WASHINGTON — A top Federal Reserve official on Tuesday offered a stark warning to lawmakers to reach a deal to fix the U.S. budget deficit, or else risk doing further harm to the nation's economy.
"It is crucial that the federal budget be put on a sustainable long-run trajectory, and we should not postpone charting that course," said Janet Yellen, the Fed's vice chair, in a speech at a conference hosted by the Federal Reserve Bank of San Francisco.
Her remarks come nearly a week after a bipartisan congressional "supercommittee" failed to agree to $1.2 trillion in deficit cuts.
Amid the logjam on Capitol Hill, Fitch Ratings on Monday kept the U.S.' credit rating but lowered the nation's outlook to negative from stable for failing to reach a deal. The ratings agency threatened it would take steps to downgrade the U.S.' riskless triple-A credit rating, if a deal wasn't cut by 2013.
Fitch said its decision to lower the U.S.' outlook reflects "declining confidence that timely fiscal measures necessary to place U.S. public finances on a sustainable path will be forthcoming."
In August, Standard & Poor's stripped the U.S. of its triple-A rating for the first time in 70 years because of Washington's inability to raise the debt ceiling.
Since the onset of the financial crisis, the federal budget deficit has widened significantly. Federal debt held by the public has increased relative to the country's national income to a level not seen the past half-century, according to Yellen.
"Even so, the ratio of debt to gross domestic product will continue to edge higher over the next decade unless the Congress and the Administration are able to agree on a program of deficit reduction that is more ambitious than the targets incorporated in last summer's Budget Control Act," said Yellen.
Yellen said a "timely plan" to place the federal budget on a sustainable path would make it easier for individuals and businesses to prepare for upcoming changes.
"The sooner our longer-term budget problems are addressed, the less wrenching the adjustment will have to be and the more control that policymakers — rather than market forces of international creditors — will have over the timing, size, and composition of the necessary adjustments," said Yellen.
Still, Yellen cautioned against swinging the pendulum too far, too quickly. She said "too much fiscal tightening" in the short-run that could harm an already stalled economic recovery.
"Significant near-term reductions in federal spending or large increases in taxes would impose an additional drag on the economy at a time when aggregate demand is already weak," said Yellen.
Existing U.S. fiscal policy, she said, is expected to impose "considerable restraint" on growth of aggregate demand next year.
"We need, and I believe we have scope for, an approach to fiscal policy that puts in place a well-timed and credible plan to bring deficits down to sustainable levels over the medium and long terms while also addressing the economy's short-term needs," she said.