Fed's Williams: We Must Get Our Fiscal House in Order

By Ann SaphirReuters

The United States must trim the deficit and control the national debt, but take care not to jeopardize the recovery by moving too fast or cutting critical areas of government spending, a top Federal Reserve official said on Monday.

"We must continue to make the investments needed to make our economy more productive and competitive," San Francisco Fed President John Williams said. "In the long run, economic growth depends not only on an expanding population, but also on how productive our people and businesses are"

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Williams repeated his support for the Fed's latest round of monetary stimulus, saying it help bring down too-high unemployment and lift inflation back up toward the Fed's 2 percent goal.

"It was essential that we at the Fed provide the stimulus needed to keep out economy moving toward maximum employment and price stability," Williams, a voter this year on the Fed's policy-setting panel, said in remarks prepared for delivery to the Financial Women's Association of San Francisco.

The Fed's actions should push down borrowing costs, making the purchase of new cars cheaper, for example, which in turn will boost sales and prompt factories to hire new workers, "exactly the kind of virtuous circle that provides the oomph in a healthy economic recovery," he said.

The U.S. central bank last month said it would buy $40 billion a month in mortgage-backed securities and keep on buying until the labor market improves substantially. It also said it would keep interest rates low through at least mid-2015.

Despite what he called "real progress" on the economic front in the last few years, Williams painted a picture of an economy far from healthy, with unemployment, at 7.8 percent, well above the 6 percent he estimates the economy could currently sustain without creating unwanted upward pressure on prices.

And the outlook, he said, is threatened by the possibility of spillover from Europe's as yet unresolved sovereign debt crisis, the looming "fiscal cliff" of automatic tax increases and spending cuts that are to go into effect at year-end unless Congress acts, and uncertainty over the economic outlook.

Williams devoted a large part of his speech to the dangers on the fiscal front, using a chart to show how national debt would balloon if Congress averts the fiscal cliff by extending the Bush tax cuts and suspends some spending cuts. Still, he said, nation needs to make "wise choices" about how to spend its money.

"Infrastructure, research and education are three areas that must not be sacrificed as we fix our budget problems," he said. "We must continue to plant the seeds for our future and not eat our seed corn."

In light of the Fed's latest action, Williams said he now expects growth in U.S. gross domestic product to accelerate, from 1.75% this year, to 2.25% next year, to an above-trend 3.25% in 2014.

The jobless rate, he predicted, will likely fall to 7.25% by the end of 2014. Inflation he said will likely increase to a level closer to the Fed's 2 percent target.

Some observers have worried the Fed's latest move could unmoor the country from the anchor of low inflation expectations.

"In no way has our commitment to price stability wavered," Williams said, noting that inflation has averaged around 1.3% over the last four years, the lowest rate recorded over a four-year period since the mid-1960s. (Editing by Eric Walsh)