Fed Chairman Speaks on The Urgent Need To Avert a Fiscal Cliff

In an address to the New York Economic Club today, Federal Reserve Chairman Ben Bernanke commented on the state of the economic recovery and the challenges faced by the U.S.--namely, a weak housing market, slow global growth, and of course, the fiscal cliff. But this third headwind to economic growth is entirely within the control of lawmakers, and Bernanke urged Washington to take on the challenge.

First, the Congress and the Administration will need to protect the economy from the full brunt of the severe fiscal tightening at the beginning of next year that is built into current law--the so-called fiscal cliff. The realization of all of the automatic tax increases and spending cuts that make up the fiscal cliff, absent offsetting changes, would pose a substantial threat to the recovery--indeed, by the reckoning of the Congressional Budget Office (CBO) and that of many outside observers, a fiscal shock of that size would send the economy toppling back into recession.

Bernanke elaborated on a plan to the fiscal cliff, advocating something similar to what CRFB President Maya MacGuineas argued for last Friday and what CRFB has been advocating since early this year. Even as we look to avoid the fiscal cliff, we cannot avoid coming up with a plan to tackle our unsustainable fiscal path. By announcing a plan with much of the deficit reduction backloaded until when the economy has recovered, Bernanke argued that we could support economic growth by giving the public and market the confidence to invest:

As fiscal policymakers face these critical decisions, they should keep two objectives in mind. First, as I think is widely appreciated by now, the federal budget is on an unsustainable path. The budget deficit, which peaked at about 10 percent of GDP in 2009 and now stands at about 7 percent of GDP, is expected to narrow further in the coming years as the economy continues to recover. However, the CBO projects that, under a plausible set of policy assumptions, the budget deficit would still be greater than 4 percent of GDP in 2018, assuming the economy has returned to its potential by then. Moreover, under the CBO projection, the deficit and the ratio of federal debt to GDP would subsequently return to an upward trend…A credible framework to set federal fiscal policy on a stable path--for example, one on which the ratio of federal debt to GDP eventually stabilizes or declines--is thus urgently needed to ensure longer-term economic growth and stability.

Even as fiscal policymakers address the urgent issue of longer-run fiscal sustainability, they should not ignore a second key objective: to avoid unnecessarily adding to the headwinds that are already holding back the economic recovery. Fortunately, the two objectives are fully compatible and mutually reinforcing. Preventing a sudden and severe contraction in fiscal policy early next year will support the transition of the economy back to full employment; a stronger economy will in turn reduce the deficit and contribute to achieving long-term fiscal sustainability. At the same time, a credible plan to put the federal budget on a path that will be sustainable in the long run could help keep longer-term interest rates low and boost household and business confidence, thereby supporting economic growth today.

In reiterating the need for balance our short-term and long-term economic needs, Chairman Bernanke makes the case for a smart and gradual deficit reduction plan to replace the fiscal cliff, just as we have.

The full transcript of Chairman Bernanke's speech can be found here.

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