Bernanke warns Congress against deep budget cuts in weak economy

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Federal Reserve Chairman Ben S. Bernanke warned lawmakers Tuesday against cutting the budget too sharply with the U.S. economy still weak and facing new stresses from the European debt crisis.

And the central bank chief expressed some empathy with protesters who have marched on Wall Street and in other cities in recent days complaining of the role of big financial institutions in creating the current economic mess.

‘Very generally I think people are quite unhappy with the state of the economy and what’s happening. They blame, with some justification, the problems in the financial sector for getting us into this mess and they’re dissatisfied with the policy response here in Washington,’ Bernanke told Congress’ Joint Economic Committee.

‘On some level I can’t blame them,’ he said. ‘Like everyone else, I’m dissatisfied with what the economy is doing right now.’

Bernanke noted the difficulty for Congress to rein in the long-term federal budget deficit while trying ‘to avoid fiscal actions that could impede the ongoing economic recovery.’

But he said that one factor weighing down the U.S. recovery is ‘the increasing drag’ from cutbacks in government spending.

‘Notably, state and local governments continue to tighten their belts by cutting spending and employment in the face of ongoing budgetary pressures, while the future course of federal fiscal policies remains quite uncertain,’ Bernanke told the committee.

He admitted that addressing the long-term budget deficit without further hindering the weak recovery is ‘a complex situation.’ And he had unusually sharp words for the bitter debate over raising the U.S. debt ceiling this summer, which led Standard & Poor’s to downgrade the nation’s credit rating and also hurt market confidence.

‘Unfortunately the brinkmanship of the summer. ... I think was a negative for the financial markets,’ Bernanke said. ‘It’s no way to run a railroad, if I might say so.’ Adding to the complex task of lawmakers is the financial turmoil in Europe.

Bernanke said the debt crisis there has been ‘a significant source of stress in global financial markets’ and is a risk to the already-sluggish U.S. economic recovery.

‘It is difficult to judge how much these financial strains have affected U.S. economic activity thus far, but there seems little doubt that they have hurt household and business confidence, and that they pose ongoing risks to growth,’ Bernanke said. ‘I believe that one of the reasons our recovery has been slower this year than last year is that we’ve faced a lot of financial volatility and a lot of that is coming from Europe.’

The Fed has determined that U.S. banks do not have a large direct exposure to debt from troubled nations such as Greece, Portugal and Ireland, he said. But a disorderly default by any of those countries or others in the Eurozone ‘would create a huge amount of financial volatility globally’ that would damage the U.S. economy.

In that case, the Fed is prepared to act.

‘We would stand ready to provide as much liquidity against collateral as needed as lender of last resort to our banking system,’ he said.

Many Republicans have criticized the Fed for its actions to try to boost economic growth, arguing they’ve been ineffective and have increased inflation. Republican congressional leaders wrote to Bernanke last month and other members of the central bank warning against ‘further extraordinary intervention’ in the economy.’

Rep. Mick Mulvaney (R-S.C.) told Bernanke that the Fed’s actions were helping fuel the continued increase in the federal deficit.

‘With all of the steps that you take to keep interest rates low ... you’re also encouraging borrowing,’ Mulvaney said. ‘You’re encouraging the federal government to continue to do what we do.’

But Bernanke defended the Fed’s actions, saying, ‘We need to keep interest rates low to support the economy, which needs support.’

Despite the warnings, Bernanke and the Fed last month moved ahead with a new $400-billion strategy to sell some short-term Treasury bonds in its portfolio and buy longer-term bonds in hopes of reducing long-term interest rates.

Sen. Robert Casey (D-Pa.), the committee’s chairman, defended the Fed.

‘Unemployment is stuck above 9%, and long-term unemployment remains at near-record levels,’ Casey said. ‘We need to use every weapon in our arsenal to support a stronger economic recovery.’

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-- Jim Puzzanghera