Ben S Bernanke: Economic and financial conditions and the federal
budget before the Committee on the Budget
Speech by Mr Ben S Bernanke, Chairman of the Board of Governors of the Federal Reserve
System, at the US House of Representatives, Washington DC, 9 June 2010.
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Chairman Spratt, Ranking Member Ryan, and other members of the Committee, I am
pleased to have this opportunity to offer my views on current economic and financial
conditions and on issues pertaining to the federal budget.
The economic outlook
The recovery in economic activity that began in the second half of last year has continued at
a moderate pace so far this year. Moreover, the economy - supported by stimulative
monetary policy and the concerted efforts of policymakers to stabilize the financial system -
appears to be on track to continue to expand through this year and next. The latest economic
projections of Federal Reserve Governors and Reserve Bank presidents, which were made
near the end of April, anticipate that real gross domestic product (GDP) will grow in the
neighborhood of 3-1/2 percent over the course of 2010 as a whole and at a somewhat faster
pace next year.1 This pace of growth, were it to be realized, would probably be associated
with only a slow reduction in the unemployment rate over time. In this environment, inflation
is likely to remain subdued.
Although the support to economic growth from fiscal policy is likely to diminish in the coming
year, the incoming data suggest that gains in private final demand will sustain the recovery in
economic activity. Real consumer spending has risen at an annual rate of nearly 3-1/2 percent
so far this year, with particular strength in the highly cyclical category of durable goods.
Consumer spending is likely to increase at a moderate pace going forward, supported by a
gradual pickup in employment and income, greater consumer confidence, and some
improvement in credit conditions.
In the business sector, real outlays for equipment and software posted another solid gain in
the first quarter, and the increases were more broadly based than in late 2009; the available
indicators point to continued strength in the second quarter. Looking forward, investment in
new equipment and software is expected to be supported by healthy corporate balance
sheets, relatively low costs of financing of new projects, increased confidence in the
durability of the recovery, and the need of many businesses to replace aging equipment and
expand capacity as sales prospects brighten. More generally, US manufacturing output,
which has benefited from strong export demand, rose at an annual rate of 9 percent over the
first four months of the year.
At the same time, significant restraints on the pace of the recovery remain. In the housing
market, sales and construction have been temporarily boosted lately by the homebuyer tax
credit. But looking through these temporary movements, underlying housing activity appears
to have firmed only a little since mid-2009, with activity being weighed down, in part, by a
large inventory of distressed or vacant existing houses and by the difficulties of many
builders in obtaining credit. Spending on nonresidential buildings also is being held back by
high vacancy rates, low property prices, and strained credit conditions. Meanwhile, pressures
on state and local budgets, though tempered somewhat by ongoing federal support, have led
these governments to make further cuts in employment and construction spending.
As you know, the labor market was hit particularly hard by the recession, but we have begun
to see some modest improvement recently in employment, hours of work, and labor income.
Payroll employment rose by 431,000 in May, but that figure importantly reflected an increase
of 411,000 in hiring for the decennial census. Private payroll employment has risen an
average of 140,000 per month for the past three months, and expectations of both businesses
and households about hiring prospects have improved since the beginning of the year. In all
likelihood, however, a significant amount of time will be required to restore the nearly
8-1/2 million jobs that were lost over 2008 and 2009.
On the inflation front, recent data continue to show a subdued rate of increase in consumer
prices. For the three months ended in April, the price index for personal consumption
expenditures rose at an annual rate of just 1/2 percent, as energy prices declined and the
index excluding food and energy rose at an annual rate of about 1 percent. Over the past two
years, overall consumer prices have fluctuated in response to large swings in energy and
food prices. But aside from these volatile components, a moderation in inflation has been
clear and broadly based over this period. To date, long-run inflation expectations have been
stable, with most survey-based measures remaining within the narrow ranges that have
prevailed for the past few years. Measures based on nominal and indexed Treasury yields
have decreased somewhat of late, but at least part of these declines reflect market
responses to changes in the financial situation in Europe, to which I now turn.
Developments in Europe
Since late last year, market concerns have mounted over the ability of Greece and a number
of other euro-area countries to manage their sizable budget deficits and high levels of public
debt. By early May, financial strains had increased significantly as investors focused on
several interrelated issues, including whether the fiscally stronger euro-area governments
would provide financial support to the weakest members, the extent to which euro-area
growth would be slowed by efforts at fiscal consolidation, and the extent of exposure of major
European financial institutions to vulnerable countries.
US financial markets have been roiled in recent weeks by these developments, which have
triggered a reduction in demand for risky assets: Broad equity market indexes have declined,
and implied volatility has risen considerably. Treasury yields have fallen as much as 50 basis
points since late April, primarily as a result of safe-haven flows that boosted the demand for
Treasury securities. Corporate spreads have widened over the same period, and some
issuance of corporate bonds has been postponed, especially by speculative-grade issuers.
In response to these concerns, European leaders have put in place a number of strong
measures. Countries under stress have committed to address their fiscal problems. A major
assistance package has been established jointly by the European Union (EU) and the
International Monetary Fund (IMF) for Greece. To backstop near-term financing needs of its
members more generally, the EU has established a European Financial Stabilization
Mechanism with up to 500 billion euros in funding, which could be used in tandem with
significant bilateral support from the IMF. EU leaders are also discussing proposals to tighten
surveillance of members' fiscal performance and improve the design of the EU's fiscal
support mechanisms.
In addition, to address strains in European financial markets, the European Central Bank
(ECB) has begun purchasing debt securities in markets that it sees as malfunctioning, and
has resumed auctions of three- and six-month loans of euros in unlimited quantities to
borrowers with appropriate collateral. To help ease strains in US dollar funding markets, the
Federal Reserve has reestablished temporary US dollar liquidity swap lines with the ECB
and other major central banks. To date, drawings under these swap lines remain quite limited
and far below their peaks reached at the height of the financial crisis in late 2008, but they
are nevertheless providing an important backstop for the functioning of dollar funding
markets. More generally, our ongoing international cooperation sends an important signal to
global financial markets that we will take the actions necessary to ensure stability and
continued economic recovery.
The actions taken by European leaders represent a firm commitment to resolve the
prevailing stresses and restore market confidence and stability. If markets continue to
stabilize, then the effects of the crisis on economic growth in the United States seem likely to
be modest. Although the recent fall in equity prices and weaker economic prospects in
Europe will leave some imprint on the US economy, offsetting factors include declines in
interest rates on Treasury bonds and home mortgages as well as lower prices for oil and
some other globally traded commodities. The Federal Reserve will remain highly attentive to
developments abroad and to their potential effects on the US economy.
Fiscal sustainability
Ongoing developments in Europe point to the importance of maintaining sound government
finances. In many ways, the United States enjoys a uniquely favored position. Our economy
is large, diversified, and flexible; our financial markets are deep and liquid; and, as I have
mentioned, in the midst of financial turmoil, global investors have viewed Treasury securities
as a safe haven. Nevertheless, history makes clear that failure to achieve fiscal sustainability
will, over time, sap the nation's economic vitality, reduce our living standards, and greatly
increase the risk of economic and financial instability.
Our nation's fiscal position has deteriorated appreciably since the onset of the financial crisis
and the recession. The exceptional increase in the deficit has in large part reflected the
effects of the weak economy on tax revenues and spending, along with the necessary policy
actions taken to ease the recession and steady financial markets. As the economy and
financial markets continue to recover, and as the actions taken to provide economic stimulus
and promote financial stability are phased out, the budget deficit should narrow over the next
few years.
Even after economic and financial conditions have returned to normal, however, in the
absence of further policy actions, the federal budget appears to be on an unsustainable path.
A variety of projections that extrapolate current policies and make plausible assumptions
about the future evolution of the economy show a structural budget gap that is both large
relative to the size of the economy and increasing over time.
Among the primary forces putting upward pressure on the deficit is the aging of the US
population, as the number of persons expected to be working and paying taxes into various
programs is rising more slowly than the number of persons projected to receive benefits.
Notably, this year about 5 individuals are between the ages of 20 and 64 for each person
aged 65 or older. By the time most of the baby boomers have retired in 2030, this ratio is
projected to have declined to around 3. In addition, government expenditures on health care
for both retirees and non-retirees have continued to rise rapidly as increases in the costs of
care have exceeded increases in incomes. To avoid sharp, disruptive shifts in spending
programs and tax policies in the future, and to retain the confidence of the public and the
markets, we should be planning now how we will meet these looming budgetary challenges.
Achieving long-term fiscal sustainability will be difficult. But unless we as a nation make a
strong commitment to fiscal responsibility, in the longer run, we will have neither financial
stability nor healthy economic growth.