Bernanke calls for action on deficits - Warns of bond market alarm over debt

Bernanke calls for action on deficits - Warns of bond market alarm over debt
By Krishna Guha in Washington
Copyright The Financial Times Limited 2009
Published: June 3 2009 15:50 | Last updated: June 3 2009 18:39
http://www.ft.com/cms/s/0/e8aa33c6-504c-11de-9530-00144feabdc0.html


Ben Bernanke on Wednesday urged Congress to act now to bring down long term budget deficits, warning that the bond market was alarmed about US government debt.

The Federal Reserve chairman said the recent sharp increases in bond yields “appear to reflect concern about large federal deficits” as well as improved optimism about the economy and other factors.

Since late April, the yield on the 10-year Treasury note has risen from below 3 per cent and peaked at 3.76 per cent last week, its highest level since November.

Mr Bernanke said large deficit-funded actions to fight the crisis were “necessary and appropriate.” But he said “near term challenges must not be allowed to hinder timely consideration of the steps needed to address fiscal imbalances.”

The Fed chief’s warning came as he reiterated his view that he expects to see growth “later this year” with “some stabilisation in final demand including consumer spending.” However, he remained cautious with numerous caveats.

At around midday in New York, the yield on 10-year Treasuries was down 6 basis points at 3.58 per cent on weak data. The S&P 500 index was down 1.4 per cent, though the dollar rallied amid selling in commodities.

The Fed chief warned that failure to address fiscal sustainability now could result in the US facing a debt trap in the future.

“We cannot allow ourselves to be in a situation where the debt continues to rise. That means more and more interest payments, which swell the deficit, which leads to an unsustainable situation,” he said.

Mr Bernanke said that to encourage lenders to finance the US at reasonable rates “we do have to persuade them that we are going to be serious about returning to a more balanced fiscal situation going forward.”

Mr Bernanke made no reference to the possibility of increasing Fed purchases of Treasuries to lean against the rise in yields. In effect, he put responsibility for dealing with debt concerns squarely in the hands of Congress and the Obama administration.

“The Federal Reserve will not monetise the debt,” Mr Bernanke said. Fed officials believe that the policy equivalent to keeping interest rates on hold would involve some modest additional Treasury purchases over and above the declared amount as purchase programmes tapered off.

But some think there may be a case for stopping at the declared amounts, even though this would involve a tightening of policy relative to expectations. Few are pressing for very large increases.

Mr Bernanke said Congress should try to stabilise the debt-to-GDP ratio at its post-crisis level of about 70 per cent and seek “over time to try to reduce it.”

The Obama administration says it can use health reform dramatically to reduce long term spending on Medicare, though investors are sceptical and worry about large medium term structural deficits, which the Congressional Budget Office estimates at about 5 per cent of GDP.

Additional reporting by Michael Mackenzie in New York