Fed’s Fisher Warns Temporary Fiscal Cliff Fix Could Be Destructive

A temporary fix to the “horrific” US federal budget deficit that fails to give businesses any clarity on tax and regulatory policy could have destructive effects on the US economy, a Federal Reserve official warned Tuesday.

US businesses are in a “defensive crouch,” Dallas Fed President Richard Fisher said in a speech to a conference sponsored by the Levy Institute. If US leaders provide only a temporary solution to the looming deadline of combined tax hikes and spending cuts, known as the fiscal cliff, “that fix may well have an effect” on the economy, Mr. Fisher said.

US tax and regulatory policies are “stuck in a pre-globalization time warp” and must be “completely rebooted,” Mr. Fisher said.

The Fed’s policy rate is near zero and in recent years officials have introduced a series of asset-purchase measures to keep long-term interest rates low, pushing the central bank’s balance sheet past $3 trillion. Mr. Fisher said inflation remains under control in the US, with underemployment and unemployment remaining a top economic concern.

“I do not believe that inflation will be the inevitable consequence” of the rapid rise of the Fed’s balance sheet, Mr. Fisher said.

Still, “we’re going to need to soon decide and signal to the markets when…the punchbowl (of ultra-accomodative monetary policy) first will be ended and then when it will be withdrawn,” he said.

The US economy has seen an uneven recovery since exiting recession in 2009 with unemployment near 8%, far above the rates associated with vibrant activity. “I’m worried about an underemployed workforce, a dispirited workforce,” Mr. Fisher said.

He noted, however, that business balance sheets are in their best shape in many years. “American businesses are ready to roll, and we want them to roll,” he said.

Mr. Fisher outlined two ways that US bond yields may rise. If inflation expectations rise, yields would increase, Mr. Fisher said, adding the Fed is guarding “ferociously” against this scenario.

The “happy” outcome, he said, is if the economy recovers and the money currently parked at the Fed is put to work in the economy. This is the scenario the Fed hopes for, he said, even if it means a loss on its holdings of debt securities.