Fed Chairman Ben Bernanke warns of ‘fiscal cliff’ risks

WASHINGTON — Fears about a looming fiscal crisis at the end of the year are starting to pinch job growth and threatening to undercut the nation’s fragile recovery, a growing number of economists and employers say.

Federal Reserve Chairman Ben S. Bernanke, in testimony Thursday before Congress, repeatedly warned about the so-called fiscal cliff — a reference to the expiration of tax cuts Dec. 31 and the imposition of automatic spending reductions Jan. 1.

By some accounts, the U.S. economy could see an unprecedented fiscal hit of as much as $720 billion if the slated changes take effect.

They would include an end to the temporary tax cuts enacted during the George W. Bush administration and to temporary Obama administration payroll tax reductions. Spending cuts in defense and on federal programs were negotiated as part of last summer’s pact to raise the debt ceiling.

If all the changes take place, the shock will probably cause the economy to contract and possibly lead to a recession, Bernanke said.

So far, however, Bernanke’s concerns about the fiscal cliff have been largely obscured by the more immediate, intensifying financial troubles in Europe and elsewhere.

On Thursday, China cut its interest rates, sparking worries that the sprawling economy might be doing worse than thought. There also is a widespread expectation that Congress will take last-minute action to pull back from the fiscal cliff.

Some analysts are skeptical that lawmakers can come together to avoid potential disaster.

“As the cliff approaches, we expect first firms and then households to start postponing decisions, weakening the economy in advance of the cliff,” economists at Bank of America said in a report this week. “When you are approaching a cliff, in a deep fog of uncertainty, you slow down.”

That’s exactly what some employers are doing.

“We were in a growth mode for the first half of 2012,” said Joe Dutra, president of Kimmie Candy Co. in Reno.

His company recently invested in factory equipment with plans to double production and add five to six workers to the payroll of 23. But he and other company managers met this week and decided to put everything on hold, even the installation of the new equipment.

“My main concern for our company is the uncertainty,” said Dutra, 59, a onetime farmer in Sacramento who started Kimmie Candy as a side business in 2000. Since then, some of his chocolate products have become national brands.

“We look at the news every day, and it’s just a roller coaster,” he said. “The government is not stable. We have a government that can’t make hard decisions.... We’re looking at the future and expecting to be going back into more of a recession in 2013.”

Bernanke wasn’t nearly as pessimistic; he told lawmakers Thursday that the economy was continuing to grow at a “moderate” pace. But he also expressed concerns about the deepening troubles in Europe, a slowdown in China and other developing countries, and the cloudy U.S. fiscal outlook.

Despite those risks and the weakening U.S. job market, the Fed chairman gave no clear signal that the central bank was about to provide more monetary stimulus to prop up the economy and bring down the unemployment rate, which inched up to 8.2% in May.

He said the fall-off in job growth — to 75,000 in the last two months, on average, from 225,000 a month in the first three months of the year — may have been exaggerated by issues related to the warm winter and by the end of what he called a spurt of “catch-up hiring” by employers who had cut payrolls aggressively during and just after the recession.

Still, Bernanke called on lawmakers to do more, “to take some of this burden from us,” reminding them of what happened last year when the debt ceiling debacle took the country to the brink of default.

“The brinkmanship last summer over the debt limit had very significant adverse effects for financial markets and for our economy.... It really knocked down consumer confidence quite noticeably,” Bernanke said. “I urge Congress to come to agreement on that well in advance so as not to push us to the 12th hour.”

Many, however, are expecting exactly that to happen again, especially in an election year.

The stakes are higher this time as several large pieces of temporary legislation are set to end at once, the biggest of which is the Bush tax cuts, estimated at $165 billion.

Democrats and Republicans in Congress remain bitterly divided on those cuts, with President Obama determined to eliminate the breaks for high-income Americans and GOP challenger Mitt Romney insisting that all the provisions should be made permanent.

In addition to the Bush-era tax cuts, Congress is likely to let expire both the payroll tax cut, which is saving the typical worker about $1,000 this year, and the federal extended unemployment benefits, though these provisions, too, could spark a fight, as they have in the past, analysts said.

“This is a problem we need to deal with, but unfortunately we’re not going to take this on until after the election,” said Rep. Daniel Lipinski (D-Ill.), referring to the fiscal cliff.

“My belief is that after the election, we’ll sit here and the leaders will say on Dec. 24, ‘We’ve reached no conclusion, and we’re going to extend everything for two to three months until the new Congress comes in.’ ”

But moving the cliff out a few months or even longer carries risks. For one thing, economists said, it could trigger a credit downgrade. It also would be likely to increase the uncertainty and prompt more companies to adopt contingency plans.

Bernanke declined to endorse specific tax extensions or spending cuts, saying what’s needed is a “combination of sensible policies that allow the recovery to continue over the next year or two, with a long-term credible plan for putting our budget on a sustainable path.”

If Congress can’t compromise on a new budget, automatic cuts will take effect under the so-called sequester outlined in the Budget Control Act. For defense, the 10% elimination would shave about $53 billion from the budget, to $472 billion.

“People in the industry are really worried a train wreck could come.... They are starting to hedge,” said Todd Harrison, a senior fellow at the Center for Strategic and Budgetary Assessments.

The impact of the uncertainty, he said, will be magnified at thousands of smaller second- and third-tier contractors, some of which are already asking, “How can you best position a business to prepare for this shock?”

John Raine is one of them. His Anderson, Ind., company has been making military field gear for 27 years. The U.S. withdrawal from Iraq and the drawdown in Afghanistan have already cost him significant business, forcing him to lay off a worker for the first time ever.

With potential defense cutbacks coming sooner or later, and higher taxes on the horizon, Raine said there was only one thing he could do.

“You’re going to batten down the hatches,” he said. “It’s the psychology.”

don.lee@latimes.com

Times staff writer Jamie Goldberg contributed to this report.