Thank you, Chairman Spratt, for arranging this important hearing.
Chairman Bernanke, you come before this Committee with the financial markets in a better position than in your previous appearance last fall. The economy is finally showing some signs of stabilizing and that’s encouraging.
But despite these short-term glimmers of hope, I’ve become more concerned about the longer-term implications of our economic policies.
On the fiscal side, the Treasury is issuing record amounts of debt – over $2 trillion this year alone – to support record government spending, and record deficits.
Meanwhile, the Federal Reserve has injected an enormous amount of monetary stimulus into the economy, and has even started purchasing longer-term Treasury bonds in an attempt to lower borrowing costs and further ease financial conditions.
This is a dangerous policy mix: the Treasury issuing debt, and the central bank buying it. It gives the alarming impression that the U.S. could one day begin to meet its fiscal obligations by simply printing money.
And we all know what happens when a country chooses to monetize its debt – it gets runaway inflation, and a gradual erosion of workers’ paychecks and family savings.
There is increased discussion in the financial press about the potential negative consequences of our current economic policies. Just this week, the yield on the 10-year Treasury bond rose to a 6-month high of over 3.7 percent — a sign that global investors are becoming concerned about our debt levels and the possibility of future inflation.
This is the bond market telling us there is no free lunch. When you issue record amounts of debt and your central bank has the monetary policy levers at full throttle, red flags are raised, and your borrowing costs go up.
There are some other faint warning bells going off. The value of the dollar has slipped recently, the price of gold is back up to nearly $1000 a troy ounce, and inflation compensation spreads in the Treasury bond market have risen to a 9-month high.
Now, I realize that some of these signs in financial markets are likely reassuring to the Fed since the predominant risk over the short term has been deflation.
But I’m genuinely concerned that the Fed will be unable to unwind its considerable monetary stimulus in a timely manner to prevent a sharp rise in inflation over the medium term.
There are a number of technical challenges associated with shrinking your balance sheet and returning to a more normal monetary policy stance, but I’m more concerned about the political challenges the Fed will face when you finally have to make this call.
I imagine there will be substantial political pressure on the Fed to delay tightening its monetary policy while the unemployment rate is still rising, for instance.
But the Fed’s political independence is critical for safeguarding its commitment to price stability, which is the chief policy concern of every central bank.
This clear commitment is all the more important at a time when that fine line between monetary policy and fiscal policy appears a bit blurry.
Despite the recent signs of stabilization in the economy, we policymakers should recognize that our most challenging period is ahead of us as we try to right the ship and get back on the path of sustainable growth and job creation.
That will clearly take a renewed sense of fiscal discipline to rein in spending and budget deficits. But it will also take a clear exit strategy on the part of the Fed and a firm commitment to price stability.
We in Congress are committed to working with the Administration to accomplish the former. And we trust the Fed will work diligently to ensure the latter.