NEW YORK -- Continuing political gridlock in the fiscal cliff fight will hurt the U.S. economy, an influential Federal Reserve official said Thursday morning.
"Congress and the administration must address the fiscal cliff in a manner that creates a credible framework for long-term fiscal sustainability," said William Dudley, president of the Federal Reserve Bank of New York, in a speech at Pace University in New York City.
"Failure to reach a credible [budget] agreement would suggest a degree of political dysfunction that would undermine U.S. economic leadership and could encourage global corporations and investors to take their business elsewhere," he said, noting that economic leaders abroad "wonder whether our political system is capable of putting the national interest above partisan interests."
Dudley warned that going over the so-called fiscal cliff, or letting a series of planned tax hikes and spending cuts take place on Jan. 1, "would drive the U.S. economy into recession." He also noted that a protracted fight could damage the economy by hurting confidence.
Paul Krugman, the Nobel Prize-winning economist, disagreed with the idea that the government needs to fix its budget now, telling WNYC on Wednesday that it may be preferable to go over the fiscal cliff in order to reach a reasonable budget agreement. He added that the government can wait to reach a long-term deficit reduction agreement.
The Obama administration and Congress are in talks to avoid the fiscal cliff, but they disagree on many issues. Republicans are demanding an extension of all the Bush-era tax cuts, coupled with cuts to Medicare and Medicaid, while Democrats want to protect entitlements and end the tax cuts on higher incomes. The government is on track to hit the debt limit in February or March if it does not raise the debt ceiling, and some congressional Republicans have threatened to use it as leverage, as they did last year.
Dudley said that businesses and consumers have put off spending decisions because they don't know how high their taxes will get or what will happen to Social Security, Medicare and other government programs. Ideally any agreement, he said, should have "broad bipartisan support" to signal a long-lasting pact.
"Things do not look sustainable at all," Dudley said, referring to the government's long-term fiscal path. He added that fixing the budget is not an economic question but "a question of political will."
Dudley declined to offer specifics about what a long-term deficit reduction deal should look like.
"I don't think it's really so critical which one you pick," Dudley said, referring to broadening the tax base or raising marginal tax rates. "But the important thing is you have to pick."