Bernanke: start work now to curb budget deficit

The nation needs to begin planning now to eventually bring taxes and spending into line, Federal Reserve Chairman Ben S. Bernanke said Wednesday, arguing that large budget deficits, if sustained, could deepen the financial crisis and choke off the economy.

Bernanke’s testimony to Congress reflected growing concern among economists and investors that the nation’s long-term fiscal imbalances could hinder economic recovery by driving up interest rates.

The rate the government must pay has already risen in recent weeks. Bernanke argued that even as the government spends to contain the financial crisis, it must be ready to move toward fiscal balance.

“Congress and the administration face formidable near-term challenges that must be addressed,” the Fed chairman told the House Budget Committee. But “unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth.”

The financial crisis is driving the country deeply into the red, with the national debt projected to double from about 41% of the economy last year to more than 82% by the end of the next decade.

President Obama has offered no specific plan to rein in Medicare costs, but has stressed the importance of reducing the deficit generally. Bernanke has often addressed congressional budget committees on the need for fiscal responsibility.

But his comments Wednesday carried more weight given recent swings in the market for Treasury bonds. In particular, the global investors who finance the nation’s large budget deficits have grown more antsy. The U.S. Treasury must now pay 3.5% to borrow money for 10 years -- low by historical standards, but up from about 3.1% a month ago and 2.9% three months ago. The increase has come even as the Fed has launched a program to buy up to $300 billion in Treasury bonds -- purchases that were designed to push down rates and did, when the program was rolled out in March.

The higher government borrowing rates have many likely causes, some of which reflect improvement in financial markets. For example, as investors have become more comfortable with risky assets such as stocks, they have been willing to move money out of safe U.S. Treasury bonds.

But other reasons are troubling. Investors, worried that Congress and the Obama administration will keep relying heavily on borrowed funds, are demanding a higher premium to lend to the government.

“These increases appear to reflect concerns about large federal deficits,” among other causes, Bernanke said.

Some analysts worry that the Fed will succumb to political pressure in the future to, in effect, print money to fund government borrowing -- a process called monetizing the debt.

Bernanke said that the Fed takes its political independence seriously and that it is now focused on easing the pain of the recession, but will respond aggressively if inflation becomes a problem.

As is his habit, he did not suggest specific ways for Congress to reduce long-term budget deficits; he views tax and spending decisions as the domain of elected officials.

Ultimately, the fundamental decision to confront “is how large a share of the nation’s economic resources to devote to federal government programs,” Bernanke said. “Crucially, whatever size of government is chosen, tax rates must ultimately be set at a level sufficient to achieve an appropriate balance of spending and revenues in the long run.”