NEW YORK – Premature fiscal tightening “could retard an already tepid economic recovery, Federal Reserve Board Vice Chair Janet L. Yellen said today.
“We need, and I believe there is scope for, an approach to fiscal policy that puts in place a well-timed and credible plan to bring deficits down to sustainable levels over the medium and long terms while also addressing the economy's short-term needs,” Yellen told a conference in new York Wednesday, according to prepared text of her speech, which was released by the Fed.
Focusing on the budget deficit, which she said “seems to have topped out,” Yellen warned, “the budget situation over the longer run presents some very difficult challenges, in part because the aging of the U.S. population implies a sizable and sustained increase in the share of the population receiving benefits from Social Security, Medicare, and Medicaid.”
In addition to demographics, rising health care costs will further strain the federal budget. “Admittedly, the ability of budget analysts to forecast the trajectory of health-care spending is limited, but it is prudent to assume that federal health spending per beneficiary will continue to rise faster than per capita GDP for the foreseeable future.”
She added, absent “significant policy changes, ... “federal spending will rise significantly faster than federal tax revenues in coming years. As a result, if current policy settings are maintained, the budget will be on an unsustainable path, with the ratio of federal debt held by the public to national income rising rapidly.”
Addressing such issues is not easy. “I do not underestimate the difficulty of crafting a long-range budget plan that will both garner sufficient political support and have sound economic foundations,” she said. “The reactions to the proposals offered by members of the President's National Commission on Fiscal Responsibility and Reform, as well as to those offered by other prominent groups, provide ample evidence of the differences that must be bridged. Nonetheless, I am encouraged that the debate seems to be moving forward and is starting to touch on some broad principles that -- if followed -- would improve economic growth and make achieving sustainable fiscal policies at least somewhat easier.”
It is important to begin now, Yellen said. “We should not defer charting a course for fiscal consolidation. Timely enactment of a plan to eliminate future unsustainable budget gaps will make it easier for individuals and businesses to prepare for and adjust to the changes. Moreover, the sooner we start addressing the longer-term budget problem, the less wrenching the adjustment will have to be and the more control we -- rather than market forces or international creditors -- will have over the timing, size, and composition of the necessary adjustments.”
She said she backs the Fed's recent action “because I believe it will be helpful in strengthening the recovery. But it is hardly a panacea. Thus, a fiscal program that combines a focus on pro-growth policies in the near term with concrete steps to reduce longer-term budget deficits could be a valuable complement to our efforts. Indeed, some budget experts are exploring the idea of explicitly coupling fiscal stimulus in the near term, when unemployment is high and resource utilization is low, with specific deficit-reducing actions that take effect at scheduled future times, when output and employment are expected to have moved closer to their potential. Although a plan of this type might be challenging to develop and implement, it could provide an effective means to support economic activity in the short run while moving toward fiscal sustainability over time.”
