The reversal of federal fiscal policy from stimulus to austerity in the intervening years has added to the factors holding back the economic recovery. On one side, we had income tax increases on upper-income Americans and the expiration of the Social Security payroll tax cut. These took a bite out of disposable income that could otherwise have been directed toward spending. On the other, budget austerity and sequestration have resulted in a drag on spending by the public sector. Overall, it is estimated that federal fiscal policy is subtracting 1½ percentage points from economic growth this year.

The tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and the labor market. In addition, federal fiscal policy continues to be an important restraint on growth and a source of downside risk.

BERNANKE: Well, I think it's -- it's quite true that business confidence, home builder confidence, consumer confidence are -- are very important. And good policies promote confidence.

That's -- the Fed policy, congressional policy, we want to try to create a framework where people understand what's happening and -- and they believe they have confidence that -- that the basics of macroeconomic stability will be preserved.

It is a difficult thing, you know, to some extent it's a political talent to create confidence in -- in your constituents. So nobody has a magic formula for that. But, clearly, the more we can demonstrate that we're working together to try to solve these important problems, the more likely we're gonna instill confidence in the public. And that, in turn, will pay off in economic terms.

Let me close by reiterating that a long-term sustainable solution for fiscal balance is absolutely in the country’s interest. But timing is an issue. We have suffered a severe financial crisis, a deep recession, and a painfully slow recovery. Fiscal policy is obviously the jurisdiction of the legislative and executive branches of government, but given the economic realities I would urge policymakers to consider scenarios where some elements of fiscal rebalancing take effect only after the economy has more fully improved, and the possibility of a less restrictive fiscal stance until that time.

The United States could be doing better. The U.S. fiscal policy program, for example, does not appear well-calibrated to the current set of economic circumstances. We have too much fiscal restraint in the short term, and too little consolidation in the long term.

In the U.S., our economy's performance near-term and longer-term will depend considerably on fiscal policy. Fiscal issues have led to across-the-board spending cuts, which are slowing U.S. economic growth in the near term. The challenge is for fiscal policymakers to enact a credible plan that will put the U.S. federal budget on a sustainable long-run path without adversely affecting the recovery. The United States is not alone in dealing with fiscal issues that threaten growth and stability. Political environments in various countries result in vastly different outlooks for fiscal action and economic and monetary policies. In Europe, the picture is mixed, with some euro zone countries advocating for fiscal austerity while others resist. In Japan, the central bank is ramping up monetary stimulus, while other parts of its government have pledged to establish a sustainable fiscal structure. Some countries may lean toward becoming more restrictive on trade, which would endanger global growth. Around the world, countries are facing fiscal problems, and how they address those problems could have real economic consequences.

Today, the U.S. economy continues to recover at a moderate pace, but unemployment remains unacceptably high. Monetary policy is supporting economic growth, but monetary policy has limits. In current circumstances, it would be particularly helpful if fiscal and regulatory policies were among the forces supporting economic growth.

The Federal Reserve has been carrying the ball for the fiscal authorities by holding down interest rates in an attempt to stoke the recovery while the fiscal authorities wrestle themselves off the mat. But there are limits to what a monetary authority can do. For the central bank also plays a fiduciary role for the American people and, given our franchise as the globe’s premier reserve currency, the world. We dare not become the central bank counterpart to Congress by adopting a Buzz Lightyear approach of “To infinity and beyond!”

The fix lies not within the purview of the Federal Reserve. The fix lies solely in the hands of a government that has the power to shape taxes and spending programs to incent businesses to go out and hire rather than ball up into a defensive crouch, or worse, go elsewhere in the world that we worked so hard to liberate, to create jobs for others rather than for our own people.

The private sector and American business community are poised to expand. But they will not do so as long as we have a government that cannot resist the temptation to devise a politically convenient patchwork instead of laying out a convincing, reliable, long-term program that job creators and consumers can count on and plan around.

Richard Fisher.... said the real problem with the economy, and the stubbornly high jobless rate, is Congress's lack of action on fiscal policy.

Fisher, who spoke to Reuters roughly six weeks ahead of a Fed policy meeting that many see coming at a critical juncture, said any perceptions that the U.S. central bank could be motivated by political factors are untrue -- but the Fed must guard against any misimpressions.

If the Fed launches another round of easing, Fisher said, "Those that do not like us as central bankers I think will be apoplectic."

Participants at the June FOMC meeting indicated that they see a higher degree of uncertainty about their forecasts than normal and that the risks to economic growth have increased. I would like to highlight two main sources of risk: The first is the euro-area fiscal and banking crisis; the second is the U.S. fiscal situation.

[T]he possibility that the situation in Europe will worsen further remains a significant risk to the outlook.

[F]iscal decisions should take into account the fragility of the recovery. That recovery could be endangered by the confluence of tax increases and spending reductions that will take effect early next year if no legislative action is taken.

The most effective way that the Congress could help to support the economy right now would be to work to address the nation's fiscal challenges in a way that takes into account both the need for long-run sustainability and the fragility of the recovery. Doing so earlier rather than later would help reduce uncertainty and boost household and business confidence.

Reflecting its concerns about the slow pace of progress in reducing unemployment and the downside risks to the economic outlook, the Committee made clear at its June meeting that it is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.

Economic theory and practice teach us that monetary policy works best when it is clear about its objectives and systematic in its approach to achieving those objectives. Granting vast amounts of discretion to our central banks in the expectation that they can cure our economic ills or substitute for our lack of fiscal discipline is a dangerous road to follow.

Our balance sheet should not be viewed as a new independent instrument of monetary policy in normal times. The exit principles also indicated the Committee’s desire to return the Fed’s balance sheet to an all-Treasuries portfolio. This re-establishes the idea that the Fed should not use its balance sheet to actively engage in credit allocations.

Under current law, on January 1, 2013, there is going to be a massive fiscal cliff of large spending cuts and tax increases. I hope that Congress will look at that and figure out ways to achieve the same long-run fiscal improvement without having it all happen one day.... 

We have a number of measures, including both tax increases, the expiration of the payroll tax cut, the sequestration that comes out of the supercommittee negotiations. All those things are hitting on the same day basically, and it is quite a big impact.

Eventually, as economic and financial conditions improve, the pursuit of the dual mandate will lead to a different monetary policy stance, one that requires higher short-term interest rates. And, the Federal Reserve will also eventually shrink the size of its balance sheet. These actions will tend to increase the Treasury's net interest costs and pull down the Federal Reserve's remittances to the Treasury. Together, these two effects will sharply push up the Treasury's net interest burden.

I was just saying the cumulative effect of all these different things -- expiration of the payroll tax, the sequestration, expiration of the Bush tax cuts and other things collectively would be a fairly sharp change in the near-term fiscal position.

I'm not saying don't pay for it; I'm just saying do it over a longer period of time. And do it, but do it seriously. I agree with Senator Sessions' concern that, you know, let's just push it off to mañana, you know.

From the Q&A Session

Even the prospect of unsustainable deficits has costs, including an increased possibility of a sudden fiscal crisis. As we have seen in a number of countries recently, interest rates can soar quickly if investors lose confidence in the ability of a government to manage its fiscal policy. Although historical experience and economic theory do not indicate the exact threshold at which the perceived risks associated with the U.S. public debt would increase markedly, we can be sure that, without corrective action, our fiscal trajectory will move the nation ever closer to that point.