Higher nominal rates in the term Treasuries market can be seen as an expression of creeping doubt that the American polity, and more specifically the policy community, is up to the sacrifices, tradeoff decisions, and the courage of convictions the situation requires.

The concerns about our economic path are crystallized in doubts expressed in some quarters about the Federal Reserve's ability to fulfill its obligation to deliver low and stable inflation in the face of very large current and prospective federal deficits. In a word, the concerns are about monetization of the resulting federal debt.

I do not dismiss these concerns out of hand. I also recognize that the task of pursuing the Fed's dual mandate of price stability and sustainable growth will be greatly complicated should deliberate and timely action to address our fiscal imbalances fail to materialize. But I have full confidence in the Federal Reserve's ability and resolve to meet its inflation objectives in whatever environment presents itself.

I am pleased to see that the new administration has embraced what was hitherto perceived as the third rail of American politics and brought the issue of unfunded entitlement liabilities to the fore. For the sake of our grandchildren, I hope that the administration and the Congress will take this vexing beast of a problem by the horns and tame it.

The recently enacted fiscal stimulus program is aimed in part at boosting economic growth, but I believe many popular accounts overstate the effects of fiscal policy actions. Keep in mind that today’s stimulus will have to be paid for at some point in the future, and the prospect of higher taxes can restrain activity as well. Moreover, some spending diverts workers and firms from other uses instead of drawing in unemployed resources. My sense is that the stimulus is likely to have only a marginal effect on the broad contours of the economic recovery.

On the fiscal side, the stimulus package passed by Congress in February will provide an important economic shot in the arm. While the program does not appear large enough to solve the economy’s problems on its own, the support it will provide to aggregate demand is significant and helpful. We will likely begin seeing its effects on the economy this quarter.

You've seen this administration work at a pace unlike you've ever seen before in history, moving very quickly to put in place this very powerful economic recovery act, to lay out a budget that makes some very powerful investments in things critical to our economic future, things that are going to make the economy grow more rapidly in the future by improving education, addressing healthcare costs, moving us to a clean energy economy, all in a framework that's fiscally responsible framework. We're moving to fix the housing crisis. The president laid out very quickly a comprehensive strategy to help bring interest rates down. Allow Americans to refinance, take advantage of lower rates. And again, help millions of Americans stay in their hopes with some meaningful reduction in monthly payments. We're also moving very quickly to get credit markets flowing again and help strengthen and save lives, the banking system

When George Shultz was director of the Office of Management and Budget, he became frustrated with the spending impulses of the Nixon administration. He reports that he called the venerable Sam Cohen, a virtual encyclopedia of budgetary history, into his office and asked, "Between you and me, Sam, is there really any difference between Republicans and Democrats when it comes to spending money?" Cohen's reply was classic: "Sir, there is only one difference: Democrats enjoy it more."

Mixing monetary and fiscal policy is fraught with risks. Many historical instances of monetary instability have been the result of central banks being prevailed upon to use their balance sheets for fiscal ends in ways that impeded their ability to keep inflation under control. That is why in recent decades, countries around the world have provided a measure of independence to their central banks, within frameworks that ensure accountability, in order to explicitly insulate them from short-run political exigencies that might diminish the credibility of their commitment to control inflation. The cornerstone of that framework in the United States dates back to 1951, when the Treasury-Fed Accord formally gave the Federal Reserve independent control of its balance sheet.⁸

...While at the present time, credit programs do not conflict with our monetary policy strategy, there could well come a time at which monetary stimulus needs to be withdrawn to prevent a resurgence of inflation, even though credit markets are not deemed fully healed. At that time, containing inflation may require closing down credit programs, or finding an alternative, non-monetary financing arrangement for them. Price stability, after all, is the vital first ingredient in financial market stability.

A critical element affecting the recovery in 2009 will be the introduction of additional fiscal stimulus into the economy.
...
For the moment, putting our economy back on its feet is the priority, and with the monetary and fiscal actions that are underway, we should see improvement as we enter the second half of 2009.

I support Marty [Feldstein]'s conclusion that there is an exceptionally strong case for substantial fiscal stimulus over the next few years. In ordinary circumstances, there are good reasons why monetary, rather than fiscal policy, should be used for stabilization purposes. But these are exceptional circumstances, and fiscal policy can help get the economy going.

(P)ublic policy responses have increasingly moved toward fiscal interventions. To date, these have mostly been aimed at improving market functioning: the Treasury's TARP program, FDIC guarantees, and the Hope for Homeowners Act, and other programs to re-work mortgages. Looking ahead, we expect large amounts of more traditional types of fiscal stimulus to increase aggregate demand. I believe a big stimulus is appropriate. But it is also sobering to be deploying large amounts of tax-payer funds at a time when our fiscal balance sheet is already coming under significant stress

 "We have worked on the fuzzy border between monetary and fiscal  policy," Kohn said. " Now that the legislation has passed I would hope we could stay on the liquidity side."

As reported by Market News International.

We are in the grip of an “adverse feedback loop” in which a credit crunch exacerbates economic weakness, which in turn weakens financial institutions, intensifying the credit crunch.  Moreover, as I have explained, the efforts of the private sector to fix itself through deleveraging and other means are only making matters worse. This is why government action was urgently needed.

SENATOR BAYH: My final question, here, as my time expires, there's been a recent increase in the price of credit default swaps on U.S. Treasuries.  What do you think accounts for that? And should be a matter of some concern in the message the market seems to be sending about their confidence?

BERNANKE: It could well -- there's been a lot of movement in a variety of spreads; for example, the spreads between the newly issued and previously issued bonds and so on.

I wouldn't read too much into that. It's a very small change. I think it has more to do with liquidity in markets and other risk aversion, other types of behavior, rather than any sense that there's a default risk.

From the Q&A session

Right now, we—you and I—are launching fiscal bombs against ourselves. You have it in your power as the electors of our fiscal authorities to prevent this destruction. Please do so.

Unless we take steps to deal with it, the long-term fiscal situation of the federal government will be unimaginably more devastating to our economic prosperity than the subprime debacle and the recent debauching of credit markets.

From Q&A as reported by Bloomberg News