Dire Warnings from Fed President in “Knocking on the Central Bank’s Door”

Federal Reserve Bank of Kansas City President Tom Hoenig issued a warning yesterday about where the nation’s economy is headed, a warning that calls into question much of what the Federal Reserve, Presidents Bush and Obama, and Congress have done in the years leading up to the economic downturn and in response to it:

“[T}he fiscal projections for the United States are so stunning that, one way or another, reform will occur,” Hoenig said in a speech for the Peterson-Pew Commission on Budget Reform Policy Forum in Washington, DC. “Fiscal policy is on an unsustainable course. The U.S. government must make adjustments in its spending and tax programs. It is that simple. If pre-emptive corrective action is not taken regarding the fiscal outlook, then the United States risks precipitating its own next crisis.”

He titled the speech “Knocking on the Central Bank’s Door,” a reference to this observation: “Throughout history, there are many examples of severe fiscal strains leading to major inflation. It seems inevitable that a government turns to its central bank to bridge budget shortfalls, with the result being too-rapid money creation and eventually, not immediately, high inflation. Such outcomes require either a cooperative central bank or an infringement on its independence. While many, perhaps most, nations assert the importance and benefits of an independent central bank, the pressures of the ‘immediate’ over the goals of the long run makes this principle all too expedient to forgo when budget pressures mount.”

Hoenig warned that continuing down the current path could lead to hyper-inflation and observed, “The immediate concern is the size of the deficit.  The CBO projects the deficit was almost 12 percent of GDP in fiscal year 2009 and will be almost 8 percent in the current fiscal year—extraordinarily high levels by historical standards.  In the entire history of the United States, the government has run deficits over 10 percent of GDP in only a few instances, and usually only during or immediately following a major war.
 
“As troubling as these deficits appear, even more disconcerting is the longer-term outlook for the federal debt caused by the accumulation of these deficits over time.  The CBO’s long-term debt projections clearly show that current fiscal policies are unsustainable.  In one scenario, the liftoff point for federal debt—that is, the time when debt starts rising without any sign of stabilizing—occurs shortly after 2020.  . . . In another, more pessimistic scenario, the liftoff in debt has already begun, with federal debt held by the public reaching 181 percent of GDP in 2035, easily exceeding the peak debt to GDP ratio of 113 percent that occurred at the end of World War II.”

Steve Stanek (sstanek@heartland.org) is a research fellow at The Heartland Institute and managing editor of Budget & Tax News.

Internet Info

Full text of Federal Reserve Bank of Kansas City President Tom Hoenig's speech, "Knocking on the Central Bank's Door": http://www.heartland.org/budgetandtax-news.org/article/27082