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."

Also on HuffPost:

Loading Slideshow...
  • Arthur Laffer

    Laffer was the economist who proved the existence of the free lunch. His Laffer Curve showed, in theory, that cutting tax rates would actually increase tax revenue. He gave intellectual cover to those conservatives who wanted to cut taxes, but who didn’t want to be seen as contributing to a big deficit. He gave them a guilt-free way to cut revenue. There’s only one problem: Laffer’s ideas didn’t pan out in practice: Tax cuts don’t pay for themselves. Tax cuts are a major cause of our $16 trillion national debt. <a href="">Read more at Market Watch.</a>

  • Pete Peterson

    If there’s one person who we can blame for making us feel guilty about the federal deficit, it’s Peterson, a hedge-fund billionaire who was a cabinet secretary in the Reagan administration. Peterson founded, funded or supported most of the institutions in Washington devoted to publicizing the problem of the deficit, including the Concord Coalition, the Peterson Foundation, The Fiscal Times, and the anti-deficit documentary “I.O.U.S.A.” Without Peterson’s billions and the guilt it bought, the deficit would be a fringe issue. <a href="">Read more at Market Watch.</a>

  • Bill Clinton

    President Clinton made budget surpluses look easy. The budget was in the black the last four years of his administration. What’s worse, he made surpluses look like a sure thing. Clinton’s surpluses were partly the result of Washington going on a serious budget diet, with higher taxes paired with moderation in spending. But it was the booming economy — and higher taxes on capital income — that turned the modest deficits of the early Clinton years into surpluses. By the time Clinton left office, politicians were beginning to talk about perpetual surpluses, in exactly the same way that hucksters on Wall Street were talking about a perpetual bull market. And with exactly the same outcome. <a href="">Read more at Market Watch.</a>

  • Alan Greenspan

    Greenspan was a high priest of both guilt and greed. He had always warned Congress about the dangers of the deficits, but his biggest failure as Federal Reserve chairman was the day in 2001 he told Congress that the worst thing it could do was pay down the debt because that would destroy the Treasury market and the Fed’s power to control the economy. That was the day he endorsed the Bush tax cuts. The Maestro’s endorsement gave intellectual cover to the conservatives who wanted to cut taxes, but who didn’t want to feel guilty. Greenspan also catered to our greedy side as a serial bubble-blower. He inflated the housing bubble in the 2000s by keeping interest rates low and by refusing to regulate the shadow banking system. <a href="">Read more at Market Watch.</a>

  • George W. Bush

    No one is more responsible for racking up our debt than Bush. He campaigned in 2000 promising to cut taxes in order to avoid paying down the national debt. And when the recession of 2001 arrived, he said tax cuts would revive the economy. And when the economy didn’t revive, he cut taxes some more. Tax cuts for all occasions. And it was all guilt-free. <a href="">Read more at Market Watch.</a>

  • Dick Cheney

    While Bush was busy cutting taxes, Cheney was busy planning the war on terror. For the first time in our history, we sent our military into battle without raising taxes at home to help pay for it. It added trillions to the debt. <a href="">Read more at Market Watch.</a>

  • Grover Norquist

    As the head of a powerful lobbying and campaign-finance organization, Norquist forced almost every Republican officeholder to sign a pledge to never raise taxes under any circumstance. If anyone declined to sign or dared to violate the pledge, Norquist would back a primary challenger. The threat worked. The Norquist pledge blocked any possibility of a budget deal between Democrats and Republicans over the past two years. Democrats insisted that any plan to balance the budget must include more revenue as well as spending cuts, but Republicans held solid against any tax increase. There are signs that Norquist could be losing his hold on the party. Several Republicans won elections this year without signing his pledge, and several incumbents have said they don’t feel bound by the pledge any more. <a href="">Read more at Market Watch.</a>

  • David Lereah

    Lereah was the chief economist for the National Association of Realtors and was perhaps the most enthusiastic and public cheerleader for the housing bubble. Even after the bubble began to deflate, Lereah still insisted that real-estate investments would never lose money. Of course, Lereah didn’t cause the bubble all by himself, but he does embody the greed that engulfed the real estate industry, the Wall Street banks that profited from it, and the homeowners who took on more debt than they could ever hope to repay. The housing and credit bubble led to the collapse of the financial system in 2008 and was the direct cause of the Great Recession and the ensuing $1 trillion-a-year deficits. <a href="">Read more at Market Watch.</a>

  • Barack Obama

    Obama may be the perfect representative of our age, because he encapsulates our national schizophrenia over the budget. He honors both the greed and the guilt. He presided over the largest deficits in history, including a large fiscal stimulus, bailouts of the auto industry, and an expansion of the safety net. But Obama also lectures us about the need for the government to tighten its belt, even during a recession. He wants to raise taxes, if only on a few, and he’s expressed willingness to cut into the great middle-class entitlements. It was Obama’s administration that first suggested the bargain in 2011 that created the fiscal cliff. <a href="">Read more at Market Watch.</a>

  • John Boehner

    The House speaker is trapped in Grover Norquist’s world. He’s a pragmatic legislator who accepts that the government needs more revenue, but his caucus in the House doesn’t agree. In the summer of 2011, Boehner nearly forced the nation to default on its debt because he couldn’t deliver the votes necessary to raise taxes. In the end, Boehner was forced to punt the problem down the road. Today’s fiscal cliff showdown is the result of Boehner’s inability to lead the House Republicans to a deal. <a href="">Read more at Market Watch.</a>