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The Fed's debt-debate role

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By Charles Lane
Thursday, Dec. 6, 2012, 8:59 p.m.
 

Judging by the latest signs and portents, President Obama and congressional Republicans appear to be at an impasse over taxes and spending, and the country might indeed be headed over the “fiscal cliff.” Next year's economic sluggishness and partisan recriminations could make today's look like a picnic.

The two parties and their allied pundits blame each other; each side has its points. But while everyone's pointing fingers, let me at least wave in the direction of the Federal Reserve and its chairman, Ben S. Bernanke. There's a case to be made that Bernanke's low interest-rate policies are part of the problem, too.

How so? What could the central bank's pursuit of its mission possibly have to do with Congress' handling of its tax-and-spend business?

The answer: nothing directly or intentionally, but everything indirectly and unintentionally.

With the U.S. economy still reeling from the Great Recession, the Fed has been trying to stimulate economic growth by holding down interest rates. It does this in large part by buying up government debt. It's perfectly consistent with the Fed's mandate.

However, in a properly functioning economy, rising government borrowing costs can play a useful role: They are the market's way of warning government that its debts are unsustainable. Muffle that signal, as Fed policy is doing now, and politicians are less able to guess right about how much time they have to fix fiscal policy.

According to the 2012 annual report of the global “central bank for central banks,” the Bank for International Settlements (BIS), “near zero policy (interest) rates, combined with abundant and nearly unconditional liquidity support, weaken incentives for ... fiscal authorities to limit their borrowing requirements.”

In short, the Fed is making it easier for Congress and the president not to do their jobs.

Bernanke has firmly denied responsibility for the politicians' fiscal dithering. In an Oct. 1 speech, he rejected the notion that the Fed should use monetary policy “to try to influence the political debate on the budget.”

“Suppose, notwithstanding our legal mandate, the Federal Reserve were to raise interest rates for the purpose of making it more expensive for government to borrow,” the chairman said. “Such an action would substantially increase the deficit” — both by raising borrowing costs and by weakening the economic growth upon which government depends for revenue.

Bernanke was correct. But no one is saying he is enabling the fiscal impasse on purpose — at least I'm not. Nor is anyone suggesting that he should reverse course on interest rates for the express purpose of disciplining the politicians.

The real point, as the BIS put it, is that “central banks are being cornered into prolonging monetary stimulus as governments drag their feet and adjustment is delayed.”

Bernanke can't raise rates without blowing up the economic recovery. The recovery, in turn, buys time for Congress and the White House to address fiscal issues under benign conditions. Yet without the spur of higher rates, politicians are more likely to waste that time — and, consequently, blow up the economic recovery.

It's anyone's guess how much longer this game can go on, before markets finally deliver an interest rate shock so powerful that even the Fed can't counteract it. But I am pretty sure that whenever that shock comes, it will be sooner than we'd like.

Charles Lane is a member of The Washington Post's editorial board.

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