Chairman Ben Bernanke provided a relatively upbeat outlook for the U.S. economy that largely reflects the Federal Reserve's recently updated central tendency projections. The Fed is projecting that growth will remain solid, near 3.5%, in 2010 and then accelerate modestly in 2011. Core inflation is moderating, while overall inflation should remain subdued.
IHS Global Insight is forecasting real GDP growth of just under 3% in 2011, so the Fed's outlook does look a little optimistic from our perspective. Fiscal drag connected with higher federal taxes and lower federal spending in 2011 and beyond—and expectations thereof—will be a major hurdle to overcome for growth to pick up in 2011.
Reading between Bernanke's lines, it is clear that monetary policy will have to remain very accommodative for quite some time in this type of environment.
Bernanke touched on the European fiscal and currency crises, indicating that the Fed believes the policy mechanisms put in place, while tardy, should begin to restore confidence in the Eurozone's fiscal situation. Collateral damage to the U.S. economy should be limited, as there are major offsets in the form of lower interest rates and industrial commodity prices. On this subject, we would agree with the Fed chairman.
Finally, Bernanke issued a strongly issued warning on long-term U.S. fiscal sustainability. Even after economic and financial conditions return to normal, the federal budget is on an unsustainable path—the aging of the U.S. population will put severe strains on Social Security and healthcare spending.
The Fed chairman closed with a stern warning "unless we make a strong commitment to fiscal responsibility, in the longer run, we will have neither financial stability nor healthy economic growth."
Completing his logic, ultimately, "Pax Americana" is at serious risk from these fiscal imbalances.
by Brian Bethune