Don't Over-correct

Throughout the economic crisis, I have thought that Fed Chairman Ben Bernanke's responses have been measured and thoughtful. As a student of the great depression, it seemed he clearly understood the dangers of doing too little. It is in this context that I find his remarks to Congress today somewhat worrisome.

As so many have noted over the course of this crisis, the Roosevelt administration responded to signs of turnaround in 1937 by hauling in the fiscal and monetary reins. The result was another precipitous decline. Bernanke's remarks today seem to suggest a similar course of action. And to the extent his advice is followed, it could have the same result.

Noting that we are scarcely out of danger, he nevertheless offers this advice

. . . even as we take steps to address the recession and threats to financial stability, maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance. Prompt attention to questions of fiscal sustainability is particularly critical because of the coming budgetary and economic challenges associated with the retirement of the baby-boom generation and continued increases in medical costs. The recent projections from the Social Security and Medicare trustees show that, in the absence of programmatic changes, Social Security and Medicare outlays will together increase from about 8-1/2 percent of GDP today to 10 percent by 2020 and 12-1/2 percent by 2030. With the ratio of debt to GDP already elevated, we will not be able to continue borrowing indefinitely to meet these demands.

Addressing the country's fiscal problems will require a willingness to make difficult choices. In the end, the fundamental decision that the Congress, the Administration, and the American people must confront is how large a share of the nation's economic resources to devote to federal government programs, including entitlement programs. Crucially, whatever size of government is chosen, tax rates must ultimately be set at a level sufficient to achieve an appropriate balance of spending and revenues in the long run. In particular, over the longer term, achieving fiscal sustainability--defined, for example, as a situation in which the ratios of government debt and interest payments to GDP are stable or declining, and tax rates are not so high as to impede economic growth--requires that spending and budget deficits be well controlled.

This is of course true -- we will eventually have to reel in both fiscal and monetary policy (though Bernanke tellingly fails to identify the monetary part). And, knowing the impossibility of tax increases within the Washington culture, he surely understands that this translates into programatic retreat. It is depressing that Bernanke expresses these concerns now, after participating in the transfer of trillions of dollars into the financial sector that brought about this mess.

As I have argued before, perhaps the most lasting effect of this crisis is likely to be the evidence it has provided for just what we can afford when the political will exists. People will remember how lavishly we spent on the rich and hopefully demand that we do the same for the poor.