Fed’s Williams Sees No ‘Magic Wand’ in Event of Default on Sovereign Debt

Federal Reserve Bank of San Francisco President John C. Williams said the central bank doesn’t have a “magic wand” to help the economy if the U.S. government defaults on its debts.

“Make no mistake -- the Federal Reserve doesn’t have a magic wand that will allow the economy to get through a crisis of this magnitude unscathed,” the regional bank chief said during a speech in Salt Lake City. “A federal default must be avoided,” he said.

Williams’ comments on the federal budget amplify similar warnings made this month by Chairman Ben S. Bernanke when he delivered the Fed’s twice-a-year economic report to Congress. Williams said there’s “no question” the nation is on an unsustainable long-run path of fiscal deficits, which must be reined in over the next decade.

On the economy, Williams said he believes growth will rebound in the second half of this year at a pace of “a bit faster” than 3 percent and that inflation will subside to a rate of about 1.5 percent next year. He repeated Bernanke’s remarks this month that the Fed may need to increase stimulus should the recovery falter, and that it may also have to remove stimulus gradually if growth picks up and inflation doesn’t fall too low.

“I do not anticipate, with this kind of forecast, having to do currently more monetary stimulus,” Williams told reporters after the speech. “But it will depend on what actually happens in the economy.”

‘High’ Hurdle

The hurdle is “high” for additional asset purchases by the central bank, given the uncertainty over what their effects would be, he said.

President Barack Obama and lawmakers in Congress are trying to break an impasse to reduce the nation’s long-term deficits in return for boosting the government’s borrowing authority, now capped at $14.3 trillion.

Unless the debt limit is raised, Treasury Secretary Timothy F. Geithner has said the government won’t be able to pay all of its bills starting on Aug. 2.

Williams, while speaking to reporters, reiterated his position that the debt ceiling needs to be raised and that failing to do so would lead to “very strong repercussions.”

U.S. stocks slid, dragging the Standard & Poor’s 500 Index lower for a fourth day, and six-month Treasury bills sank as lawmakers indicated they were no closer to an agreement to raise the debt ceiling.

S&P 500 Slips

The S&P 500 slipped 0.3 percent to 1,300.67 at 4 p.m. in New York to extend this week’s loss to 3.3 percent. A drop in six-month Treasury bills, maturing just after the U.S. exhausts the ability to borrow on Aug. 2, sent their yield as high as 0.20 percent.

Williams said the weak housing market, tight credit and spending cuts by state and local governments will continue to weigh on the economic recovery in the months ahead. That’s why the Fed is justified in keeping interest rates at record lows near zero and maintaining monetary stimulus, he said.

“If the recovery stalls and inflation remains low or deflationary pressures reemerge, then we may need to keep our very stimulatory policies in place for quite some time or even increase stimulus,” Williams said. “On the other hand, assuming growth picks up and inflation doesn’t fall too low, then at some point we’ll need to start gradually removing stimulus.”

Job Growth Slows

Data released this month show retail sales stagnating and the labor market struggling, with employers adding 18,000 jobs in June, the fewest in nine months, and the unemployment rate climbing to 9.2 percent.

The economy probably grew in the second quarter by 1.8 percent, the slowest pace in a year, according to the median estimate of 84 economists surveyed by Bloomberg News before the Commerce Department’s report tomorrow.

Fed officials gathered at last month’s meeting lowered their forecasts for growth and employment this year and next, while saying inflation excluding food and energy will be somewhat higher than previously forecast.

Williams, who has worked in the Fed system since 1994, was a senior economist for the Council of Economic Advisers during the Clinton administration. The Sacramento native succeeded Janet Yellen, now the Fed board’s vice chairman.

Williams, 49, will become a voting member of the rate- setting FOMC next year.

To contact the reporters on this story: Jeannine Aversa in Washington at javersa@bloomberg.net; Vivien Lou Chen in San Francisco at vchen1@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz in Washington at cwellisz@bloomberg.net

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Federal Reserve Bank of San Francisco's John C. Williams

Tim Rue/Bloomberg

John C. Williams, president of the Federal Reserve Bank of San Francisco.

John C. Williams, president of the Federal Reserve Bank of San Francisco. Photographer: Tim Rue/Bloomberg