Budget deficits a risk to low interest rates, Greenspan says

Federal Reserve chairman Alan Greenspan took issue with the White House view that rising budget deficits pose little near-term threat to the climate of low interest rates that the US economy enjoys.

Rising red ink, he said, could potentially push up long-term interest rates in the near term, potentially slowing an economy now struggling to create jobs.

The comments on the budget deficit came as Mr. Greenspan gave a generally upbeat assessment of a recovering economy Wednesday to Congress.

But he worried more than anticipated about the recent surge in the forecast for federal budget deficits in years ahead. The deficit could, he said, "put substantial pressure" on the nation's ability in coming years to provide "even minimal government services" while maintaining such programs as Social Security and Medicare "without debilitating increases" in taxes.

He also had a stark warning about potential near-term impacts of a federal deficit projected at $521 billion this year: If investors doubt Congress's ability to tame expenditures, "an appreciable backup in long-term interest rates is possible." The Bush administration, by contrast, has downplayed such near-term risks, while pledging to cut the projected deficit in half by 2009.

Still, the Fed chairman's semiannual report on monetary policy to the House was mostly reassuring.

"The picture has brightened," he said. The recovery is solid. "In all likelihood, employment will begin to grow more quickly before long." Inflation remains low, partly because of large gains in productivity. "Overall, the economy has made impressive gains in output and real incomes; however, progress in creating jobs has been limited," he said.

In reply to a question, he said unemployment could fall "close to 4 percent level" without stirring up inflation. It was 5.6 percent in January. The Fed remains "patient." It does not need yet to boost short-term interest rates from their present 1 percent level, news usually pleasing to the bond market. But he said rates can't stay so low indefinitely.

Nonetheless, some Fed watchers anticipate no rate hike until after the fall election, perhaps not even until 2005. Other analysts see an initial interest rate boost this summer.

Any Fed action on interest rates affects not only financial markets and business borrowing, but also people who are buying homes or refinancing mortgages. Car buyers also would face a bigger bill.

In Wednesday's testimony, Greenspan took note of the 25 percent rise in stock prices last year, seeing it as reflecting "robust earnings growth and the repair of business balance sheets over the past few years." But he warned of the negative impact that rising energy prices could have on the economy.

Since 1997, the Dow average has fallen 11 of the 14 times Greenspan has testified to Congress. But in July of 1997, that stock market index rose 155 points, and three years later 148 points.