Ben Bernanke is running out of bullets. That should be a sobering fact for politicians still bent on playing games with the debt limit.
On national television today, the Federal Reserve chairman painted a picture of a recovery that, two years after it began, remains “frustratingly slow” and too weak to make a meaningful dent in joblessness anytime soon. Even if the current slowdown proves temporary, as the Fed expects, its forecast pace of growth won’t bring unemployment back down below 7 percent until after 2013.
Much more troubling is the country’s lack of a backup plan if things get worse. The economy’s weakness leaves it vulnerable to shocks of the kind that Europe’s festering sovereign-debt crisis could easily deliver. But neither the Federal Reserve nor the U.S. government is in a good position to provide more life support should it become necessary.
Having already spent some $2.3 trillion on two bond-buying programs aimed at lowering interest rates and boosting growth, Bernanke recognizes that the costs of a third round of so-called quantitative easing may outweigh the benefits.
For one, the recent acceleration in inflation presents a genuine risk, and also provides ammunition for political scare-mongering that could negate any positive effect on confidence and stock prices.
Record Cash Levels
What’s more, businesses and consumers don’t stand to gain much from slightly lower interest rates. Companies are already sitting on record levels of cash, and most homeowners who can refinance their mortgages have already done so. Further easing could give U.S. exporters an edge by pushing down the dollar’s exchange rate against other currencies, but that can only go so far before central bankers in other parts of the world retaliate.
Indeed, even the most recent $600 billion round of quantitative easing has had mixed results. It appears to have helped fend off deflation, but its effect on growth has been muted at best. The Fed currently expects the economy to grow at an inflation-adjusted rate of between 2.7 percent and 2.9 percent this year, down from an estimate of 3.4 percent to 3.9 percent in January.
The country’s only other emergency backup would be increased government spending. Already, economists at Goldman Sachs Group Inc. estimate that as the federal stimulus tapers off, the slowdown in spending will shave about half a percentage point from annualized economic growth in the second half of this year, and more next year.
Done right, another $1 trillion or more in fiscal stimulus wouldn’t necessarily worsen the government’s debt burden. If, for example, massive, visible public-works spending managed to create jobs and improve confidence, stronger growth could ease the debt-to-GDP ratio automatically. This is unlikely to happen; the political currents are flowing in the opposite direction.
Fortunately, other approaches could have a similar effect: For maximum impact on jobs, the government might offer a tax credit commensurate to the number of new workers that firms add to their payrolls, as proposed by Alan Blinder, a Princeton University professor of economics.
Here, too, officials’ hands are tied. Unless politicians put the government’s long-term finances on a sustainable track by agreeing on how to rein in or pay for obligations such as Medicare and Medicaid, any extra spending now will look irresponsible. As countries from Russia to Greece have learned, markets may react by driving up the interest rate the government must pay on its borrowings, making the debt much harder to bear. As Bernanke put it today: “I do think in my role as somebody who is extremely interested in financial stability, that addressing the medium-to-long-term deficit problem is very urgent.”
Realism and Clarity
Realism and clarity are what taxpayers, businesses and markets need from the political system. An agreement in principle on what part of society -- retirees, workers, employers, homeowners, consumers -- ultimately will pay to fix the government’s finances, either through cuts in services or higher taxes, would go a long way toward restoring confidence. It should include mechanisms that guarantee the fix will happen, yet allow some leeway if the economy worsens.
Instead, politicians are engaging in high-stakes haggling over immediate budget cuts as they approach an August deadline for raising the federal-debt limit. If they don’t reach a deal, they risk triggering immediate, sharp spending cuts and a downgrade of the U.S. government’s AAA credit rating. Such a shock could quickly erase the meager gains the U.S. economy has made in the course of the recovery.
Brinkmanship makes for good political theater, and can do wonders for individual politicians’ careers. Unfortunately, as Bernanke made clear on a sweltering day in Washington, it’s a luxury the U.S. can’t afford right now.
Read more Bloomberg View editorials.
To contact the Bloomberg View editorial board: firstname.lastname@example.org.