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Home Publications Blogs Beat the Press Bernanke Offers Little Help On Budget Deficit

Bernanke Offers Little Help On Budget Deficit

Thursday, 28 April 2011 05:51

Given the deficit obsession of the Washington media it is remarkable that none of the reporters covering Federal Reserve Board Chairman Ben Bernanke's press conference noted the fact that he offered little help on dealing with the budget deficit. There were two obvious steps that he could have taken.

First, the main reason that the deficit has soared in the last few years is that the economy collapsed following the bursting of the housing bubble, which Bernanke apparently failed to see. (We are a very forgiving lot in Washington.) If the unemployment rate was brought down quickly by more aggressive monetary policy, then the deficit could be reduced by an enormous amount.

In 1996, the Congressional Budget Office (CBO) projected a deficit of almost $250 billion (@ 2.6 percent of GDP) for the 2000 fiscal year. The country actually had a budget surplus of almost the same size in fiscal 2000, representing a shift from deficit to surplus in the year 2000 of more than 5 percentage points of GDP.

Congress did not approve any major tax increases in this 4-year period, nor were there any major unscheduled cuts to spending. Rather this shift from deficit to surplus of more than 5 percentage points of GDP ($750 billion in today's economy) was attributable almost entirely to better than expected economic performance.

In 1996 CBO projected that the unemployment rate would be 6.0 percent in 2000. Unemployment actually averaged just 4.0 percent. This was due to the fact that Alan Greenspan ignored the overwhelming consensus in the economics profession and allowed the unemployment rate to fall below the conventionally accepted levels of the NAIRU.

This decision, which was made over the objections of the Clinton appointees to the Fed, allowed millions of more people to get jobs than would have otherwise been the case. It also allowed strong wage growth for people at the middle and bottom of the wage distribution as their labor was then in demand. And it reduced the budget deficit. Because Bernanke offered little hope of more aggressive Fed actions to reduce unemployment, he is not offering any similar growth dividend on the budget deficit.

The other potential help that Bernanke is not offering is holding large amounts of government debt. The Fed now holds close to $3 trillion in government debt and other assets. If it continued to hold this debt throughout the decade, rather than selling it back to the private sector, it would reduce interest payments by close to $1.5 trillion over the course of the decade. It could deal with any inflationary pressures resulting from these holdings by simply raising reserve requirements. Bernanke is not offering this help either.

It would have been useful to readers to point out what the Fed is not doing to help address the deficit.

Comments (9)Add Comment
Your Best Yet Dr. Baker!
written by Paul, April 28, 2011 7:41
Finally someone rationally explains the budget deficit in terms even a RepubliCon could understand. Hopefully, Paul Ryan reads this before he is voted out of office...oh wait, forget that.
Free Markets are Irredeemably Obscure: Don't Fix It If It Ain't Broke
written by izzatzo, April 28, 2011 7:51
... Alan Greenspan ignored the overwhelming consensus in the economics profession and allowed the unemployment rate to fall below the conventionally accepted levels of the NAIRU.

In the great Hayekian tradition, Greenspan - in contrast to socialists like Baker - understood that the internal workings of free markets cannot possibly be understood by outsiders, much less regulated. The absence of transparency is a virtue, not a vice.

Any attempt to fine tune the delicate gyroscope of added value would just have resulted in even worse current conditions. We must live in the long run, where risks are worth it when evaluated across centuries, not decades, where in the short run we're all dead.

Stupid liberals.
sacrificing now for dividends down the road
written by frankenduf, April 28, 2011 8:22
lol isthatso- that last sentence is the essence of great comedy- silliness, pun, and profundity all balanced at once- bravo
written by skeptonomist, April 28, 2011 9:00
The problem with the Fed is not that it is not doing enough, it is that it is relied on too much.

When Geenspan and Bernanke assured everyone that there was no housing bubble, this took pressure off to do something about it. The Fed had done its best to create a housing boom (in 2002 Krugman had even called literally for a housing bubble) - it would be against all human nature for them to turn around and admit that it had turned into a destructive bubble.
The Fed was active in the wrong ways during the 2008-2009 panic as Bernanke colluded with Paulson to bail out their friends in the big banks. As Dean urged all along, the crisis could have been handled by the FDIC and other agencies and there would have been no worldwide crash - these agencies were specifically constructed to avoid that among other things. The bailout neatly avoided the possibility of any real reform and assisted in the consolidation and empowerment of the big banks.

The Fed did do what it was supposed to do in cutting rates rapidly from August 2007, and Bernanke did implement quantitative easing as he promised (though I have not yet spotted those helicopters). This obviously did not prevent the worst recession since 1933, most of the "money" created is sitting in bank reserves, and interest rates rose rather than fell as both QE1 and QE2 were implemented. But since rates are still lower than they have been for over 40 years it is pretty silly anyway to think that the problem is that rates are too high. The Fed has shot its bolt and its supporters are reduced to calling on the moral effect of announcing yet again that federal funds rate will be held low and that the Fed will not take action immediately against inflation.

As for deficits, there is a simple economic principle which seems to have been obliterated from the minds of economists as well as politicians: revenue must meet expenditures. The Fed has nothing to do with this.

There has never been any evidence that the Fed has the economic powers attributed to it by many economists, even if we really had all-wise Maestros instead of Randian crackpots.
Zombie Lie, Skeptonomist
written by Dennis Doubleday, April 28, 2011 9:19
Krugman did not "call for a housing bubble". He just pointed out that that was the only (but still bad) option available to Greenspan to goose the economy. It was in the context of a criticism of Administration policies.
Even Arnold Kling didn't fall for it, skeptonomist
written by Dennis Doubleday, April 28, 2011 9:25
written by vorpal, April 28, 2011 11:04
Here's another blog entry about economists and the bubble.

written by paine, April 28, 2011 1:14
quite a post dean

maybe it jumps too far between lilly pads
covering all this ground

take the glancing blow at nairu
if mentioned
i'd certainly would pause to debunk nairu

we have nominal wage control in the service of real wage control
the secret target index is the unit labor cost
index eh ??

and nairu is its boggus taboo line totem
definitively refuted by alan

and even more central i'd suggest gentle ben could help job markets
by sugggesting another giant fiscal stimulus that he could quantitaively ease
with concrete spending consequences
barely visible with the present
policy of absorbing existing securities
and thus price propping both the bond and equity markets
written by David S., April 29, 2011 7:05

I have always appreciated your repeated comment that the Fed can engage in various forms of monetary easing without undue concern for inflation because it can always raise reserve requirements if (we should be so lucky!) the economy starts to overheat.

I have wondered why this point does not mollify critics of pro-growth monetary policy. I think the answer might be this: A monetary policy to purchase and hold government securities allows for more GOVERNMENT spending now, whereas an increase in the reserve requirement decreases PRIVATE lending later. (Never mind that, through the fiscal multiplier or the money multiplier, each initial round of spending, whatever its origin, will result in significant private spending.)

So, it would appear that critics on the right would prefer austerity and recession now, rather than risk less private lending later. Of course, they forget that, in the long run we are all .. yada, yada, yada ....

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.