Greenspan Stresses Need to Balance the Budget - by Higher Taxes and Lower Outlays

Thursday, June 09, 2005

The US budget deficit has to get balanced even if that means higher taxes, Federal Reserve chairman Alan Greenspan told the US Congress after 115 minutes of intense questioning. Asked by Democratic Representative Jack Reed whether there would be another way to do that besides raising taxes and lowering outlays, Greenspan answered, "not that I am aware of".
While Greenspan affirmed in his opening remarks that the Fed will continue to remove its accommodative policy at a measured pace, repeating the wording of the latest FOMC minutes, he sees "the US economy on a reasonably firm footing, and underlying inflation remains contained." "It is very difficult to know where that so called neutral rate is. We don't have the statistical capability where that is," he did not want to give an indication when the Fed would step off the rate-accelerator, which it has been pushing down with a very light foot since the rate increases began.
From this point on warnings took the upper hand in the chairman's responses to the Congress representatives.
Greenspan repeated his concern on the unprecedented behavior of long-term interest rates and said this was "clearly of international origin" because the world is eager to invest in the US. But this may not be the case forever if the US would not begin balancing its budget. "The effect (so far) on the US is very clear. Mortgage rates are lower than they would ordinarily be," he pointed out but showed confidence that housing prices would gradually flatten.
"I have no doubt as this boom begins to defuse we will see the rate of increase in mortgage debt slow down," he said.
He again contradicted that an inverse yield curve would be a precursor to a recession
as it has always been so far, saying, "We have ultimate means of financing and I would hesitate to read into an actual downward tilt of the yield curve what it meant 30, 40 years ago." So this time it will be different?
Concerning taxes Greenspan refrained from commenting individual tax policies but said, "in the 1970's there was at least an awareness that balancing the budget was a critical issue. We have abandoned that and we have to find a way to construct a system that chooses between A and B. Right now everybody wants A and B." Nevertheless he supports tax cuts in the context of pay-go, meaning the government first must have the money to pay for its outlays before enacting them. Looking back at his many years as a policymaker Greenspan said, "I have persuaded and tried to persuade lots of people in this town" (about pay-go.)
On the ballooning current account deficits the Fed head said, his concern was whether foreigners would build up net claims against US residents. But he was confident that markets would not allow that to happen, and be it by changes in the exchange rates. The budget deficit is of greater concern to him, he said, "markets cannot adjust the federal budget deficits, that is a fiscal question."
He also warned of protectionist measures in international trade. Referring to his times in the private economy he said, "competition is not something anybody likes but in the end I realized that they made me work harder and better."
Education Is a Major Problem
Two pressing issues were Medicare and education. While Medicare would build up claims that are not properly evaluated, Greenspan devoted a significant part of his time at the Capitol towards the need of an improvement of the education sector. "We have managed until very recently to maintain a high level of skills. We are running into problems. They are not overwhelming yet but I am concerned about labor force in the next generation. We have to do it sooner rather than later." He said that the educational standards in the US are falling well below of the median of the whole world. The Bush administration has enacted significant cuts in education budgets.
In the end Greenspan found some enlightening words again. "Every decade or so we look forward and it looks awful. Somehow by some means we seem to recreate ourselves and this is one of the extraordinary aspects of this country. The constitution is creating a dynamism to solve problems. I don't know how its going to happen but we will do it."
But demographic shifts in retirement and the problems in the nations' schools are pressing, "and we know what will happen if we don’t address them."
Last but not least Greenspan said he no longer preceives oil prices to come back to "normal levels" in the 20 to 30 dollar region, adding "the reason is more political than economic," because large parts of the reserves are located in OPEC countries. That has created an increase in expectations of future oil shortages. But the US economy would find a way around that by employing more energy efficient methods in production and consumption. Sell that SUV and get a compact car.
NOTE: A video of Greenspan's testimonial is available at C-Span.

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