Bernanke Warns Large Deficits Could Unhinge U.S. Economy

Although consumer spending in some areas including auto sales are up so far this year, the U.S. should be very concerned about rising deficits, said Federal Reserve (Fed) Chairman Ben Bernanke on Wednesday.

Without a curb in government spending, the nation could experience unsustainable deficits in the range of four-to-nine percent of Gross Domestic Product (GDP) by 2020, Bernanke warned during a hearing before the Joint Economic Committee. Though the job market should rebound slightly in the coming years, Congress must find ways to address the debt level, he said.

"Although sizeable deficits are unavoidable in the near term, maintaining the confidence of the public and financial markets requires that policymakers move decisively to set the federal budget on a trajectory toward sustainable fiscal balance."

While he reminded the committee that home sales for 2010 are not where they need to be, Bernanke said that given recent gains in both GDP growth and hiring in sectors such as manufacturing, it is evident that recovery is underway, and will continue modestly going forward. When asked how such projections will affect interest rates, which have been kept at historically low levels for several months, Bernanke said that would depend on a number of things.

"At some point, the markets will make a judgment...[about] our political will to achieve longer-term sustainability," Bernanke told Sen. Sam Brownback (R-Kan.). "At that point interest rates could go up and that would be, of course, a negative for economic growth and recovery. We don't know when that point would be reached."

Despite low levels of lending, the Fed, said Bernanke, is encouraging banks to continue building up capital. Acknowledging that "sluggish" loan demand coupled with conservative lending has impacted businesses looking to receive credit, Bernanke said he is hopeful that the Fed's bank supervision won't "impede sound lending," or get in the way of banks finding a suitable balance between lending and liquidity.

Bernanke was peppered with questions about a financial regulatory reform bill making its way through the Senate. Specifically, Bernanke was asked to judge the proposed Consumer Financial Protection Agency (CFPA), a key pillar of reform, that would act as a watchdog for individual consumers, and would likely be housed inside the Fed.

"I understand why people would be concerned [over its location]," Bernanke said, adding that there are a few items within the legislation that must be clarified before he can offer a more detailed analysis. For example, the question of how the CFPA would be funded must be answered by Congress, he said.