Chairman Alan Greenspan told Congress on Wednesday that the currently solid pace of U.S. economic growth could be threatened by too much deficit spending by the federal government.
Greenspan said little that was new about the economy, calling the expansion "reasonable" and playing down the threat of a fallig dollar.
However, in his toughest rhetoric to date on the subject, Greenspan said the federal deficit needed to be addressed before 78 million baby boomers start retiring in 2008.
"The consequences for the U.S. economy of doing nothing could be severe," he said.
Recent projections from the White House and the Congressional Budget Office suggest the budget deficit won't narrow much in coming years unless big changes occur.
"We may have already committed more physical resources to the baby-boom generation in its retirement years than our economy has the capacity to deliver," Greenspan said in his prepared remarks. "If existing promises need to be changed, those changes should be made sooner rather than later."
In addressing budgetary shortfalls, Greenspan renewed his endorsement of President Bush's plan to shift Social Security funds for younger Americans into private accounts. But he stressed that this plan would not fully address the more immediate problems.
For shrinking the deficit in the short term, Greenspan said, Congress should concentrate on benefit cuts rather than tax increases. He called for the renewal of budget rules from the Budget Enforcement Act of 1990, which were allowed to expire in 2002 following the brief emergence of surpluses in the late 1990s. The rules required tax cuts to be offset by spending cuts and spending increases to be offset by tax increases.
"Reinstating a structure like the one provided by the Budget Enforcement Act would signal a renewed commitment to fiscal restraint and help restore discipline to the annual budgeting process," Greenspan said.
A possible consequence of a widening deficit, according to Greenspan, is diminished foreign investment in the U.S. Because foreign financial institutions are largely responsible for funding the government's budgetary shortfalls, such a move could have bad implications for the U.S. economy. Still, while the Fed chairman said that is a concern for the future, he sees little evidence of any significant changes on the part of foreign investors to date.
He did not signal any change in rate policy. The Fed has raised its key interest rate six times by a quarter percentage point since June and is widely expected to do so again this month.