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Bernanke Says Fiscal Cliff Fix May Bring ‘Very Good’ Year

By Joshua Zumbrun and Caroline Salas Gage
November 20, 2012 1:25 PM EST 41 Comments

Federal Reserve Chairman Ben S. Bernanke said that an agreement on ways to reduce long-term federal budget deficits could remove an impediment to growth, while failure to avoid the so-called fiscal cliff would pose a “substantial threat” to the recovery.

“Cooperation 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,” Bernanke said in remarks to the Economic Club of New York at the Marriott Marquis Hotel in Times Square. “The realization of all of the automatic tax increases and spending cuts that make up the fiscal cliff, absent offsetting changes, would pose a substantial threat to the recovery.”

Bernanke’s efforts to bring down 7.9 percent unemployment and spur the three-year expansion with purchases of $40 billion in housing debt each month are being impeded by Congress’s inability to reach agreement to stabilize U.S. outlays and revenues and avoid the so-called fiscal cliff. Bernanke also said Fed policy will remain accommodative until the recovery is on a firmer footing.

Bernanke, 58, said that “uncertainty” about imminent tax and spending cuts, the ability of Congress to raise the debt ceiling in a timely manner, and the long-term challenges of balancing the U.S. budget appear “already to be affecting private spending and investment decisions and may be contributing to an increased sense of caution in financial markets, with adverse effects on the economy.”

Pulling Back

Some businesses are pulling back on concern that hurtling over the fiscal cliff will damage the economy. Spending on equipment and software was little changed from June through September, the weakest reading since the second quarter of 2009, according to figures from the Commerce Department.

“I do think there’s important potential for the economy to strengthen significantly if there’s a greater level of security and confidence about where we’re going as a country,” Bernanke said in response to a question after the speech.

The Fed chief, in his prepared remarks, repeated his warning that over $600 billion in spending cuts and tax increases that could take effect in January could send the economy “toppling back into recession.”

While Fed policy is “by no means a panacea,” Bernanke said it is helping the economy.

Recovery Established

“We will want to be sure that the recovery is established before we begin to normalize policy,” he said.

Stocks declined after Bernanke’s remarks. The Standard & Poor’s 500 Index fell 0.4 percent to 1,381.54 at 1:24 p.m. in New York after rising as much as 0.2 percent. The yield on the 10-year Treasury note climbed to 1.64 percent from 1.61 percent yesterday.

The Fed is also purchasing about $45 billion a month of longer-term Treasury securities as it replaces the same amount of short-term debt on its balance sheet. The program, known as Operation Twist, is designed to lower longer-term interest rates without increasing the overall size of the central bank’s securities holdings.

Bernanke’s large-scale asset purchases have pumped up the central bank’s balance sheet to $2.88 trillion, close to a record. The so-called quantitative easing has helped reduce borrowing costs and push down unemployment from a peak in October 2009 of 10 percent. The Fed cut its target interest rate to zero in December 2008 and forecasts it will probably hold it there through at least mid-2015.

Bernanke used his remarks to offer a detailed analysis of the U.S. economy since the recession and said that the potential growth has been damaged by the recovery.

Financial Crisis

“The accumulating evidence does appear consistent with the financial crisis and the associated recession having reduced the potential growth rate of our economy somewhat during the past few years,” Bernanke said. This would explain “why the unemployment rate has declined in the face of the relatively modest output gains we have seen during the recovery.”

One gauge of unemployment -- which includes those who have given up searching for work and those who are employed part-time because they can’t find a full-time job -- stood at 14.6 percent in October.

Long-term unemployment has also remained elevated throughout the recovery. Among the unemployed, 40.6 percent have been without work for 27 weeks or longer.

Source of Strength

At the same time, the housing market has become one of the economy’s sources of strength as mortgage rates driven to record lows by the Fed’s asset buying spur higher prices, construction and builder sentiment. The average fixed rate on a 30-year home loan fell to 3.34 percent last week, the lowest in four decades of data, Freddie Mac data show.

New-home construction unexpectedly climbed to a four-year high in October, a report today showed.

Housing starts rose 3.6 percent to a 894,000 annual rate, the fastest since July 2008 and exceeding all estimates in a Bloomberg survey, according to Commerce Department figures. The median forecast of 82 economists called for an 840,000 pace. Permits for the construction of single-family homes also advanced to the highest in four years.

Sales of existing homes rose 2.1 percent in October, and the median price rose from a year earlier as inventories dropped to the lowest level in almost a decade, the National Association of Realtors said yesterday. The National Association of Home Builders/Wells Fargo index of builder confidence increased to a six-year high in October.

Housing Market

The recovering housing market has boosted performance at Home Depot Inc. and Lowe’s Cos., the largest and second-largest U.S. home improvement retailers. Lowe’s surged the most in more than three years yesterday after fiscal third-quarter profit topped analysts’ estimates. Last week, Home Depot also posted third-quarter profit that topped analysts’ estimates.

“Recently, the housing market has shown some clear signs of improvement,” Bernanke said, echoing remarks from a Nov. 15 speech in Atlanta.

“It seems likely that, on net, residential investment will be a source of economic growth and new jobs over the next couple of years,” he said today, quoting that tight terms from lenders and underwater borrowers will prevent “the sort of powerful housing recovery that has typically occurred in the past.”

President Barack Obama’s re-election this month set up a showdown over the federal budget with the Republican-controlled House of Representatives. Economists including Bernanke have voiced concern that if not averted, the so-called fiscal cliff could cause a recession.

Many participants at the last Federal Open Market Committee meeting said doubts over resolution of the U.S. fiscal challenge is “likely to restrain the pace of economic growth in coming months,” according to the minutes said. Officials said the fiscal contraction would put the economic expansion at risk, and that businesses have already reported “delaying or cutting back on hiring and capital spending” because of the uncertainty, according to the minutes.

-- With assistance from Jeff Kearns in Washington. Editors: James Tyson, Christopher Wellisz

To contact the reporters on this story: Joshua Zumbrun in Washington at jzumbrun@bloomberg.net

Caroline Salas Gage in New York at csalas1@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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