Fiscal policy actions that reduce uncertainty and stimulate recovery are badly needed.  What would be especially helpful at this juncture are fiscal policy actions that work in tandem with monetary policy to stimulate the economy.  One example of such a policy is the recently announced U.S. government initiative to make it easier for underwater homeowners to take advantage of very low rates and refinance their mortgages.  This will trim monthly payments for some households and could reduce foreclosure rates.  And it could also eventually provide a modest boost to consumer spending.  Other actions that address the continuing problems in the housing market could help spur recovery and enhance the effectiveness of monetary policy as well. 

Too much fiscal tightening in the near term could harm the 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. Indeed, under current law, federal fiscal policy is slated to impose considerable restraint on the 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.

In this environment, monetary policy alone would take a very long time to bring about the desired outcome of maximum employment. Fiscal policy actions that reduce uncertainty and stimulate recovery are badly needed. What would be especially helpful at this juncture are fiscal policy actions that work in tandem with monetary policy to stimulate the economy.

“No one wants to see 9 percent official unemployment and the extensive underemployment,” Fisher said. Businesses are “in a defensive crouch,” he said. “We are in a stasis.”

“We need to completely reboot our fiscal policy,” Fisher said. “We have to compete in terms of our tax regimes and the incentives we provide for business.”

It would be greatly beneficial if the Administration and Congress could more effectively work together to craft a coherent fiscal policy. As I see it, this would consist of two elements—continued near-term fiscal support to underpin economic activity and long-term fiscal consolidation to ensure debt sustainability. Without action in Washington, fiscal policy will turn sharply restrictive in 2012—exerting a direct drag on real GDP growth of more than one percentage point. At the same time, the long-term path under current policy is unsustainable.

You can give people all the money they want -- which we have done ... They won't use it unless they have confidence in the future. And that future is being undermined by oyur fiscal authorities.

Monetary policy can be a powerful tool, but it is not a panacea for the problems currently faced by the U.S. economy. Fostering healthy growth and job creation is a shared responsibility of all economic policymakers, in close cooperation with the private sector. Fiscal policy is of critical importance, as I have noted today, but a wide range of other policies--pertaining to labor markets, housing, trade, taxation, and regulation, for example--also have important roles to play. For our part, we at the Federal Reserve will continue to work to help create an environment that provides the greatest possible economic opportunity for all Americans.

Domestically, the controversy during the summer regarding the raising of the federal debt ceiling and the downgrade of the U.S. long-term credit rating by one of the major rating agencies contributed to the financial turbulence that occurred around that time.

It may turn out to be optimal for central banks to guarantee fiscal authority debts in some situations. If so, we again have to think of price level determination as something that is done jointly by the fiscal authority and the central bank

Finally, and perhaps most challenging, the country would be well served by a better process for making fiscal decisions. The negotiations that took place over the summer disrupted financial markets and probably the economy as well, and similar events in the future could, over time, seriously jeopardize the willingness of investors around the world to hold U.S. financial assets or to make direct investments in job-creating U.S. businesses.

“Make no mistake -- the Federal Reserve doesn’t have a magic wand that will allow the economy to get through a crisis of this magnitude unscathed,” the regional bank chief said in the text of a speech in Salt Lake City. “A federal default must be avoided,” he said.

I suspect that as we’ve done in the past we will look to the central bank of the United States and the world’s central banks to inflate our way out of this because it’s so much easier.

Well, there appears to be a contradiction between the need to maintain support for the recovery in the short term and the need to address fiscal issues in the longer term. But there -- I don't think there is a contradiction. If we recognize that we can take a long-term perspective on addressing the deficit and achieving the sustainability of our -- of our fiscal position.

As the chairman pointed out, you know, these increases in entitlement costs are very serious, but they take place over a long period of time. So we should be addressing those now, but, you know, that it is a long-term proposition.  We should also in the long term be looking at -- at how our spending and tax policy affects our long-term growth. I mean, those are important issues. We need to reform our tax code. We need to make sure that we're investing our government spending wisely.

So there are some substantial long-term issues. But I think we do need to take some care that we don't -- by excessive restriction in the short term that we don't hamper what is already a very slow recovery that would be partly -- of course it would be a very bad thing from the point of view of the unemployed, but it also would be a problem from the point of view of the federal budget, because if you slow economic growth, you affect the tax collections as well.

Well, there appears to be a contradiction between the need to maintain support for the recovery in the short term and the need to address fiscal issues in the longer term. But there -- I don't think there is a contradiction. If we recognize that we can take a long-term perspective on addressing the deficit and achieving the sustainability of our -- of our fiscal position.

As the chairman pointed out, you know, these increases in entitlement costs are very serious, but they take place over a long period of time. So we should be addressing those now, but, you know, that it is a long-term proposition.  We should also in the long term be looking at -- at how our spending and tax policy affects our long-term growth. I mean, those are important issues. We need to reform our tax code. We need to make sure that we're investing our government spending wisely.

So there are some substantial long-term issues. But I think we do need to take some care that we don't -- by excessive restriction in the short term that we don't hamper what is already a very slow recovery that would be partly -- of course it would be a very bad thing from the point of view of the unemployed, but it also would be a problem from the point of view of the federal budget, because if you slow economic growth, you affect the tax collections as well.

We've looked at {the possibility of debt ceiling constraints} and thought about making preparations and so on. The arithmetic is very simple. The revenue that we get in from taxes is both irregular and much less than the current rate of spending. That's what it means to have a deficit.

So immediately, there would have to be something on the order of a 40 percent cut in outgo. The assumption is that as long as possible the Treasury would want to try to make payments on the principal and interest of the government debt because failure to do that would certainly throw the financial system into enormous disarray and have major impacts on the global economy.

So this is a matter of arithmetic. Fairly soon after that date, there would have to be significant cuts in Social Security, Medicare, military pay or some combination of those in order to avoid borrowing more money.  If in fact we ended up defaulting on the debt, or even if we didn't, I think, you know, it's possible that simply defaulting on our obligations to our citizens might be enough to create a downgrade in credit ratings and higher interest rates for us, which would be counterproductive, of course, since it makes the deficit worse.

But clearly, if we went so far as to default on the debt, it would be a major crisis because the Treasury security is viewed as the safest and most liquid security in the world. It's the foundation for most of our financial -- for much of our financial system. And the notion that it would become suddenly unreliable and illiquid would throw shock waves through the entire global financial system.