WASHINGTON — Federal Reserve Chairman Alan Greenspan said Wednesday that the recovery was gaining momentum again after a spring slowdown, but he warned that Washington's burgeoning budget deficits posed a long-term threat to the economy.
Recent economic data suggest that "the expansion has regained some traction" since the second-quarter "soft patch," Greenspan told the House Budget Committee. Consumer spending and housing construction rallied in July, he said, and energy prices have eased.
Although the Fed chairman didn't mention interest rates, economists interpreted his remarks as a signal that the central bank was likely to continue raising short-term rates in quarter-point increments. The next rate hike is expected when Fed policymakers meet Sept. 21.
"He made it quite clear they intend to continue raising rates at a measured pace, including in September," said Bank of America senior economist Peter Kretzmer. "He confirmed that things have gone the way the Fed expected them to go."
Greenspan said higher energy prices were the main cause of the spring slowdown, in which economic growth fell to an annualized rate of 2.8% from 4.5% in the first quarter. Now that energy prices are subsiding, growth is picking up again, he said.
"The underlying structure of the recovery is still there, and in my judgment were it not for the very sharp rise in oil prices we would still be seeing very strong growth," he said. "We still have problems ... but the economy is doing reasonably well."
Investors interpreted Greenspan's economic outlook as a bit less optimistic than expected. Bond market interest rates and major stock indexes declined modestly.
Greenspan was less sanguine about the economy's long-term prospects. He said the revival of deficit spending and the looming retirement of the baby boom generation could undermine the nation's fiscal stability.
The Congressional Budget Office estimated Tuesday that the budget shortfall would reach $422 billion this fiscal year, which ends Sept. 30. That would be a record in dollar terms but somewhat smaller than the deficits of the mid-1980s and early 1990s as a share of the economy.
The annual deficits would total $4.5 trillion over 10 years if Congress extended President Bush's previous tax cuts, CBO analysts estimated. Other proposals advocated by the president, such as the partial privatization of Social Security, could cause future debt levels to rise even more.
Although Greenspan didn't criticize specific tax or spending proposals, he said long-term structural deficits would put upward pressure on interest rates, causing government interest payments to rise and budget deficits to grow even bigger.
"If you get into that kind of debt maelstrom," he said, "it is a very difficult situation to get out of."
The government's big benefits programs will soon be swamped by an unprecedented wave of retirees, as the first baby boomers become eligible for Social Security in 2008 and Medicare in 2011, Greenspan said. Already, he added, federal outlays for Medicare and Medicaid are growing much faster than the economy.
Washington will find it increasingly difficult to continue paying the level of Social Security and Medicare benefits required under current law, a challenge that will be exacerbated by the prospect of big budget deficits, Greenspan said.
"As a nation, we may have already made promises to coming generations of retirees that we will be unable to fulfill," he said. "If on further study that turns out to be the case, it is imperative that we make clear what real resources will be available so that our citizens can properly plan their retirements."
He urged lawmakers to reinstate previous "pay-as-you-go" budget rules that required Congress to offset new tax cuts or spending increases with savings in other areas of the budget.
Greenspan, a Republican, said he personally favored tax cuts and spending reductions but only if they ultimately led to a balanced budget. "Others might choose higher taxes and higher spending," he said, "but choices have to be made."
Greenspan expressed general support for President Bush's previous tax cuts, but he took issue with assertions by some Republicans that tax reductions would pay for themselves by causing the economy and federal revenues to grow faster.
Although some portion of the lost revenue might be recovered because of economic growth, he said, "very few economists believe that you can cut taxes and get the same amount of revenue back."