Greenspan: Economy Moving Forward

Federal Reserve Chairman Alan Greenspan told Congress Thursday that fallout from the recent spate of devastating hurricanes should prove fleeting and that the economy remains sturdy.

The trio of hurricanes Katrina, Rita and Wilma is likely to "exert a drag" on employment and production in the short term and may aggravate inflation pressures, Greenspan said in prepared testimony to Congress' Joint Economic Committee.

"But the economic fundamentals remain firm, and the U.S. economy appears to retain important forward momentum," the retiring Fed chairman said in his most extensive remarks to date on the impact of the storms.

While the Fed chief sounded optimistic about the economy's prospects, Greenspan, who leaves early next year after 18 years, made clear that the Fed is keeping a close eye on high energy prices to make sure they don't spark broader inflation.

Although Greenspan didn't specifically mention the future course of interest rates, many analysts predict that borrowing costs will climb in the months ahead as the Fed seeks to combat inflation.

Greenspan used strong language to warn Congress to gets the nation's fiscal house in order. Bloated budget deficits, if not curbed, could pose a danger to the economy's long-term health, he warned.

"Unless the situation is reversed, at some point these budget trends will cause serious economic disruptions," Greenspan said.

The government ran up a budget deficit of $319 billion in the 2005 fiscal year that ended Sept. 30. That followed a record amount of red ink last year.

"Lowering the deficit further in the near term, however, will be difficult in light of the need to pay for post-hurricane reconstruction and relief," Greenspan said.

Looking ahead, the budget will be severely strained by the huge wave of baby boomers that will start to retire in 2008.

The Fed chief underscored his belief that benefits currently promised to the baby boom generation through Social Security and Medicare likely cannot be met and probably will have to be trimmed.

"We owe it to those who will retire over the next couple of decades to promise only what the government can deliver," Greenspan said.

On the budget front, he repeated his call for lawmakers to restore caps on spending. And, Greenspan called on Congress to pay for any future tax cuts with either increases in other taxes or reductions in spending.

Greenspan's appearance on Capitol Hill comes two days after he and his Fed colleagues decided to boost the federal funds rate by one-quarter of percentage point, to 4 percent, to thwart inflation. That was the 12th increase of that size since the Fed began to tighten credit in June 2004.

In response to the Fed's rate decision, commercial banks lifted their prime lending rates to 7 percent. These rates are used to determine many short-term consumer loans, including certain credit cards and popular home equity lines of credit.

The Fed's action pushed the funds rate, which is the interest banks charge each other on overnight loans, and the prime rate to their highest level in more than four years.

Many economists are predicting the Fed will bump up rates at its next session, on Dec. 13, as well as on Jan. 31, which will be Greenspan's last meeting. Some analysts also are calling for a rate increase on March 28, which would be the first presided over by Ben Bernanke, President Bush's choice to replace Greenspan.

A former Fed governor, Bernanke is chairman of the White House's Council of Economic Advisers. His nomination is subject to Senate approval, which is expected.

Bernanke has said that his first priority will be to maintain continuity with Greenspan's policies. Fed watchers say that means inflation-fighting will keep playing a prominent role.

Even with the bruising punches of hurricanes Katrina, the most costly natural disaster in U.S. history, and Rita, the economy grew at a solid 3.8 percent pace in the third quarter.

Damage from the storms, however, was evident in the nation's payrolls. They shrank by 35,000 in September, the first nationwide decline in two years. But many analysts are predicting an October rebound of around 100,000 jobs. The government releases October's employment report on Friday.