Bernanke: Fed Ready to Help, and Austerity Should Wait

The Federal Reserve chairman says that the central bank will do its part to ensure the economy keeps growing but worries that government could get in the way of the recovery

In a speech on Thursday, Federal Reserve Chairman Ben Bernanke provided some reassurance on the stalling recovery, along with a warning. He attributed the weak first half of 2011 mostly to temporary shocks to the economy. While the damage those events caused could affect the second half of the year, he stressed that the U.S. economy should continue to grow -- unless policymakers screw things up. He also asserted that the central bank will do its part to continue to stimulate growth.

The Danger of Austerity

Perhaps the most striking part of Bernanke's speech was his clear explanation of how Congress should view budget cutting:

The prospect of an increasing fiscal drag on the economy in the face of an already sluggish recovery highlights one of the many difficult tradeoffs currently faced by fiscal policymakers. As I have emphasized on previous occasions, without significant policy changes to address the increasing fiscal burdens that will be associated with the aging of the population and the ongoing rise in health-care costs, the finances of the federal government will spiral out of control in coming decades, risking severe economic and financial damage. But, while prompt and decisive action to put the federal government's finances on a sustainable trajectory is urgently needed, fiscal policymakers should not, as a consequence, disregard the fragility of the economic recovery. Fortunately, the two goals--achieving fiscal sustainability, which is the result of responsible policies set in place for the longer term, and avoiding creation of fiscal headwinds for the recovery--are not incompatible. Acting now to put in place a credible plan for reducing future deficits over the long term, while being attentive to the implications of fiscal choices for the recovery in the near term, can help serve both objectives. (my emphasis)

In short, Congress should continue to spend now and plan to pay later. Many in Washington don't share Bernanke's philosophy here, however. Some Republicans are calling for immediate budget cuts, and few would support additional stimulus spending. This political reality must worry Bernanke. Towards the end of his speech, he warns: "Thus I do not expect the long-run growth potential of the U.S. economy to be materially affected by the financial crisis and the recession if--and I stress if--our country takes the necessary steps to secure that outcome." (his emphasis)

A Fed Ready and Willing to Provide More Support?

Bernanke also appeared to indicate that the Fed would be ready and willing to take action if the economic weakness continues:

. . . the Federal Reserve has a range of tools that could be used to provide additional monetary stimulus. We discussed the relative merits and costs of such tools at our August meeting. My FOMC colleagues and I will continue to consider those and other pertinent issues, including, of course, economic and financial developments, at our meeting in September and are prepared to employ these tools as appropriate to promote a stronger economic recovery in a context of price stability.

Indeed, the August meeting minutes revealed that a number of tools were considered and that the monetary policy committee will meet for a day longer than planned to further discuss putting these possible stimulus tools into action. Bernanke closes by saying, "The Federal Reserve will certainly do all that it can to help restore high rates of growth and employment in a context of price stability." That isn't an unequivocal statement that we'll definitely see additional action in September, but it certainly appears that Bernanke would be on board.

So which tools might the Fed use? Jon Hilsenrath of the Wall Street Journal reports on some likely candidates. One option would shift the Fed's portfolio towards longer-term securities, to try to bring down longer-term interest rates. This would not require expanding the size of its balance sheet. Another tool would be to cut the interest rate that the Fed pays banks on their cash reserves. This would also encourage banks to expand credit without the Fed purchasing more assets. Finally, the Fed could get even more specific about exit timing, providing specific economic triggers for when support with would be withdrawn.

The next Fed meeting is just a few weeks away. Unless we get some very optimistic economic reports between now and then, we may see the Fed employ additional tactics to keep the recovery moving forward. But if Congress insists on immediate, aggressive austerity, then it won't be easy for the U.S. economy to achieve moderate growth in the near-term.

Image Credit: REUTERS/Larry Downing