” he said. “I don’t buy the idea that a short-term descent off the fiscal cliff would not be costly … in fact we’re already seeing costs.”

His warning was underlined by new policy action from the Fed, which announced it was expanding its monthly asset purchases beginning in 2013. Already buying $40 billion in mortgage debt a month, the Fed will also begin buying $45 billion in Treasury bonds per month in its bid to further drive down interest rates and spur economic activity. The Fed said in its statement announcing the move was spurred by continued lackluster economic growth and a stubbornly high unemployment rate.

“The Committee remains concerned that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions,” the Fed said in the statement. “Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook.”

The Fed also announced it planned to keep interest rates near zero until the unemployment rate dipped to 6.5 percent, pegging for the first time monetary policy moves to explicit economic numbers.

As he had in the past, Bernanke refrained from weighing in on the issues bedeviling negotiations, such as how to handle tax rates for the wealthy and entitlement programs. However, he did flesh out what he believes an agreement needs to look like at least from a logistical perspective. First and foremost, policymakers need to establish some hint of a framework during the lame duck, as opposed to simply extending current policy to buy more time, he argued.

“There’s a problem with kicking the can down the road,” Bernanke said. “It could create concerns about our longer term fiscal situation … it’s in the best interest of the economy to come to a two-part solution.”

At the very least, lawmakers need to craft an agreement in the coming days that defers the dramatic fiscal contraction due at the beginning of next year and creates a blueprint for more comprehensive reform. Any agreement missing both of those elements would be a failure, he said.

Despite the continued standoff, Bernanke refused to believe that Washington would fail to do what he sees as necessary — insisting that the consequences are too dire.

“It’s always a delicate balance. You don’t want to scare people, and I actually believe that Congress will come up with a solution,” he said. “It’s exceptionally urgent and important that Congress and the administration come to a sensible agreement.”

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