Federal Reserve Chairman Ben Bernanke warned U.S. politicians squabbling over budget issues that they hold in their hands both the promise of a "very good" 2013 and the threat of a disaster.
Already, the U.S. central bank chief said Tuesday, concerns about the so-called "fiscal cliff" are weighing on the economy as the prospect of some $600-billion (U.S.) in combined tax increases and spending cuts hinders business investment now.
The uncertainty has become a headwind for the still-struggling U.S. recovery. President Barack Obama and congressional leaders say they are committed to an agreement to avoid the fiscal cliff, and negotiations are expected to dominate Washington for most of December, if not longer. Mr. Bernanke called on lawmakers to act sooner rather than later.
Speaking in New York, he sought to motivate Washington to settle the fiscal cliff issue, predicting an economic bounce in 2013 if politicians strike a credible budget agreement. If left unfixed, the fiscal cliff would pose a "substantial threat" to U.S. recovery, he warned, citing projections of the Fed and others that the country could plunge back into recession.
"Such uncertainties will only be increased by discord and delay," Mr. Bernanke said in prepared remarks for the New York Economic Club. "In contrast, co-operation and creativity to deliver fiscal clarity – in particular, a plan for resolving the nation's longer term budgetary issues without harming the recovery – could help make the new year a very good one for the American economy."
Despite the warning about the cost of further political gridlock, Mr. Bernanke's remarks were among his most positive in some time.
He presented an analysis of the recovery that argues the U.S. economy would be doing better if not for headwinds that are either beyond the control of authorities – or, in terms of the budget negotiations, entirely controllable.
Mr. Bernanke played down suggestions that the economy has been fundamentally altered by the financial crisis, saying that it is possible the country's non-inflationary output potential is lower at the moment, but that he does not think it will last.
Unlike typical recoveries, the economy for several years has had to do without any support from the housing industry. That is changing, Mr. Bernanke noted, on a day that new figures showed U.S. housing starts increased to an annualized pace of 894,000 in October, the fastest pace since July, 2008.
Tight lending conditions also have impeded the recovery, and Mr. Bernanke suggested banks are being overly conservative. But that could change if bankers became more confident about the prospects for growth, the Fed chief said, drawing a link to the negotiations of the fiscal cliff.
The other headwind is the European debt crisis. He praised decisions by the European Central Bank to buy the debt of distressed countries and governments to strengthen their financial backstop and move toward fiscal and banking unions. "Further improvement in global financial conditions will depend in part on the extent to which European policy makers follow through on these initiatives," he said.
His strengthening optimism is incremental, however. The Fed chief said the high number of unemployed Americans remains a serious problem and reiterated that the central bank expects borrowing costs will remain extremely low until well into 2015.
In a question-and-answer session, he said lawmakers should remember that the Fed's powers are significant, but limited.
"The ability of the Fed to offset headwinds is not infinite," he said.
If nothing is done to resolve the fiscal cliff issue, "I don't think the Fed has the tools to offset that."