Bernanke warns on deficits as interest rates rise

WASHINGTON -- Federal Reserve Chairman Ben Bernanke warned Congress on Wednesday that it must act promptly to narrow the yawning federal budget deficit or risk losing the confidence of financial markets.

"In order to make lenders willing to continue to finance us at reasonable rates, we do have to persuade them that we are serious about returning to a more balanced fiscal situation going forward," Bernanke told the House Budget Committee.

"Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth."

Separately, the Fed chief reiterated his forecast for a tepid start to economic recovery later this year, a view backed by mixed reports Wednesday on the service industry and business employment.

The deficit has swelled, largely as a result of the $787 billion stimulus package, the $700 billion Wall Street rescue plan and lower tax revenues during the recession. A rising federal debt spooks lenders and drives up interest rates. Bernanke partly blamed the red ink for recent increases in yields on long-term Treasury notes and fixed-rate mortgages.

Noting that tax increases can dampen a recovery by eroding consumer buying power, Bernanke suggested Congress must look closely at paring entitlement programs — a politically explosive idea. Social Security and Medicare, he said, will rise to 12.5% of the economy by 2030, up from 8.5% today.

"The fundamental question that Congress, the administration and the American people face is how large a share of the nation's economic resources to devote to federal government programs, including entitlement programs," he said.

Bernanke noted that consumer spending has been flat this year after plunging the second half of 2008 while existing home sales have stabilized. He expects the economy to "bottom out, and then turn up later this year."

But he predicted a lackluster recovery, adding that unemployment, now 8.9%, "is likely to rise for a time, even after economic growth resumes."