Greenspan: Economy Sturdy After Hurricanes

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Federal Reserve Chairman Alan Greenspan (search) told Congress Thursday that economic fallout from the recent spate of devastating hurricanes should prove fleeting and that the economy remains sturdy.

The trio of hurricanes — Katrina, Rita and Wilma — is likely to "exert a drag" on employment and production in the short term and may aggravate inflation pressures, Greenspan said in testimony to Congress' Joint Economic Committee.

"But the economic fundamentals remain firm, and the U.S. economy appears to retain important forward momentum," the retiring Fed chairman said in his most extensive remarks to date on the impact of the storms.

While the Fed chief sounded optimistic about the economy's prospects, Greenspan, who leaves early next year after 18 years, made clear that the Fed is keeping a close eye on high energy prices to make sure they don't spark broader inflation.

Although Greenspan didn't specifically mention the future course of interest rates, many analysts predict that borrowing costs will climb in the months ahead as the Fed seeks to combat inflation.

"We are very firm in the notion that this country should not visit the 1970s again in the way of inflation," Greenspan said, referring to a period where the economy was rocked by skyrocketing prices.

Greenspan used strong language to warn Congress to get the nation's fiscal house in order. Bloated budget deficits, if not curbed, could pose a danger to the economy's long-term health, he warned.

"Unless the situation is reversed, at some point these budget trends will cause serious economic disruptions," Greenspan said.

The government ran up a budget deficit of $319 billion in the 2005 fiscal year that ended Sept. 30. That followed a record amount of red ink last year.

"Lowering the deficit further in the near term, however, will be difficult in light of the need to pay for post-hurricane reconstruction and relief," Greenspan said.

If the swollen deficits are left unchecked, they eventually will put upward pressure on long-term interest rates, Greenspan warned.

Greenspan was questioned about the support he gave in 2001 to President Bush's successful drive to get Congress to pass sweeping tax cuts that totaled $1.3 billion over 10 years. Those tax cuts are blamed by Democrats for bringing back record deficits.

Given the facts known at the time, Greenspan said he would still support the tax cuts because of projections, which later proved wrong, that the federal government was facing huge surpluses.

Committee members, noting that Greenspan had appeared before Congress many times during his nearly two decades at the Fed, praised him for the job he had done keeping the U.S. economy on track.

"Mr. Greenspan, we are going to miss you. You have done a heck of a job," said Rep. Maurice Hinchey (search), D-N.Y.

The Fed chief underscored his belief that benefits currently promised to the baby boom generation through Social Security and Medicare likely cannot be met and probably will have to be trimmed.

"We owe it to those who will retire over the next couple of decades to promise only what the government can deliver," Greenspan said.

On the budget front, he repeated his call for lawmakers to restore caps on spending. And, Greenspan called on Congress to pay for any future tax cuts with either increases in other taxes or reductions in spending.

Greenspan's appearance on Capitol Hill comes two days after he and his Fed colleagues decided to boost the federal funds rate by one-quarter of percentage point, to 4 percent, to thwart inflation.

Oil prices briefly shot up past $70 a barrel in late August, and gasoline prices topped $3 a gallon before moderating. But home heating costs are expected to be much higher this winter than a year ago.

"I think people are going to be quite surprised at their heating bills this winter," Greenspan said.

Still, the Fed chief appeared hopeful businesses would be restrained in passing along elevated energy costs in the prices charged to consumers. "As long as the Fed is perceived to be holding inflation expectations in check ... the passthrough of energy costs will be subdued," he said.

Many economists are predicting the Fed will bump up rates at its next session, on Dec. 13, as well as on Jan. 31, which will be Greenspan's last meeting. Some analysts also are calling for a rate increase on March 28, which would be the first presided over by Ben Bernanke (search), President Bush's choice to replace Greenspan.

Bernanke has said that his first priority will be to maintain continuity with Greenspan's policies. Fed watchers say that means inflation-fighting will keep playing a prominent role.