Answers to the Fiscal Crisis

BLOOMBERG, EVAN SOLTASFederal Reserve Chairman Ben S. Bernanke, taking questions during a February House hearing on monetary policy, uttered two very special words: fiscal cliff.

“Under current law, on January 1, 2013,” Bernanke said, “there’s going to be a massive fiscal cliff of large spending cuts and tax increases.”

[…] Whatever Bernanke’s intention in February, Congress now works in fear of falling off his fiscal cliff. The irony is that while economic recovery rests largely in Bernanke’s hands, the tyranny of impending austerity is leading Congress toward poor decisions about the long-term structure of public spending and tax policy. These are mistakes monetary policy could never offset.

The cause of our cliff problem rests in the commingling of responsibility between fiscal and monetary policy in managing the economic recovery. A more mature way of doing business would charge the Fed with stabilizing demand in the short run and Congress with a structural environment conducive to the social welfare and economic growth over the long run. The U.S. is doing neither well right now.

Neither institution, however, can achieve such ends without the cooperation of the other.

Congress, with good reason, does not want to send the economy spiraling back into recession; yet to put in place any spending curbs in the coming years will require a monetary commitment to recovery. The Fed, with good reason, would like to re-establish a normal policy regime and leave the bond-buying business—but it won’t do that knowing that Congress is about to implement one of the biggest austerity packages in modern economic history.

Meanwhile, what matters—a real need for proper long-term arrangements of public finance—is lost in the consideration of short-term political ends and the fear of blame for economic contraction. The best response is incremental-but-accelerating austerity consistent with a recovery. Such a mix of fiscal and monetary policies would support growth while putting the structural deficit on a clear path to elimination.

Read the rest on Bloomberg View