william c dudley : remarks at panel discussion on fiscal challenges remarks by mr william c dudley, president and chief executive officer of the federal reserve bank of new york, at panel discussion at 2012 us monetary policy forum, sponsored by the initiative on global markets, university of chicago booth school of business, new york city, 24 february 2012. * * * it is a pleasure to have the opportunity to speak here today on a panel with charles plosser of the federal reserve bank of philadelphia, and juergen stark, formerly of the european central bank. our topic today is fiscal policy – for central bankers always dangerous waters to swim in. i will focus my remarks on the united states as others are better qualified to comment on the situation in europe and elsewhere. to start, let me stress that it is essential that the united states put in place a credible program of medium - term fiscal consolidation that addresses our sizeable and growing structural deficits in a manner that is consistent with supporting ongoing economic recovery. today i am going to discuss two specific issues relevant to u. s. fiscal policy. first, i am going to highlight the importance of taking the increase in debt service costs into account that will take place when economic conditions permit the normalization of monetary policy. i will argue that we are in an unusual period in which net interest expense is temporarily depressed. this will not last and the fiscal authorities need to factor this in when considering what needs to be done to put the federal budget deficit and the nation ’ s debt burden on a sustainable path. second, i will argue that fiscal consolidation should take into consideration the offsetting adjustments needed to keep the economy on an even keel. while fiscal consolidation is a necessary condition for a healthy economy over time, it is not a sufficient condition. fiscal adjustments require offsetting changes in private - sector spending and saving behavior, and in the trade sector. prudent economic policies and international coordination can help ensure that such adjustments take place in ways that support economic activity ( and, by extension also support government revenue ). as always, what i have to say today reflects my own views and opinions and not necessarily those of the federal open market committee ( fomc ) or the federal reserve system. as we all are aware, the federal budget deficit is very high and the federal debt burden has climbed sharply as a share of gross domestic product ( gdp ) ( figure 1 ). despite this, the net interest burden on the outstanding debt remains low as a share of gdp (

given the uncertainties around economic forecasts that far into the future, it would be highly desirable for the fiscal authorities to put in place a medium - term program of fiscal consolidation now, while market conditions are benign. at the same time, i think we must be careful and not focus exclusively on the imperative of fiscal consolidation. that is because fiscal policy adjustments have important implications for the 2011 remittance figure is a preliminary unaudited estimate. bis central bankers ’ speeches the level and composition of economic activity more broadly – both here and abroad. if we must undertake fiscal consolidation – and over time we must – then we need to be cognizant that this adjustment will need to be accompanied by other offsetting changes in the composition of economic activity in our and the global economy. 2 one way of illustrating these interrelationships is to use the following accounting identity, which imposes an adding up constraint on the overall economy : if you define private - sector net saving as the private balance and public sector net saving as the public balance, then : private balance + public balance = current account balance. at the outset of the financial crisis, the private balance, which was negative, swung sharply into surplus, and this was largely accommodated by a decrease in the public balance – in other words, an increase in the government deficit. recently, 3 this accounting identity looked roughly like this : 6. 5 % of gdp private balance + ( – 9. 5 % of gdp ) public balance = – 3 % of gdp current account balance realistically, the public balance 4 needs to be reduced to about – 3 percent of gdp over the next five years or so for the ratio of federal debt held by the public - to - gdp to stabilize around 75 percent to 80 percent of gdp. one might reasonably do more, but this just strikes me as the minimum adjustment that would be prudent and sustainable. this requires a large change from where we are today. for the accounting identity to continue to hold, which it must, there needs to be sizable shifts in the private balance and / or the current account balance. this is not a policy choice – it is basic math – but policy choices can help ensure that the adjustments take place in a way that is supportive of economic activity. the private balance can be further divided into two pieces – the household balance and the business balance. currently, for the united states, the household balance is about 2. 5 percent of gdp and the business balance is about 4 percent