Bernanke warns lawmakers country headed for 'massive fiscal cliff'

By Peter Schroeder - 02/29/12 01:26 PM ET

Congress risks taking the economy over a “massive fiscal cliff,” Federal Reserve Chairman Ben Bernanke warned lawmakers on Wednesday.
In remarks that hit Wall Street stock prices, the central bank boss suggested the economy could hit a serious roadblock if Congress allows the Bush tax rates and a payroll tax cut to expire and $1.2 trillion in spending cuts to be implemented simultaneously in January.

“Under current law, on Jan. 1, 2013, there’s going to be a massive fiscal cliff of large spending cuts and tax increases,” Bernanke told the House Financial Services Committee. “I hope that Congress will look at that and figure out ways to achieve the same long-run fiscal improvement without having it all happen at one date.

“All those things are hitting on the same day, basically. It’s quite a big event.”
The tax hikes and spending cuts could knock GDP growth in 2013 down from 2.6 percent to 1 percent, according to Andrew Fieldhouse, a federal budget policy analyst with the liberal Economic Policy Institute .

“There is obviously a huge fiscal drag pending if Congress adheres to existing law,” he said.
Bernanke’s comments underline the stakes for this year’s post-election lame-duck session of Congress, when the fate of the tax rates and spending cuts are likely to be determined. Congress is also not expected to raise the debt ceiling until after Election Day, but is unlikely to be able to punt that decision beyond the lame-duck session.
The nation’s triple-A credit rating hangs in the balance, with agencies likely to decide on whether to downgrade the United States depending on what happens to the debt ceiling, tax rates and spending cuts. The fiscal triple whammy was set up by the failure of a supercommittee of lawmakers to agree on a deficit-cutting plan last year.
Bernanke, who has long advised policymakers to rein in the deficit, called again Wednesday for a “credible plan” to reassure markets that the nation is repairing its finances.

Failure to do so could trigger another financial crisis and sharply higher interest rate, as is happening in Europe, he said.
Bernanke warned that draining funds from the economy by allowing tax cuts to expire and trimming spending could slow growth.
“You ... have to protect the recovery in the near term,” he warned.
Some Republicans, such as Sen. John McCain (Ariz.), have already vowed to find alternatives to the spending cuts, which would hit the Pentagon. And the fight over the Bush tax rates will be a central theme of the presidential election.
President Obama wants to extend the individual tax rates for families with annual income below $250,000 and individuals below $200,000, while allowing tax rates on higher incomes to rise. Republicans want to extend all the Bush-era rates.
Congressional Democrats are increasingly embracing $1 million in income as the right threshold above which higher income taxes should kick in.
“Obviously, the Speaker is opposed to the massive tax hike that Washington Democrats have engineered for the end of the year,” Michael Steel, a spokesman for House Speaker John Boehner (R-Ohio), said Wednesday.
While economic conditions have improved and the unemployment rate has fallen, Bernanke warned that the labor market is still “far from normal.”
“The unemployment rate remains elevated, long-term unemployment is still near record levels and the number of persons working part-time for economic reasons is very high,” he said.
Underlying data suggest the economic expansion is “uneven and modest by historical standards,” and that Europe’s debt crisis remains a persistent threat to the U.S. recovery, he said.
The Fed has lowered interest rates effectively to zero and vowed to keep them there through the end of 2014 in response to those challenges, but Bernanke suggested there is little more the central bank can do.
“Monetary policy is not a panacea,” he said. “The long-term health of the economy depends mostly on decisions taken by Congress and the administration.”
Bernanke acknowledged the difficult politics of taxes and spending cuts.
“These criticisms are easy for me to make,” he said. “I don’t have to deal with the politics.”
He steered clear of recommending a specific deficit-reduction path for Congress, but said it is “very important” to address rising healthcare costs and that the economy would benefit from a clear plan from Congress to reform the housing market.