Federal Reserve Chairman Ben Bernanke Sounds Upbeat Tone on Recovery

On Friday, Federal Reserve Chairman Ben Bernanke sounded an upbeat tone on the economy in public comments released prior to the unemployment figures. Pedro Nicolaci da Costa reports that Bernanke, in his comments, emphasized that he sees "increased evidence that a self-sustaining recovery in consumer and business spending may be taking hold." However, his optimism was still tempered by the reality that unemployment numbers would still be elevated, and that its effects on consumer confidence and household income are still threats to our country's economic recovery. His hedged optimism isn't shared by all.

Bernanke's Reasoning

Federal Reserve Chairman Ben Bernanke is viewing the economy through single dimensional facts and figures that report on consumer and business spending. In most short-lived economic downturns, these data would be sufficient, and when these started showing signs of increasing, it could be safe to consider us on the path to recovery. This recession and recovery are different.

The Missing Pieces

Missing from Bernanke's data is the effect that the long-running recession has had on state budgets and the impact the midterm elections will have on states' budgets over the next two years. The former has meant that tax revenues have severely suffered for a year or more. The latter will likely mean cuts to state and local government spending which, while fiscal sanity is definitely needed to curb the dramatic increase in the size of government over the years, could mean higher unemployment and less money to be spent by local communities.

Falling Tax Revenues - A History Lesson

In the Great Depression, falling tax revenues meant that the United States was losing income. A tax cut was enacted in 1929 to give money back to the people at the height of the roaring '20s, after which the stock market crashed and the Great Depression set in. A tax surplus quickly turned into a severe tax deficit, and according to Gene Smiley in the Library of Economics and Liberty, President Hoover recommended an across the board tax increase, which was enacted in 1932 to shore up the federal government's budget. This further restricted household spending, and added to the systemic decrease in the production and sale of goods and services that had been caused by the Federal Reserve's inaction.

Falling Tax Revenues - Today's Response

Fast forward to the Great Recession, and we see a Federal Reserve that has been much more responsive in easing economic policy to avert deflation. Largely because of the Federal Reserve's actions in stimulating the economy through ultra-low interest rates, the purchase of bad debts, and the dramatic easing of credit, the Federal Reserve has staved off a depression, at least for now.

But, the federal and many state and local governments are once again facing severe budgetary crises because tax revenues have fallen. Having learned from the Great Depression that tax increases during an economic downturn are akin to kicking the economy while it's down, we aren't likely to repeat that fiasco. So what's a cash-starved government going to do? Cue the reformers.

Tea Party to the Rescue - of the Deficit

The midterm elections ushered in a new crop of legislators, both at the federal and state levels, who campaigned on limited government and fiscal reform. These new legislators promised to cut the size of government by restricting funds and cutting government programs to decrease the government deficit. The fervor created by the Tea Party helped to catapult the Republican Party into power in the House of Representatives and in many state legislatures.

In a departure from the Republican Party, which seems most focused on repeal of the health care law, the Tea Party sees reduction of the deficit, by any means necessary, as one of the nation's top priorities. Indeed, a Pew Research Center poll conducted on Dec. 9, 2010, indicated that 51 percent of Tea Party respondents indicated that even tax hikes should be considered to balance the budget. The desire to increase taxes at this time is muted, and the clout of anyone who would choose to do so at this time is virtually nonexistent, meaning efforts to cut the deficit will almost certainly center on spending cuts.

What this Means for the Economy

By definition, any spending cuts will mean less money in state and local economies. If the federal, state, or local governments make cuts to or refuse to fund programs such as food stamps, unemployment, housing aid, etc., money is removed from local economies. Furloughing or cutting the number of state and local government workers also removes money from local economies. Infrastructure cuts, like road, bridge, and railway construction, mean that construction jobs are lost or never materialize. Much of this lost money would have been spent at grocery and convenience stores, on rent or mortgage payments, on clothing, vehicles and more.

As our economy is a system of goods and services and their providers, less spent on these goods and services means that fewer jobs are needed to produce them. A vicious cycle can occur in which states make cuts to offset a decrease in tax revenues, but these cuts further erode tax revenues, forcing more budget cuts. Some would argue that taxes shouldn't be a means of robbing the rich to feed the poor, or that this spending is adding to an already dangerously high debt, but the fact is: This system is already in place. To change the system, a gradual transition must occur to dampen the negative effects. Abruptly cutting programs without encouraging the private sector to step up is irresponsible and can only harm us all in the long run.

Bernanke's Blind Spot

Federal Reserve Chairman Ben Bernanke misses the mark when he neglects to talk about the effects that decreased government spending will have on the economic recovery. A return to fiscal sanity is definitely needed in order to avoid a default on the nation's soaring debt. However, the path our country takes to restore a budget surplus could be the high road leading to more individual responsibility via a slow transition of cuts and replacement, and the recognition that targeted tax increases may be necessary to make a dent in the national debt, or it could be the low road, rife with austerity, strewn with the bodies of those who couldn't adapt to our country's new "limited government."

Sources:

da Costa, Pedro Nicolaci. (2011). Bernanke Grows More Confident in Recovery.
Smiley, Gene. (2011). Great Depression.
Pew Research Center. (2010). Deficit Solutions Meet with Public Skepticism.