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Greenspan: Economy in Good Shape, Still Watching Inflation

Federal Reserve (search) Chairman Alan Greenspan (search) on Wednesday urged a go-slow approach on personal Social Security accounts, saying that while he embraces the idea central to President Bush's proposed overhaul, he is concerned about stability in financial markets.

"If you are going to move to private accounts, which I approve of, you have to do it in a cautious, gradual way," Greenspan said in response to intense questioning from both Republicans and Democrats in an appearance before the Senate Banking Committee (search).

"I think it's a good thing to do over the longer run," he said because something must be done to fix the system.

Bush's proposal would allow workers under age 55 to divert a chunk of their Social Security taxes into voluntary, private investment accounts.

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

His remarks came as he delivered the Fed's twice a year economic outlook to Congress.

On the economic front, Greenspan told the panel 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 struck a fairly positive tone about the economy, which had been mired in a midyear 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 to the committee.

On Social Security, Greenspan didn't prescribe any fixes. In previous appearances before Congress the Fed chief has said benefit cuts and possibly tax increases would be need to close the massive funding gap faced by Social Security.

"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.

How inflation fares in the coming months will shape whether Fed policy-makers — now on a gradual path of raising short-term interest — will need to speed up or slow down that campaign, 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. 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.

Economists viewed Greenspan's remarks on the economy as buttressing their view the Fed for now will stick to its gradual approach to raising rates. "It's still steady as she goes. We will continue to get measured rate hikes," said Richard Yamarone, economist at Argus Research Corp.

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.

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

Fed policy-makers in an updated economic forecast said economic growth this year should clock in at a range of 3.75 percent to 4 percent, as measured from the fourth quarter of last year. That's about the same as the 3.7 percent growth seen in 2004.

On the inflation front, a gauge of prices that excludes food and energy costs is projected to increase around 1.5 percent to 1.75 percent this year — close to the 1.6 percent increase registered in 2004.

The nation's jobless rate should dip to around 5.25 percent this year, compared with 5.4 percent for all of 2004.