Ben Bernanke
J. Scott Applewhite  /  AP
Federal Reserve Chairman Ben Bernanke said the housing slowdown will be a drag on the economy's growth this year.
updated 10/4/2006 4:09:17 PM ET 2006-10-04T20:09:17

Unless Social Security and Medicare are revamped, the massive burden from retiring baby boomers will place major strains on the nation’s budget and the economy, Federal Reserve Chairman Ben Bernanke said Wednesday.

“Reform of our unsustainable entitlement programs” should be a priority, he said in prepared remarks to the Economics Club of Washington. “The imperative to undertake reform earlier rather than later is great,” Bernanke added.

It marked the Fed chief’s most extensive comments to date on the challenges facing the United States with the looming retirement of 78 million baby boomers.

In his remarks, Bernanke did not offer Congress and the Bush administration recommendations on how the massive entitlement programs should be changed. Efforts by the administration to overhaul the Social Security program — once a centerpiece of President Bush’s second-term agenda — sputtered last year, meeting resistance from Republicans and Democrats alike.

As the population ages, the nation will have to choose among higher taxes, less non-entitlement spending by the government, a reduction in spending on entitlement programs, a sharply higher budget deficit or some combination thereof, Bernanke said.

Government spending on Social Security and Medicare alone will increase from about 7 percent of the total size of the U.S. economy to almost 13 percent by 2030 and to more than 15 percent by 2050, he said.

Bernanke declared: “The fiscal consequences of these trends are large and unavoidable.”

The government recorded a budget deficit of $319 billion last year. This year’s red ink is projected by the White House to total around $296 billion.

Financially shoring up Social Security and Medicare will involve difficult choices by lawmakers and other policymakers, Bernanke said.

For instance, if the government tried to finance projected entitlement spending entirely by revenue increases, the taxes collected by the federal government would have to rise from about 18 percent of the total size of the economy to about 24 percent in 2030, he said.

If the government attempted a fix through spending cuts, spending for programs other than Social Security and Medicare would need to be cut sharply — the equivalent “to a budget cut of approximately $700 billion in non-entitlement spending,” he said.

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As the aging population collects Social Security and Medicare benefits, Bernanke warned: “The coming demographic transition will create severe fiscal challenges, as the cost of entitlement programs rises sharply.”

In his speech, Bernanke did not discuss the future course of interest rates.

But during a brief question and answer period afterward, he said a “substantial correction” was taking place in the housing market, which will be a drag on the economy’s growth. He estimated that the housing slowdown would trim about a percentage point off growth in the second half of this year.

Some of the fallout from the now cooling housing market, however, should be cushioned by other positive factors, including good job creation and income growth, Bernanke added.

The housing cooldown, after a five-year boom, holds important implications for consumer spending and overall economic activity. “How far will this correction go? It is very difficult to tell, is the honest answer,” Bernanke said.

The Federal Reserve meets next on Oct. 24-25, and many economists believe the policymakers will leave rates unchanged for the third meeting in a row.

With the economy slowing, the central bank in early August decided to halt — for the first time — a two-year long campaign to boost interest rates to fend off inflation. Policymakers suggested that the cooling economy would eventually lessen inflation pressures.

There’s been relief on the inflation front as once-surging energy prices have settled down. Gasoline prices, which had topped $3 a gallon in the summer, have slid and are now averaging $2.31 a gallon nationwide, the Energy Department says.

Bernanke called the recent drop in energy prices welcome, but said Fed policymakers, while continuing to believe that slower economic activity will eventually lessen inflationary pressures, will keep a close eye on inflation.

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