Bernanke: Default on debt would increase deficit

Federal Reserve Chairman Ben Bernanke warned U.S. lawmakers Thursday that they would deliver a "self-inflicted" wound to the nation's economy by holding up efforts to raise the government's borr...

Federal Reserve Chairman Ben Bernanke warned U.S. lawmakers Thursday that they would deliver a "self-inflicted" wound to the nation's economy by holding up efforts to raise the government's borrowing limit.

The Fed chief also said the central bank had no immediate plans to introduce new stimulus measures, elaborating on remarks he made a day earlier that the Fed stood ready to take additional steps to boost the economy if conditions worsened.

His comments ended an early-morning rally on Wall Street. Traders had interpreted Wednesday's comments to mean the Fed was about to embark on another round of bond purchases, analysts said.

The government hit its $14.3 trillion borrowing limit in May. Republicans have held up increasing the limit because of concerns that excessive government spending has widened the federal deficits. The Treasury Department said it will default on its debt if the limit is not raised by Aug. 2.

Bernanke told a Senate panel that a default on the debt would lead to even greater federal deficits. Interest rates would rise, and the government would be forced to pay higher rates on its debt. At the same time, higher rates would slow the economy and an already-weak job market. That would curtail tax revenue.

"I think it would be a calamitous outcome, create a very severe financial shock," Bernanke told the Senate Banking Committee during his second appearance before Congress this week. "Treasury securities are critical to the entire financial system ... A default on those securities would throw the financial system ... potentially into chaos."

Bernanke was on Capitol Hill to deliver his semiannual economic report. On Wednesday, he told a House panel that the Fed would consider various options for boosting the economy if growth does not rebound. Stocks rose immediately after he made those comments.

But on Thursday, he made clear that the Fed had no immediate plans to launch another round of bond purchases. He said the economy is more complex now than a year ago, when the Fed decided to institute a $600 billion program of buying Treasury bonds to lower long-term interest rates.

Last summer, the Fed was concerned about a prolonged period of falling prices, or deflation, Bernanke said. This year, inflation is higher.

"We'd like to see if, in fact, the economy does pick up, as we are projecting. ... We're not prepared at this point to take further action" to stimulate the economy, Bernanke said.

Stocks had been trading higher before the hearing. They fell immediately after he spoke. The Dow Jones industrial average closed down 54 points.

Investors took Bernanke's remarks on Wednesday to mean that the Fed chairman had all but guaranteed new action to stimulate the economy, said Jeff Cleveland, senior economist at money manager Payden & Rygel.

"They realize that's not the case now," Cleveland said.

The Fed in its weekly accounting of the central bank's finances reported that its balance sheet rose to a record level of $2.88 trillion on Wednesday. That is more than three times the size of the Fed's balance sheet before the financial crisis began.

Bernanke's second day of testimony was dominated by questions over the borrowing limit impasse.

Republicans are demanding that any increase in the borrowing limit be accompanied by an equal amount of spending cuts. President Barack Obama and Democrats have insisted that tax increases be a part of any long term deficit-cutting deal, something Republicans have rejected.

Sen. Pat Toomey, R-Pa., said there was a big difference between an actual default on the debt, which would occur if the government missed an interest payment, and delaying other government payments for a brief time.

Bernanke said the Treasury has told him that prioritizing payments would be an unworkable solution. He also said the prolonged debate was already having adverse consequences.

Moody's Investors Service said Wednesday it will consider lowering the United States' credit rating because of a small but rising risk that the government will default on its debt.

A downgrade would raise interest rates on U.S. treasury bonds, increasing the interest paid by U.S. taxpayers. It would also push up rates for mortgages, car loans and other debts, which are linked to Treasury rates.

The United States pays an average of about 3 percent on its existing debt, according to the Treasury Department. In 2010, that added up to $197 billion in interest payments.

The nonpartisan Congressional Budget Office has forecast that interest payments will rise to $463 billion by 2014. That is under an assumption that the U.S. keeps its top credit rating. A reduced rating would force the government to pay higher interest rates.

"I would urge Congress to take every step possible to avoid defaulting on the debt or creating even any significant probability of defaulting on the debt," Bernanke said.


AP Business Writer Francesca Levy contributed from New York to this report.

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