Tuesday, July 21, 2009

Is a Successful Exit Strategy Likely?

Below is an excerpt from Ben Bernanke's testimony on March 3, 2009. Highlighted in red are my comments, which were not part of the original speach.

Unfortunately, the spending for financial stabilization, the increases in spending and reductions in taxes associated with the fiscal package, and the losses in revenues and increases in income-support payments associated with the weak economy will widen the federal budget deficit substantially this year. Taking into account these factors, the Administration recently submitted a proposed budget that projects the federal deficit to increase to about $1.8 trillion this fiscal year and to remain around $1 trillion in 2010 and 2011. As a consequence of this elevated level of borrowing, the ratio of federal debt held by the public to nominal GDP is likely to move up from about 40 percent before the onset of the financial crisis to more than 60 percent over the next several years--its highest level since the early 1950s, in the years following the massive debt buildup during World War II.

Of course, all else equal, this is a development that all of us would have preferred to avoid. But our economy and financial markets face extraordinary challenges, and a failure by policymakers to address these challenges in a timely way would likely be more costly in the end. We are better off moving aggressively today to solve our economic problems; the alternative could be a prolonged episode of economic stagnation that would not only contribute to further deterioration in the fiscal situation, but would also imply lower output, employment, and incomes for an extended period. (They would not be more costly in the long run, the current policy will -- read on).

With such large near-term deficits, it may seem too early to be contemplating the necessary return to fiscal sustainability. To the contrary, maintaining the confidence of the financial markets requires that we begin planning now for the restoration of fiscal balance. As the economy recovers and resources become more fully employed, we will need to withdraw the temporary components of the fiscal stimulus (It will be years before our economy can be fully employed). Spending on financial stabilization also must wind down; if all goes well, the disposition of assets acquired by the Treasury in the process of stabilization will be a source of added revenue for the Treasury in the out years (Bernanke is speculating on behalf of the tax payers?). Determining the pace of fiscal normalization will entail some difficult judgments. In particular, the Congress will need to weigh the costs of running large budget deficits for a time against the possibility of a premature removal of fiscal stimulus that could blunt the recovery. We at the Federal Reserve will face similar difficult judgment calls regarding monetary policy.

As I mentioned earlier, the President has recently submitted a budget, and it proposes an ambitious agenda, including new initiatives for energy, health care, education, and tax policy. These are all complex policy issues in which the specific design of each program is as important as the budgetary amount allocated to it. The Congress will have considerable work in evaluating how to proceed in each of these areas. (Bernanke is warranting Congress to determine what will ultimately benefit economic growth. In other words, Tweedle-Dee is giving Tweedle-Dum the reigns.)

As part of that evaluation, it will be critical to consider the formidable challenges and tradeoffs needed to simultaneously achieve an economic and financial recovery, fiscal responsibility, and program reforms that accomplish their desired goals effectively and efficiently. In particular, policymakers must remain prepared to take the actions necessary in the near term to restore stability to the financial system and to put the economy on a sustainable path to recovery. But the near-term imperative of achieving economic recovery and the longer-run desire to achieve programmatic objectives should not be allowed to hinder timely consideration of the steps needed to address fiscal imbalances. Without fiscal sustainability, in the longer term we will have neither financial stability nor healthy economic growth. (Bernanke conveniently concludes that economic success, or armageddon, will reside in the lap of congress. He is, of course, partly correct. The other part of that equation would be the Fed, whose negative effects on the economy he does not acknowledge. In either case, congress has never been able to be fiscally responsible, which is why Bernanke is covering his Fed A**).

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