Fed Chief Upbeat On Economy

Federal Reserve Chairman Alan Greenspan told Congress on Wednesday that the economic expansion rolled into the new year at a respectable pace and that inflation — while not an immediate threat — is something policy-makers must continue to guard against.

Greenspan, delivering the Fed's twice-a-year economic outlook to lawmakers, struck a fairly positive tone about the economy, which had been mired in a mid-year lull last year and has since improved.

"All told, the economy seems to have entered 2005 expanding at a reasonably good pace, with inflation and inflation expectations well-anchored," Greenspan said in prepared testimony before the Senate Banking Committee.

How inflation fares in the coming months, however, will shape whether Fed policy-makers — now on a gradual path of raising short-term interest — will need to adjust the speed of the campaign by either speeding up or slowing down, Greenspan indicated.

One factor to keep an eye on is whether companies — amid slowing productivity growth — boost workers' salaries and then pass along those higher costs onto customers, the Fed chief said.

"Going forward, the implications for inflation will be influenced by the extent and persistence of any slowdown in productivity," Greenspan said.

The inflation outlook also will be shaped by the direction of oil prices and the value of the dollar, which has been falling over the last few years.

Federal Reserve policy-makers embarked on a rate-raising campaign in June and have pushed up short-term interest rates six times, each in modest, quarter-point moves. The last rate increase on Feb. 2 left a key rate at 2.50 percent. Another rate boost is expected at the Fed's next meeting on March 22.

Greenspan repeated his call to Congress to take action to shore up the massive entitlement program of Social Security and Medicare, which face huge financial strains with the looming retirement of 78 million baby boomers in 2008.

"Benefits promised to a burgeoning retirement-age population under mandatory entitlement programs, most notably Social Security and Medicare, threaten to strain the resources of the working-age population in the years ahead," Greenspan said.

"Real progress on these issues will unavoidably entail many difficult choices. But the demographics are inexorable and call for action," he added.

In his prepared remarks, Greenspan didn't prescribe any fixes or weigh in on President Bush's proposal to allow workers under age 55 to divert a chunk of their Social Security taxes into voluntary, private investment accounts.

However, Greenspan in previous appearances before Congress has said benefit cuts and possibly tax increases would be need to close the massive funding gap faced by Social Security.

He also repeated his call for Congress to be more fiscally disciplined.

Before the Fed started to push up rates in June, its key rate, the funds rate, was at a 46-year low of 1 percent. The funds rate is the interest banks charge each other on overnight loans and is the Fed's main tool to influence economic activity.

That extraordinarily low rate was used to shore up the economy, which struggled to recover from the recession of 2001 and the Sept. 11 attacks. With the economic expansion more deeply rooted, the Fed needs to move the funds rate to a more normal level so all the cheap money does not lay the groundwork for inflation.

Despite the Fed's increases to short-term rates, long-term rates such as mortgage rates, have actually moved lower in recent months in the United States and some other countries, Greenspan said.

Private economists have been puzzled by the decline in long-term interest rates and Greenspan admitted that he was stumped as well.

"For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum," Greenspan said.

But the Fed chief cautioned that investors should be careful in taking the continued existence of low long-term rates for granted.

"History cautions that people experiencing long periods of relative stability are prone to excess," he said. "We must thus remain vigilant against complacency."