Bernanke Scolds Congress on Deficits, but Provides Little Guidance

Congress is used to hearing people complain about its runaway deficits, but will it mean more coming from the Federal Reserve Chairman? Ben Bernanke testified today before the House Budget Committee on the state of the U.S. economy. This included a wide variety of topics, but he expressed the most concern about the ever-growing national debt.

In his prepared remarks, Bernanke began by providing an update on the economy and his monetary policy activities. For anyone who follows those topics, there was little new revealed. The recovery is slowly moving forward, but the labor market will take a very long time to heal. He expressed the need for the Fed's current quantitative easing strategies in light of the unemployment problem and said inflation remains low, despite recent gasoline and other commodity price increases.

Then, he turned to the nation's fiscal status. He expressed concern at the unsustainable path U.S. government borrowing is on. He noted that current budget projections show federal debt reaching 90% of GDP by 2020 and 150% of GDP by 2030. Then he explained the negative effects too much borrowing will have on the economy:

The CBO's long-term budget projections, by design, do not account for the likely adverse economic effects of such high debt and deficits. But if government debt and deficits were actually to grow at the pace envisioned, the economic and financial effects would be severe. Sustained high rates of government borrowing would both drain funds away from private investment and increase our debt to foreigners, with adverse long-run effects on U.S. output, incomes, and standards of living. Moreover, diminishing investor confidence that deficits will be brought under control would ultimately lead to sharply rising interest rates on government debt and, potentially, to broader financial turmoil. In a vicious circle, high and rising interest rates would cause debt-service payments on the federal debt to grow even faster, resulting in further increases in the debt-to-GDP ratio and making fiscal adjustment all the more difficult.

These are some pretty serious consequences to imagine. You can look to Europe to see some nations grappling with precisely such issues due to sovereign debt crises.

Due to the potential disaster the U.S. faces if it doesn't get its fiscal house in order, Bernanke appeared to see this as the biggest potential problem on the economy's horizon. Comparatively, he seemed unworried that the recovery would proceed and that inflation wouldn't grow out of control. Yet due to his position as Fed chair, he couldn't really provide much concrete advice on how to fix the budget.

One tangible recommendation he did provide is for Congress to adopt a long-term plan to cut deficits. This would help convince the market that huge deficits won't last forever. Although numerous representatives asked him various questions about the best ways to do so, he said such questions were out of his purview. Instead, his general guidance suggested they fix the budget in such a way that is constructive to growth and international competitiveness.

If you read between the lines, then this appears to suggest drastic tax increases on both the personal and corporate levels are not advisable. Tax reform would be a good step, and some rates will have to rise, but not so high that business activity is severely stifled.

Of course, tax increases won't be enough. So the mission for the government is to cut spending in such a way that it doesn't harm growth. That likely means federal spending on priorities like education and research shouldn't be a chief target for budget-cutters.

These principles might seem obvious, but they're rarely discussed. At this point, there is broad agreement that a plan needs to be put in place to put U.S. borrowing on a sustainable path. The disagreement stems from how to do so. Ultimately, a compromise will be necessary. Taxes will rise and spending will decline, but both should do so in such a way to keep the best interest of the economy in mind.