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Greenspan Issues Deficit Warning

Reserve Board Chairman Alan Greenspan, Congress
AP / CBS
Federal Reserve Chairman Alan Greenspan warned Wednesday that "substantial and excessive" federal budget deficits will over time harm the ability of the U.S. economy to expand strongly enough to drive down the unemployment rate.

In a second day of congressional testimony on the Fed's midyear economic forecast, Greenspan was more pointed in his criticism of soaring federal deficits than he had been in an appearance Tuesday before the House Financial Services Committee.

"There is no question that if you run substantial and excessive deficits over time you are draining savings from the private sector," Greenspan said, pointing to the area where economists believe deficits inflict the most harm on the economy.

Rising government borrowing crowds out the borrowing private corporations need to make investments to expand and modernize. It is this investment that is a major contributor to rising productivity, which allows the economy to grow at faster rates and boosts U.S. living standards.

"There is no question that we need to come to grips with this deficit question," Greenspan said. He noted that the rising deficits were coming in the period just before 75 million baby boomers will begin retiring at the beginning of the next decade. Those retirements will make severe demands on the government's two biggest benefit programs, Social Security and Medicare.

Greenspan said the benefits already promised have created a situation where Congress has promised a level of spending "in excess of our capability to finance it. ... When we get into the period beyond 2010, 2011, 2012, we are running into potentially serious problems."

Greenspan never specifically mentioned the Bush administration's new deficit projections, released on Tuesday, which forecast record deficits of $455 billion this year and $475 billion next year, sharply higher than the administration's forecast earlier in the year.

But Democrats on the committee seized on Greenspan's remarks to bolster their arguments that the government's soaring deficits, which they blame on the administration's tax cuts, will be harmful to the economy.

Greenspan, who was wrapping up two days of congressional testimony, repeated comments he made on Tuesday before a House panel. He reiterated that the Fed was prepared to leave interest rates low "for as long as it takes" to revive the sluggish economy.

Private analysts predicted that the federal funds rate, the rate banks use for overnight loans to each other, will stay at its current 1 percent or even go lower if necessary. The next rate cut could come Aug. 12 at the next meeting of the Federal Open Market Committee, which sets the rate.

Many analysts said that means at the very least no Fed interest rate increases this year or well into 2004 — which should allow consumers to continue to enjoy low rates for mortgages and auto loans as well as short-term credit tied to banks' prime lending rate, which is currently at 4 percent, the lowest level since 1959.

Greenspan expressed hope that the economy will pick up momentum in the second half of this year as low interest rates and President Bush's latest round of tax cuts take hold, telling the House Financial Services Committee, "We could very well be embarking on a period of extended growth."

Greenspan indicated that if this forecast proves too optimistic, the central bank was prepared to cut the federal funds rate further. The Fed last cut the funds rate to 1 percent, the lowest level since 1958, at its June 25 meeting.

Some economists had believed that the Fed would not move the funds rate lower than 0.75 percent, saying interest rates lower than that would make if difficult for money market mutual funds to meet expenses and still pay returns to investors.

Greenspan disagreed with that notion, saying, "substantial further conventional easings could be implemented" if needed. He said financial firms such as money market mutual funds would find a way to make money even at low rates.

At the Fed's last meeting in June, Greenspan said Fed policy-makers discussed at some length the possibility of using alternatives for influencing interest rates beyond the Fed's conventional lever of adjusting the funds rate and he said Wednesday that those options were still being actively considered if they needed to be used.

In its economic forecast, the Fed predicted the economy would grow this year at an annual rate in the range of 2.5 percent to 2.75 percent but would be rebound sharply to growth between 3.75 percent to 4.75 percent next year.