Federal Reserve

Fiscal tightening a reason to keep stimulus, Fed says

PUBLISHED : Friday, 20 September, 2013, 12:00am
UPDATED : Friday, 20 September, 2013, 4:03am

The Federal Reserve thinks the economy is showing promising signs of strength but with a major caveat: things would look a lot better if not for Washington's drive to slash the deficit.

The central bank shocked observers on Wednesday by saying it would keep a bond-buying stimulus programme at full throttle, rather than scaling back purchases as many expected.

The decision was partly because policymakers were worried over a spike in borrowing costs and a fragile labour market, while inflation remains very low.

But the Fed's top official also flagged concerns about government austerity hurting the economy while political gridlock threatens to shut down government and trigger a debt default, adding to the risks facing markets and growth.

"It's extraordinarily important that Congress and the administration work together to find a way to make sure that the government is funded, public services are provided, that the government pays its bills," said Fed chairman Ben Bernanke.

Bernanke pointed to bright economic signals like a drop in jobless claims and more hours worked throughout the economy, but said this was happening despite tax increases and federal budget cuts that will likely reduce employment by hundreds of thousands of jobs this year.

The austerity drive has helped sharply reduce the federal deficit this year.

But Washington is fast approaching an end-of-the-month deadline to approve new government spending plans. Missing that deadline would largely shut down the federal government, sucking billions of dollars out of the economy.

Even more worrisome, the government will run out of cash and default on the national debt soon after mid-October if Congress does not authorise more borrowing.

That could rock the US economy by fuelling a surge in borrowing costs, while also slamming the stock market.

Bernanke said holding off on reducing bond purchases was partly due to uncertainties over "upcoming fiscal debates".

A government shutdown or failure to raise the debt limit could have "very serious consequences for the financial markets and for the economy", he said.