"Bad Fiscal Policy Creates Pressure for Bad Monetary Policy"

Here's part of a speech on fiscal policy by Richard Fisher, president of the Federal Reserve Bank of Dallas:

Fiscal Issues: From Here to Eternity, President, by Richard W. Fisher, FRB Dallas: ...I am going to speak today ... about fiscal policy, an area into which central bankers rarely wander. ... Before doing so, let me remind you that the Federal Reserve is a strictly nonpartisan institution; when you enter the temple of the Federal Reserve, you check your partisan affiliation at the door...

According to official government trustee reports, the infinite-horizon discounted present value of our unfunded liability from Social Security and Medicare—in common language, the gap between what we will take in and what we have promised to pay—now stands at $83.9 trillion. The potent combination of lower birthrates, higher medical costs and longer life expectancies provides little reason to hope that the figure will fall.

Just how big is an $83.9 trillion shortfall? Well, it is six times the U.S. gross domestic product. It is more than 100 times the country’s annual defense budget. And it is about 10,000 times the annual budget of the Environmental Protection Agency. That is a lot of money, even for a central banker. ...

When people think about these kinds of issues, they usually assume Social Security is the big problem. But, by golly, it isn’t. As these figures show, the unfunded liability from Medicare Part D alone—the drug benefit—is greater than the entire Social Security shortfall. Taken together, Medicare’s unfunded liabilities are more than five times that of Social Security. So while we can applaud policymakers who have tried to shore up Social Security, we must be ever mindful that the lion’s share of the total $83.9 trillion unfunded liability problem will remain even if they succeed.

But we’re a big country, so let’s look at it on a per-person basis. If you divide the $83.9 trillion evenly among the 300 million U.S. residents, you get a per-person liability of $280,000—more than five times the average household’s annual income. Each of us would have to pay that much today if we wanted to guarantee the solvency of our entitlement system for future generations. ...

Now that I have your attention, remember that to save promised benefits, we would have to dramatically cut spending starting right now or raise income taxes and never bring them back down. And by doing so, we would only be covering the shortfall from Social Security and Medicare payroll tax receipts. All other existing sources of entitlement funding, including payroll tax revenue, copays, deductibles and premiums, would have to remain in place.

This is not a pretty picture. And as bad as the situation currently is, the necessary response becomes ever more drastic the longer we wait. If past is prologue, the most likely response may be to adjust the parameters of the current system—for example, by raising the retirement age or making the payroll tax more progressive. Many options would improve the fiscal fitness of our entitlement system and reduce the need for drastic action elsewhere in the federal budget. But let’s be honest: Any option would work only because some people would get less than they are currently slated to receive. Painful as that is, the question is whether other options on the table would be even more so.

Our short-term fiscal challenges are significant as we grope our way toward a future in which we begin to pay down the federal debt. The long-term challenge of entitlements is much more severe, with implications both for our own well-being and for the long-term strength of the global economy. Yes, we remain the biggest player on the global stage, but if we fail to get our fiscal house in order, we could bequeath our descendants unconscionable debt and slow the global economy to boot. Is that to be our legacy?

At face value, fiscal policy may not seem a concern for the Federal Reserve. Taxing and spending, after all, are not the Fed’s business. Congress holds the power of the purse. But the Fed cannot be an indifferent bystander to the overall thrust of fiscal policy. The reason is straightforward: Bad fiscal policy creates pressure for bad monetary policy. When fiscal policy gets out of whack, monetary authorities face pressure to monetize the debt, a cardinal sin in my mind.

I have spoken in previous speeches of our “faith-based currency,” a term I use only slightly tongue in cheek. The dollar—like the euro, the yen, the British pound and other currencies—is what economists call a fiat currency. It is backed only by the federal government’s power to raise the revenues needed to meet its obligations and by the rectitude of the U.S. central bank. If the market were to lose faith in either assumption, the dollar would be debased.

The Fed is not the answer to our fiscal woes. Remember, the executive proposes, and the legislative disposes. Congress, as keeper of the government’s purse and the sole body with the power to tax and spend the people’s money, is where the buck stops. Congress has the duty and the means to impose solutions to these imbalances, hopefully inspired by presidential leadership. And here is the rub: Voters like you elect the Congress. And you elect the president. ...

History may place blame on this or that president or on Congress for failing to act. But, ultimately, the responsibility to solve these looming fiscal issues rests with voters. In the end, the person who is responsible for the $83.9 trillion meltdown that is happening before our very eyes—the person responsible for saddling each of your children and every other person you love with $280,000 in debt—is the one you look at in the mirror each morning.

Two other speeches from the Fed today:

• Price Stability and Welfare, FRB Philadelphia, by Charles Plosser
• Changing World Demographics and Trade Imbalances, FRB St. Louis, by William Poole