Economic future ‘unusually uncertain’

With the outlook for the economy “unusually uncertain,” Federal Reserve Chairman Ben S. Bernanke advised Congress on Wednesday not to precipitously cut stimulus spending in a drive to rein in the deficit, but rather focus on longer-range budget reforms that will reduce the deficit in the next five years but not immediately threaten economic growth.

Mr. Bernanke told the Senate Banking, Housing and Urban Affairs Committee that the central bank is reviewing its own options for further stimulating economic growth “if the recovery seems to be faltering,” although he insisted that he still expects moderate growth of 3 percent to 3.5 percent for the rest of the year.

His remarks confirmed fears in financial markets that the economy recently took a turn for the worse, and sent the Dow Jones Industrial Average down by more than 100 points. Just before he spoke, President Obama signed into law a financial reform bill giving major new powers to the Fed and other regulators to impose restrictions on credit and banks, adding to the uncertainty overhanging the markets.

Because of concerns about the economy, the Fed chairman took the unusual step of weighing in on what he described as the “very contentious” debate over stimulus spending versus deficit reduction that has been raging on Capitol Hill.

After weeks of partisan wrangling, the Senate on Wednesday extended further aid to the long-term unemployed over the objections of Republicans and conservative Democrats who had insisted on immediate cuts in spending to offset the stimulus.

Mr. Bernanke stressed that both goals are important: Congress should continue to support the still-fragile recovery with some stimulus, but it also must lay plans for dramatic reductions in the deficit to prevent the government debt from getting out of control and precipitating a financial crisis in coming years.

He said the goals could be married by focusing deficit reduction efforts on the “medium term,” meaning the next four or five years, when the burgeoning public debt poses the biggest threat of precipitating a crisis.

“There’s not much need to reduce the 2010 deficit” of about $1.4 trillion, he said, noting that the Treasury has been able to easily finance it this year because of a rush into safe-haven investments when the European debt crisis erupted.

“At the current moment, large deficits, as unattractive as they are, are important for restoring economic activity and stability. I would be reluctant to withdraw spending too precipitously,” he said.

“I would much prefer to see consolidation or cuts over the medium term as opposed to immediately,” he added.

Mr. Bernanke said Congress’ goal should be to cut the yearly budget deficit to a “sustainable” level of about 3 percent of economic output or $450 billion by the middle of the decade - the goal set by a presidential commission that will recommend anti-deficit measures later this year.

Congress should focus on resolving “structural” budget problems - such as the government’s increasingly insolvent retirement programs - rather than “cyclical” problems like the loss of revenues or increase in unemployment benefit spending that resulted from the deep recession, he said.

“Anything we can do to reduce the structural deficit would be positive for the markets, and would make it easier to maintain stimulus,” he said.

Failing to address the longer-term deficit risks bringing on a sharp rise in interest rates and jarring financial crisis that would pose serious problems for the U.S. economy, he said.

But while Mr. Bernanke urged major efforts to reduce the spiraling deficit and stave off a debt crisis like the one engulfing Europe, he was characteristically short on recommending specific program changes to Congress.

The Fed chairman passed up an opportunity to endorse letting the Bush tax cuts expire at the end of the year, as advocated recently by his predecessor, Alan Greenspan, out of concern about rising deficits.

Republicans vehemently oppose that and contend that it would send the economy into a tailspin, while Mr. Obama has proposed extending only the tax cuts for the “middle class,” which he defines as people earning less than $200,000 a year.

Worries about the economy prompted Senate Budget Committee Chairman Kent Conrad of North Dakota, a conservative Democrat, to say Wednesday that he supports extending all the tax cuts, including those for wealthier Americans, although that would require a waiver of budget rules.

“You’d not want to do tax changes, tax increases … until the recovery is on more solid ground,” he told reporters on Capitol Hill.

Senate Finance Committee Chairman Max Baucus, Montana Democrat, on the other hand, has questioned whether the country can afford to extend the tax cuts for the wealthier, and former Treasury Secretary Robert E. Rubin contends that higher taxes on wealthier Americans would not hurt the economy.

Mr. Bernanke avoided taking a stand on the tax cuts, perhaps mindful of the sharp criticism Mr. Greenspan endured nearly a decade ago by lending momentum to the Bush tax cuts with his endorsement, which he recently retracted.

Congress must carefully weigh both the potential to hurt economic growth from higher taxes, and the need to curb burgeoning deficits, Mr. Bernanke said.

Without action by the end of the year, tax rates for all income groups will rise, with the top rate reverting to its Clinton-era level of 39.6 percent from 35 percent today.

Under questioning from Republicans, Mr. Bernanke said that uncertainty about the fate of the tax cuts could be clouding the outlook for the economy and financial markets.

Republicans say the markets have been plagued by worries about a sharp rise in taxes on capital gains and dividends at the end of the year.

Moreover, the threat of looming tax increases on the highest income groups could be preventing small-business owners from hiring workers, they say, since many small businesses are not incorporated and are subject to the top individual tax rates.

Mr. Bernanke said that could be a concern for some businesses, but he stressed that the uncertainties plaguing the markets and the economy go well beyond Washington and reach as far as the outlook for growth in China and other emerging markets.