March 3 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said policy makers may need to expand aid to the banking system beyond the $700 billion already approved and take other aggressive measures even at the cost of soaring fiscal deficits.
“Without a reasonable degree of financial stability, a sustainable recovery will not occur,” the Fed chairman said today in testimony prepared for the Senate Budget Committee. “Although progress has been made on the financial front since last fall, more needs to be done.”
Bernanke’s comments suggest he sees a role for bigger federal outlays as the Obama administration seeks congressional approval for a budget of $3.55 trillion for the fiscal year beginning in October. President Barack Obama has already signed into a law a $787 billion economic stimulus package of tax cuts and government spending.
Obama’s first budget seeks standby authority for as much as $750 billion in new aid to the financial industry. Whether those funds will be needed “depends on the results of the current supervisory assessment of banks” and the evolution of the economy, Bernanke said.
Bernanke said policy makers would have “preferred to avoid” what is likely to be the largest ratio of federal debt compared with gross domestic product since the end of World War II, and he urged lawmakers not to lose sight of fiscal discipline.
Cost to Budget
“But our economy and financial markets face extraordinary challenges,” and doing less now would eventually prove to be more costly, he said. “We are better off moving aggressively today to solve our economic problems; the alternative could be a prolonged episode of stagnation” that would cause budget deficits to swell further, increase unemployment and undermine incomes “for an extended period.”
The Fed has more than doubled its assets to $1.9 trillion during the past year by expanding loans to banks, launching programs to revive commercial paper and other markets and backing the merger of Bear Stearns Cos. with JPMorgan Chase & Co.
The 55-year-old Fed chairman told the Senate Banking Committee last week there’s a “reasonable prospect” the recession will end in 2009 “if the actions taken by the administration, the Congress and the Federal Reserve are successful in restoring some measures of financial stability.”
Stock Slump
Fed policy makers face headwinds from equity markets, with the Standard and Poor’s 500 Index falling this year by 22.5 percent and the S&P Financials Index tumbling 44.2 percent.
The government is still trying to stabilize large financial institutions such as Citigroup Inc. and insurer American International Group Inc. Shares of Citigroup traded at $1.33 this morning at 9:33 a.m., and the government expanded its aid to AIG yesterday after the company reported a fourth-quarter loss of $61.7 billion, the worst loss by any U.S. corporation.
The spending blueprint delivered to Congress last month forecasts government spending this year of $3.94 trillion, up 32 percent from a year ago. That would yield a record deficit of $1.75 trillion in the year ending Sept. 30, equal to about 12 percent of the nation’s gross domestic product, the highest since World War II. Government spending of $3.55 trillion next year will include about $350 billion approved as part of the stimulus package.
Stimulus Impact
“By supporting public and private spending, the fiscal package should provide a boost to demand and production over the next two years as well as mitigate the overall loss of employment and income that would otherwise occur,” Bernanke said.
Still, the size of the impact on the economy from government spending is “subject to considerable uncertainty,” Bernanke said. Consumers may decide to pay down debt or save their cash rather than spend it, he noted.
January forecasts by Fed officials suggest “a full recovery of the economy from the current recession is likely to take more than two or three years,” Bernanke told lawmakers last week.
The U.S. unemployment rate rose to 7.6 percent in January, the highest level since 1992. Job losses spanned almost all industries from trucking and construction to retailing and finance.
Fed officials expect unemployment in the fourth quarter to average 8.5 percent to 8.8 percent, which would be the highest since 1983, according to their January forecasts. Gross domestic product will contract 1.3 percent to 0.5 percent, and inflation will run at just 0.3 percent to 1 percent this year, their projections indicate.
Fed Forecasts
Fed officials don’t see labor markets improving until 2011, when growth forecast at 3.8 percent to 5 percent reduces the unemployment rate to a range of 6.7 percent to 7.5 percent.
Economic models used by Macroeconomic Advisers LLC show the Obama stimulus package could keep the jobless rate at about 8.8 percent instead of the 9.5 percent rate that would result without the package.
The Fed is stepping up efforts to stem the worst credit crisis in seven decades by expanding a program aimed at supporting consumer and business loans to $1 trillion from $200 billion and adding commercial real estate. It is also buying $600 billion of debt sold by government-backed housing finance companies and mortgage-backed securities they guarantee.
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