Fed boss wants 'fiscal exit' to cut debt

The US economic recovery is at risk because politicians are failing to deal with its long-term budget deficit, the Federal Reserve chairman has warned.

Ben Bernanke told lawmakers in blunt language that they needed a "fiscal exit strategy" that will tackle the country's unsustainable deficits, as the national debt mounts throughout this decade.

Although he left the door open for politicians to enact more short-term economic stimulus, particularly in relation to unemployment, Mr Bernanke warned that financial markets need a sign that Congress is also willing and able to cut government spending commitments or raise taxes in coming years.

Barack Obama this month created a bipartisan commission that will look into the issue of spending cuts and limits on entitlements such as social security benefits, following the publication of a budget that shows the national debt rising to 77 per cent of GDP by the end of the decade, even in a rosy economic scenario. Annual deficits are never projected to fall below the 3 per cent of GDP that Mr Bernanke said was sustainable.

"I realise it is extremely difficult to address this issue, but it would be helpful to the current recovery, helpful to the markets and helpful to confidence if there was a plan for a 'fiscal exit', if you will," the Fed chairman said, answering questions from the House financial services committee.

Mr Bernanke said that such a plan – or even a concerted political effort to create one – could reduce market interest rates on government debt, stimulating the economy right away. And he added that failing to do so was dangerous for the economic recovery: "It's not necessarily just a long-term issue because it is possible that bond markets will become worried about sustainability and we may find ourselves facing higher interest rates even today."

In his prepared testimony, the chairman described the economic recovery as "nascent" and reiterated that the Fed will hold interest rates "exceptionally low... for an extended period". He warned that most of the rebound so far could be explained by government stimulus and businesses restocking inventories from very low levels, while final customer demand was rebounding much more slowly and unemployment – currently just below 10 per cent in the US – was still too high.

Stock markets read the chairman's statement to mean that monetary tightening could be further away than thought, and rallied on his comments. The Dow Jones was 100 points higher at lunchtime, despite news that new homes sales slumped 11.2 per cent in January, setting a record low volume, and suggesting that the US housing market remains fragile.

The US budget deficit is projected to balloon to a record $1.6 trillion, thanks to the $787bn economic stimulus enacted 12 months ago. Mr Bernanke stressed that his worries about the deficit were medium-term concerns, and he refused to endorse committee members who said Congress needed to cut the deficit in the current year. The Senate this week moved forward with an additional $15bn Jobs Bill aimed at bringing down unemployment.

And he was also short with lawmakers who complained that banks were still withholding loans from small businesses that wanted funds for expansion. He said Congress had "stigmatised" bailout money given to the banks to such an extent that many of them had paid it back early. "It is no longer available for credit, and that is unfortunate."