Federal Reserve Chairman Alan Greenspan said Wednesday the U.S. economy has made "impressive gains" since last summer and predicted that even the lagging jobs market should perk up in coming months.
But he also cited the soaring federal deficit as a risks factor, saying this problem must be addressed soon to avoid the threat of "serious longer-term fiscal difficulties."
In delivering part of the Fed's twice-a-year economic report to Congress, Greenspan repeated the central bank's recent pledge to be patient in keeping interest rates at a 45-year low to ensure that the economic rebound takes hold.
However, he cautioned that such low interest rates "will not be compatible indefinitely" with the Fed's primary job of fighting inflation.
Financial markets tumbled in late January after the Fed dropped a promise it had been making since August — to keep rates low "for a considerable period" — and replaced that phrase with the pledge to be "patient" before raising rates.
Testifying before the House Financial Services Committee, Greenspan delivered a generally upbeat outlook saying the economy's prospects had "brightened" since his last monetary report in July. He said conditions had been helped by a reduction in geopolitical tensions, strengthened consumer and business confidence and a sharp rebound in economic growth as measured by the gross domestic product.
"Overall, the economy has made impressive gains in output and real incomes; however progress in creating jobs has been limited," Greenspan told the committee.
But even in the jobs area, Greenspan held out hopes for an improvement in coming months as continued strong GDP growth makes businesses more confident about hiring back laid-off workers.
"As managers become more confident in the durability of the expansion, firms will surely once again add to their payrolls," Greenspan said.
But he said the optimism could turn out to be misplaced if any of a number of risks derail the economy's prospects. Among the risks he listed were a sharp increase in oil and natural gas prices and the possibility that investors will become spooked by the soaring budget deficit. Last week, the administration projected that this year's deficit will hit an all-time high in dollar terms of $521 billion.
"Should investors become significantly more doubtful that the Congress will take the necessary fiscal measures, an appreciable backup in long-term interest rates is possible," said Greenspan. That view is at odds with the Bush administration, which has argued that the deficits pose no immediate threat of pushing interest rates higher.
Greenspan devoted a considerable part of his testimony to urging Congress to get control of the soaring deficits, which the administration is pledging to cut in half over the next five years.
Greenspan said the need to start taking action is critical in light of the country's soaring current account trade deficit, which hit $550 billion last year, requiring the United States to borrow that amount from foreigners during a period when the dollar is weakening in value.
"Given the already substantial accumulation of dollar-denominated debt, foreign investors, both private and official, may become less willing to absorb ever-growing claims on U.S. residents," Greenspan said.
Many private economists are concerned that if foreigners suddenly become spooked and start dumping their U.S. holdings, stock prices could plunge and interest rates soar.
Greenspan's testimony was accompanied by a new Fed forecast for 2004 that was moderately more optimistic about the economy than the July forecast had been.
The new forecast predicted the GDP will grow by between 4.5 percent and 5 percent in 2004, up from a July forecast that had pegged 2004 growth at between 3.75 percent and 4.75 percent.
The Fed predicted that the unemployment rate, which dropped in January to 5.6 percent, would show a slight improvement this year, edging down to be 5.25 percent and 5.5 percent by the fourth quarter. The Fed projected that inflation will remain under control with an inflation gauge tied to the GDP rising by just 1 percent to 1.25 percent this year, around the level that the Fed considers as representing price stability.
By Martin Crutsinger