Bernanke warns $85B spending cuts to slow economic recovery

Federal Reserve Chairman Ben Bernanke warned Congress risks slowing the economy by allowing $85 billion in automatic spending cuts to be triggered on Friday, arguing they should be replaced with more deliberate, long-term cuts.

In testimony for the Senate Banking Committee, Bernanke argued the sequester would create a “significant headwind” for the economic recovery.

“I hope it’s not controversial to say I think that Congress ought to think carefully about how it taxes and spends,” he said.

Bernanke did not offer an opinion on whether tax hikes should be included as part of a sequester replacement, and he did not call for any specific entitlement reforms. But in calling for action on “long-term imbalances” in the budget, he pointed to the need to address the growth of entitlement spending.

“The Congress and the administration should consider replacing the sharp, front-loaded spending cuts required by the sequestration with policies that reduce the federal deficit more gradually in the near term but more substantially in the longer run,” he said. “Such an approach could lessen the near-term fiscal headwinds facing the recovery while more effectively addressing the longer-term imbalances in the federal budget.”

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The White House has been warning for weeks of the dire consequences that would result from the automatic cuts. While Bernanke agreed that the sequester would damage the economy, he said the impact would not be evident when the clock strikes midnight on Friday.

“I wouldn’t expect to see a big impact immediately,” he said. “I think it would probably build over a period of months.”

Bernanke also disputed the notion that the cuts could be rearranged to minimize the impact on the economy. “The impact on growth would not be substantially different if you did it that way,” he said.

Instead of the indiscriminate cuts, Bernanke urged Congress to support tax and spending policies that incentivize employment and saving; develop workplace skills; promote research and development; and fund “necessary and productive” infrastructure.

At the same time, he acknowledged that his perspective as an economist does not take into account the political obstacles facing Congress.

“It’s easy to criticize, but politics is very difficult,” he said. “I don’t think Congress is not trying. I know you’re trying.”

While pressing lawmakers to take action, Bernanke often found himself playing defense against Republicans critical of the Fed’s efforts to boost the economy.

Sen. Bob Corker (R-Tenn.) accused the Fed of initiating a “global currency war” with its policies, and Bernanke of not paying enough attention to controlling inflation. He said the Fed’s independence has dwindled ever since the financial crisis and the resulting bailouts.

Bernanke, who almost always maintains an even keel, bristled at Corker’s accusations.

“None of the things that you said are accurate,” he said, defending his record on controlling inflation as “the best of any chairman in the post-war period,” referring to World War II.

Bernanke offered a strong defense of the Fed's monetary policy and gave no indication it will slow its efforts, despite minutes of Fed meetings that show some officials want the stimulus to end. Bernanke said the Fed's bottom-barrel interest rates and massive bond purchases are clearly supporting the recovery while keeping inflation in check.

The Fed is currently in the midst of its third round of “quantitative easing” and intends to buy $85 billion of bonds each month until it sees substantial improvement in the labor market. The central bank has said it expects to keep interest rates near zero until the unemployment rate dips below 6.5 percent — it now stands at 7.8 percent — or inflation climbs above 2 percent.

The Fed's expansionary policy has “helped spark recovery” in the housing market, increased the sales and production of cars and other major goods and boosted employment, Bernanke argued.

“The risk of not doing anything is severe as well,” Bernanke said. “We’re trying to balance those things the best we can.”

The Fed chairman described the economy as growing at “a moderate if somewhat uneven pace.”

Even though the Commerce Department reported that the economy shrank 0.1 percent in the fourth quarter of 2012, Bernanke warned that the data should not be read as a “stalling” of the recovery.

He contended the fourth-quarter dip reflected weather-related disruptions and “transitory declines in a few volatile categories of spending.”

“Available information suggests that economic growth has picked up again this year,” he said.

Bernanke largely dismissed concerns about Fed policies encouraging risk-taking in the markets and reiterated his confidence in the central bank’s ability to unwind its multitrillion-dollar portfolio without fueling inflation.

“At this point, they’re not a sufficient concern that they outweigh the important benefits of trying to support the continued recovery,” he said.

—This story was first posted at 10 a.m. and has been updated.