Bernanke Calls Debt Limit ‘Wrong Tool’ to Force Budget Cuts

Federal Reserve Chairman Ben S. Bernanke
Ben S. Bernanke, chairman of the U.S. Federal Reserve, waits to speak at the Committee For Responsible Federal Budget annual conference in Washington, D.C. on June 14, 2011. Photographer: Andrew Harrer/Bloomberg

Federal Reserve Chairman Ben S. Bernanke said the U.S. debt ceiling shouldn’t be used as a bargaining chip to force budget cuts, and failing to raise it could cause “severe disruptions” in financial markets.

Using the debt limit deadline to force some “necessary and difficult fiscal-policy adjustments” is “the wrong tool for that important job,” he said. “We should avoid unnecessary actions or threats that risk shaking the confidence of investors in the ability and willingness of the U.S. government to pay its bills,” Bernanke said today in the text of remarks in Washington.

Lawmakers are wrangling over spending cuts and budget reforms as they seek an agreement to increase the $14.3 trillion debt limit before Aug. 2, the date on which the Treasury Department said it will have exhausted all its borrowing authority. Moody’s Investors Service on June 2 said that it expects to place the U.S. government’s top credit rating under review for a possible downgrade if there’s no progress on increasing the debt limit by mid-July.

“I urge the Congress and the Administration to work in good faith to quickly develop and implement a credible plan to achieve long-term sustainability,” Bernanke said. “I hope, though, that such a plan can be achieved in the near term without resorting to brinkmanship or actions that would cast doubt on the creditworthiness of the United States.”

Retail Sales Report

Treasuries fell today after a report showing retail sales declined less than forecast last month. Yields on the 10-year Treasury notes climbed 10 basis points, or 0.1 percentage point, to 3.09 percent at 3:38 p.m. in New York, according to BGCantor Market Data prices. The Standard & Poor’s 500 Index rose 1.3 percent to 1,288.24.

Bernanke said suggestions that Treasury payments could be “prioritized” to avoid a default wouldn’t work because, “while debt-related payments might be met in this scenario, the fact that many other government payments would be delayed could still create serious concerns about the safety of Treasury securities.”

Republican lawmakers, including Pennsylvania Senator Pat Toomey, Senator Jim DeMint of South Carolina and Representative Joe Walsh of Illinois, have scoffed at warnings that failing to raise the U.S. debt limit would trigger a financial catastrophe. Obligations to bondholders can be met with the tax revenue that will continue to pour into the Treasury, and the government’s other bills can be delayed or cut without panicking financial markets, the Republicans say.

Long-Term Growth

Bernanke reiterated his view that lawmakers should rein in budget deficits to ensure long-term growth without cutting back so quickly as to choke off the recovery at a time when the economy is still fragile. A recent stretch of disappointing economic data, including a rise in the unemployment rate to 9.1 percent in May, have increased the odds the Fed will keep its benchmark interest rate near zero into next year.

“Acting now to put in place a credible plan for reducing future deficits would not only enhance economic performance in the long run, but could also yield near-term benefits by leading to lower long-term interest rates and increased consumer and business confidence,” Bernanke said at the Committee for a Responsible Federal Budget annual conference.

An advantage of taking a longer-term plan for debt reduction is that policy makers “can avoid a sudden fiscal contraction that might put the still-fragile recovery at risk.”

Budget Forecasts

The annual budget shortfall is projected to reach $1.4 trillion, matching the previous record in fiscal 2009, according to the non-partisan Congressional Budget Office. In the fiscal year 2010 ended last Sept. 30, the annual budget deficit totaled $1.3 trillion, the second largest.

“History makes clear that failure to put our fiscal house in order will erode the vitality of our economy, reduce the standard of living in the United States, and increase the risk of economic and financial instability,” Bernanke said.

For all the concern about the deficit in Washington, bond yields in the U.S. are lower now than when the government was running a budget surplus a decade ago. The yield on the benchmark 10-year Treasury note is below the average of 7 percent since 1980 and the average of 5.48 percent in the 1998 through 2001 period, according to Bloomberg Bond Trader.

Signs of economic weakness have added to the pressure for lawmakers to reach an accord over the budget, with Treasury Secretary Timothy F. Geithner warning that a failure to do so would have catastrophic consequences for the U.S. economy and choke off access to credit markets.

Hiring Slows

Payrolls grew at the slowest pace in eight months in May, Labor Department figures released on June 3 showed. Manufacturing grew at its slowest pace in more than a year in May, according to Institute for Supply Management data, and consumer spending rose less than forecast in April as households felt the pinch of grocery and energy costs, a Commerce Department report showed.

The Federal Open Market Committee plans this month to finish a $600 billion bond purchase program, and the minutes of their April meeting showed central bankers have been discussing the tools they’d use to remove their record stimulus.

Bernanke said last week that “accommodative monetary policies are still needed” to boost a “frustratingly slow” recovery. He said growth is likely to pick up in the second half of the year as fuel prices recede and disruptions of parts supplies dissipate as factories in Japan recover from an earthquake and tsunami.

Honda Motor Co., Japan’s third-largest carmaker, said May 27 that its North America and China vehicle production will return to normal in August as parts suppliers recover from Japan’s earthquake. In the U.S., only production of Honda’s Civic cars will continue to be slowed by limited supplies of some parts, the Tokyo-based company said.

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