Fed Chair Bernanke Warns of Debt Crisis

Common sense dictates that it is unwise to spend more than you make. Both companies and individuals who engage in this type of behavior eventually find themselves bankrupt and with their futures in doubt.

Governments however, seem to think that they are immune from common sense. Washington, DC has long had an addiction to this type of deficit spending, and the Obama administration has taken this addiction to new highs. Under President Obama’s watch the national debt has increased by a staggering $4 trillion.

Abetting the deficit spending frenzy has long been the role of the Federal Reserve, so it is surprising to find the current Fed Chairman, Ben Bernanke, finally pointing out that rapid increases in the national debt can not be allowed to continue.

Bernanke’s warning came during testimony to the House Committee on the Budget on February 2. Describing an “exceptional increase in the deficit,” he noted: “The federal budget deficit widened appreciably with the onset of the recent recession, and it has averaged around 9 percent of gross domestic product (GDP) over the past three fiscal years.”

An increasingly large debt, he warned, can have severe economic consequences.

Having a large and increasing level of government debt relative to national income runs the risk of serious economic consequences. Over the longer term, the current trajectory of federal debt threatens to crowd out private capital formation and thus reduce productivity growth. To the extent that increasing debt is financed by borrowing from abroad, a growing share of our future income would be devoted to interest payments on foreign-held federal debt. High levels of debt also impair the ability of policymakers to respond effectively to future economic shocks and other adverse events.

More worryingly, Bernanke pointed out that the damages of carrying a large national debt may not just accrue gradually over time, but may suddenly reach a tipping point.

Unsustainable deficits have costs, he said, “including an increased possibility of a sudden fiscal crisis. As we have seen in a number of countries recently, interest rates can soar quickly if investors lose confidence in the ability of a government to manage its fiscal policy. Although historical experience and economic theory do not indicate the exact threshold at which the perceived risks associated with the U.S. public debt would increase markedly, we can be sure that, without corrective action, our fiscal trajectory will move the nation ever closer to that point.”

The obvious solution to a growing debt is to cut wasteful spending, and Bernanke told the House Committee that this is exactly what should be done.

“To achieve economic and financial stability, U.S. fiscal policy must be placed on a sustainable path that ensures that debt relative to national income is at least stable or, preferably, declining over time. Attaining this goal should be a top priority,” he emphasized.


Marring this refreshing dose of common sense, though, was at least one statement that makes less sense when considered in the light of actual Fed monetary policy.

In keeping with long-term Fed policy, Bernanke said that one objective should be to “keep longer-term interest rates low,” meaning that the money supply should continue to be expanded. Yet he also said that our nation’s polices “should increase incentives to work and save...”

Keeping interest rates low punishes savers and rewards borrowers. While cutting spending and reducing debt are exactly what is needed, arbitrarily holding down interest rates will likely do little to encourage the big spenders in Washington to curtail their mortgaging of the nation’s future.