Bernanke steps up warnings over fiscal cliff

Fed chairman Ben Bernanke stepped up his warnings Tuesday over the looming "fiscal cliff," saying its mandatory tax hikes and spending cuts posed a "substantial threat" to US economic recovery.

With President Barack Obama's administration and Congress locked in crunch talks on avoiding the cliff and slashing the budget deficit, Bernanke said rising cuts to federal spending were already holding back growth.

"Congress and the administration will need to protect the economy from the full brunt of the severe fiscal tightening at the beginning of next year that is built into current law -- the so-called fiscal cliff," the US central bank chief said in a speech in New York.

"The realization of all of the automatic tax increases and spending cuts that make up the fiscal cliff, absent offsetting changes, would pose a substantial threat to the recovery," he said, according to the prepared text.

"Indeed, by the reckoning of the Congressional Budget Office and that of many outside observers, a fiscal shock of that size would send the economy toppling back into recession."

Bernanke said the Federal Reserve already views growth as disappointingly slow and troubled by threats from the eurozone crisis, slow job creation and the reticence of banks to loosen lending standards -- which Bernanke said is holding back recovery in the housing sector.

The unemployment rate, currently 7.9 percent, remains "well above" what Fed officials want to see, Bernanke said, adding that the country has "some way to go before the labor market can be deemed healthy again."

But Bernanke pointed out that pressures to wind up the stimulus programs and other policy actions designed to pull the country out of recession, and stepped-up efforts to rapidly reduce the federal budget deficit, are now "restraining" gross domestic product growth.

"Indeed, under almost any plausible scenario, next year the drag from federal fiscal policy on GDP growth will outweigh the positive effects on growth from fiscal expansion at the state and local level," he said.

Bernanke's warning came as the White House and top officials from Congress are locked in talks to avert the cliff and set a long-term plan for reducing the deficit, which has topped $1 trillion a year for four years running.

The cliff comprises two challenges: a drastic spending reduction program, and the expiration of a broad range of "temporary" tax decreases.

Both are to take place on January 1, and together would suck at least $500 billion out of the economy, forcing it into recession.

Republicans and Democrats have sharply differed on what kind of long-term spending reductions and increases in tax revenues should be put in place to replace the cliff.

Bernanke said that the deficit is "on an unsustainable path," requiring a "credible framework" to stabilize and reduce the country's debt and deficit load.

But he warned policymakers "to avoid unnecessarily adding to the headwinds that are already holding back the economic recovery."

"Preventing a sudden and severe contraction in fiscal policy early next year will support the transition of the economy back to full employment," he said.

Asked after the speech how the central bank could mitigate the impact of the fiscal cliff, Bernanke replied: "I don't think the Fed has the tools to offset that."

But analysts found Bernanke sounding somewhat more optimistic about the economy's potential than he had in recent months, presuming the fiscal cliff is averted.

"For his standards, this was probably one of the most 'upbeat' speeches that Fed Chairman Bernanke has given over the last five years," said economist Harm Bandholz of UniCredit.

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