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Bernanke: The 2 Big Risks We Won’t Resolve

Strange comments in this morning’s speech by Dr. Bernanke.  He says:

“Risks to the Outlook
Participants at the June FOMC meeting indicated that they see a higher degree of uncertainty about their forecasts than normal and that the risks to economic growth have increased. I would like to highlight two main sources of risk: The first is the euro-area fiscal and banking crisis; the second is the U.S. fiscal situation.

Earlier this year, financial strains in the euro area moderated in response to a number of constructive steps by the European authorities, including the provision of three-year bank financing by the European Central Bank. However, tensions in euro-area financial markets intensified again more recently, reflecting political uncertainties in Greece and news of losses at Spanish banks, which in turn raised questions about Spain’s fiscal position and the resilience of the euro-area banking system more broadly. Euro-area authorities have responded by announcing a number of measures, including funding for the recapitalization of Spain’s troubled banks, greater flexibility in the use of the European financial backstops (including, potentially, the flexibility to recapitalize banks directly rather than through loans to sovereigns), and movement toward unified supervision of euro-area banks. Even with these announcements, however, Europe’s financial markets and economy remain under significant stress, with spillover effects on financial and economic conditions in the rest of the world, including the United States. Moreover, the possibility that the situation in Europe will worsen further remains a significant risk to the outlook.

The Federal Reserve remains in close communication with our European counterparts. Although the politics are complex, we believe that the European authorities have both strong incentives and sufficient resources to resolve the crisis. At the same time, we have been focusing on improving the resilience of our financial system to severe shocks, including those that might emanate from Europe. The capital and liquidity positions of U.S. banking institutions have improved substantially in recent years, and we have been working with U.S. financial firms to ensure they are taking steps to manage the risks associated with their exposures to Europe. That said, European developments that resulted in a significant disruption in global financial markets would inevitably pose significant challenges for our financial system and our economy.

The second important risk to our recovery, as I mentioned, is the domestic fiscal situation. As is well known, U.S. fiscal policies are on an unsustainable path, and the development of a credible medium-term plan for controlling deficits should be a high priority. At the same time, fiscal decisions should take into account the fragility of the recovery. That recovery could be endangered by the confluence of tax increases and spending reductions that will take effect early next year if no legislative action is taken. The Congressional Budget Office has estimated that, if the full range of tax increases and spending cuts were allowed to take effect–a scenario widely referred to as the fiscal cliff–a shallow recession would occur early next year and about 1-1/4 million fewer jobs would be created in 2013.3 These estimates do not incorporate the additional negative effects likely to result from public uncertainty about how these matters will be resolved. As you recall, market volatility spiked and confidence fell last summer, in part as a result of the protracted debate about the necessary increase in the debt ceiling. Similar effects could ensue as the debt ceiling and other difficult fiscal issues come into clearer view toward the end of this year.

The most effective way that the Congress could help to support the economy right now would be to work to address the nation’s fiscal challenges in a way that takes into account both the need for long-run sustainability and the fragility of the recovery. Doing so earlier rather than later would help reduce uncertainty and boost household and business confidence.”

The good news is that they seem to be thinking in a more proactive manner.  The problem is that they just seem to be thinking about it and not doing a whole lot.  Bernanke thinks the Europeans have the tools to resolve their crisis.  This is true.  But they don’t have the political will to resolve the currency crisis – a true resolution would involve a full break-up or full unity.  I still don’t see signs that they’re resolving that issue.  Rather, they seem to just keep kicking the can.  I don’t know why Bernanke isn’t more critical here.  This ridiculous crisis never ends.  And he’s just fine letting it persist – or so it seems.

On the fiscal side Dr. Bernanke clearly has no idea that our true constraint is always an inflation constraint and not a solvency constraint.  As an autonomous currency issuer we are never going to “run out of money” like Greece or a household.  If he understood this he wouldn’t call the fiscal path “unsustainable” in the same speech where he says rates of inflation “are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”   His recommendation on the path of fiscal policy sounds like vague political rhetoric and nothing more.

I don’t understand why he isn’t more direct and specific in these testimonies.  It’s one of the few times where he gets to be face to face with the lawyers running this country and cue them in on a few things that matter on the economic side.  This speech is just more vague rhetoric without a real path or purpose.  Bernanke might know there are risks out there, but he doesn’t seem to be trying very hard to help us avoid them….

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