Bernanke flies with deficit hawks

NEW YORK (CNNMoney.com) -- Ben Bernanke, chairman of the Federal Reserve, warned Monday that the United States faces serious long-term fiscal challenges that could threaten the nation's economic future.

In prepared remarks from a speech to policy analysts in Rhode Island, the central bank chief said the U.S. budget deficit should narrow over the next few years as the financial markets improve. But he said policymakers will need to make some difficult choices now to put the nation back on a path toward long-term fiscal sustainability.

"An improving economy should reduce near-term deficits," said Bernanke, the nation's top monetary policymaker. "But our public finances are nevertheless on an unsustainable path in the longer term, reflecting in large part our aging population and the continual rise in health-care costs."

Bernanke acknowledged that the current deficit, which is at its highest level since World War II when measured as a percentage of the national income, is largely a result of the financial crisis and the economic recession it spawned in 2008-2009.

But the economy remains too weak to reduce the deficit significantly over the next year or two, he said. "Indeed, premature fiscal tightening could put the recovery at risk."

And he became the latest Fed official to suggest the central bank is leaning toward more asset purchases in an effort to jump start the sputtering U.S. economy.

He said previous purchases of nearly $2 trillion in mortgages and long-term Treasurys by the Fed had been an "effective program" and when asked about the possiblity of additional purchases, he responded "I do think they have the ability to ease financial conditions."

As to the questions about the future of the federal deficit, he stressed that the bigger problem now is how to fund entitlement programs such as Medicaid and Social Security as the Baby Boom generation reaches retirement age.

"Our fiscal challenges are especially daunting because they are mostly the product of powerful underlying trends, not short-term or temporary factors," he said.

While he said these issues will eventually be resolved, Bernanke warned that failing to address them could expose the nation to "serious economic costs and risks."

The Fed chairman called on fiscal policymakers to quickly put in place "a credible plan" for bringing down the deficit over the medium term. "Opportunities for both taxing and spending reforms are ample," he said.

In addition, he called for overhauling the nation's tax code and making existing government programs more efficient.

Bernanke also discussed fiscal rules, such as the pay-as-you-go policy Congress adopted in the 1990s. He said fiscal rules, including deficit targets and mandated caps on spending, have had varying degrees of success in other countries.

"Well-designed fiscal rules cannot substitute for the political will to take difficult decisions, but U.S. and international experience suggests that they can be helpful to legislators in certain circumstances," he said.