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Fed chief says huge deficits will leave economy wobbling

By Martin Crutsinger
The Associated Press

Alan Greenspan

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A day of reckoning will come, Greenspan warned, because there is no "free lunch."

Greenspan used a speech to a Federal Reserve banking conference in Chicago to make the case again that this year's presidential campaign should address reforms of those massive entitlement programs.

Both President Bush and Democratic challenger John Kerry have said they will deal with the expected shortfalls. But unlike Greenspan, the candidates have avoided suggesting that benefits cuts are needed to cope with the financial demands from 77 million baby boomers retiring.

Speaking by satellite, Greenspan told the conference he was more concerned about the economic impact of budget deficits than the soaring trade deficit or record levels of household debt.

Normal economic forces will come into play to handle the trade deficit and household debt, he said. "The yawning fiscal deficit" will require political action to bring under control, the Fed chief said.

"Our fiscal prospects are, in my judgment, a significant obstacle to long-term stability, because the budget deficit is not readily subject to correction by market forces that stabilize other imbalances," Greenspan said.

He warned against having a false sense of security just because these imbalances have yet to trouble financial markets with problems such as rising interest rates.

Posing the question of whether something has fundamentally changed that would allow the country to "disregard all the time-tested criteria of imbalance and economic danger," Greenspan said, "Regrettably, the answer is no. The free lunch has still to be invented."

Democrats have sought to make the deficits a campaign issue. Senate Democratic Leader Tom Daschle said he hoped "Greenspan's urgent warnings serve as a wake-up call" for Republicans in the White House and Congress.

Surplus not very long ago
 

Greenspan noted that the federal deficit, estimated by the Bush administration to reach a record $521 billion this year, will amount to 4.25 percent of the total economy. Just four years ago, there was a record surplus.

Among the Fed chairman's main concerns was that these deficits are coming right before the first wave of baby-boomer retirements.

"We have legislated commitments to our senior citizens that, given the inevitable retirement of our huge baby-boom generation, will create significant fiscal challenges in the years ahead," Greenspan said.

He did not offer specific solutions to the budget problem. But in Capitol Hill appearances, he has spoken of an urgent need to address the issue before baby boomers start becoming eligible for Social Security benefits in 2008.

He has suggested raising the retirement age or scaling back Social Security's annual cost-of-living adjustments.

Greenspan told lawmakers last month it was imperative they act soon so that baby boomers could have time to adjust their finances, rather than waiting until the retirement surge and saying, "Whoops, we miscalculated, we cannot give you what we promised."

Administration has a plan

The administration says it has a plan to cut the deficit in half over the next five years, a period that critics say comes before the onset of serious shortfalls in Social Security and Medicare. Greenspan did not comment yesterday on interest rates. Fed policy-makers met Tuesday and left a key interest rate at a 46-year low of 1 percent.

But they dropped a pledge to be "patient" before starting to raise rates.

Most economists think the Fed's first rate increases in more than four years will start this summer, probably in August, and will come in the form of one-quarter of a percentage point rise in the federal funds rate.

Noting that some economists have worried that the extended period of low rates has spawned a bubble of inflated home prices, Greenspan said any "misalignment" of home prices probably would be dealt with by "a softening in housing markets" as rates rise.