WASHINGTON (AP) — Federal Reserve Chairman Ben Bernanke on Tuesday urged Congress and the Obama administration to strike a budget deal to avert tax increases and spending cuts that could trigger a recession next year.
Without a deal, the measures known as the "fiscal cliff" will take effect in January.
Bernanke also said Congress must raise the federal debt limit to prevent the government from defaulting on Treasurys debt. Failure to do so would impose heavy costs on the economy, he said. Bernanke said Congress also needs to reduce the federal debt over the long run to ensure economic growth and stability.
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Uncertainty about all these issues is likely holding back spending and investment and troubling investors, the Fed chairman said in a speech to the Economic Club of New York.
Resolving the fiscal crisis would prevent a sudden and severe shock to the economy, help drive down unemployment and strengthen growth, he said.
"A stronger economy will, in turn, reduce the deficit and contribute to achieving long-term fiscal sustainability," Bernanke told the group.
Bernanke also said the severity of the Great Recession may have reduced the economy's potential growth rate. He didn't say by how much or how long slower-than-normal growth might persist.
Over the long run, the U.S. economy has grown an average of about 2.5 percent each year. Economists predict growth in the July-September quarter will be revised up to an annual rate of around 3 percent, higher than the government's initial 2 percent growth estimate. But they think the economy is slowing to an annual growth rate below 2 percent in the October-December quarter.
Annual growth below 2 percent is too slow to make a significant dent in unemployment.
Bernanke said several factors have weighed on growth: Long-term unemployment has reduced many workers' skills and led some who have lost jobs to stop looking for one.
Companies have spent less on machinery, computers and other goods, reducing their production capacity. Stricter lending rules and uncertainty about the economy may have discouraged would-be entrepreneurs from starting more companies, the Fed chairman said.
Even assuming that the economy's potential growth has declined, Bernanke said that unemployment, now at 7.9 percent, remains abnormally high.
Bernanke suggested, though, that the drags on economic growth should fade as the economy heals.
It's unclear what, if anything, the Fed could do to cushion the economic impact of the fiscal cliff beyond the bond purchases it's already making to try to lower long-term borrowing rates and stimulate spending.
The minutes of the Fed's last policy meeting suggest that it will likely unveil a bond buying program in December to try to drive down long-term rates. The new purchases would replace a bond-buying program that expires at year's end.
But the minutes also noted that "several' Fed policymakers questioned whether additional bond buying would be needed and that "a couple" worried that keeping rates too low for too long could drive up inflation.
A new bond buying program would come on top of a program the Fed launched in September to buy $40 billion a month in mortgage bonds to try to reduce long-term interest rates and make home buying more affordable. That program represented the Fed's third round of major bond purchases to expand its holdings.
Fed officials also announced at the September meeting that they planned to keep the Fed's benchmark short-term interest rate near zero through mid-2015. This rate for overnight loans has been at a record low since December 2008.
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