Mr. Greenspan comments on the current direction of the US economy and
the fiscal situation in the United States Testimony by the Chairman of the Board of the
US Federal Reserve System, Mr. Alan Greenspan, before the Committee on the Budget of the
US Senate on 29/1/98.
Mr. Chairman and members of the Committee, in just a few weeks, the Federal
Reserve Board will submit its semiannual report on monetary policy to the Congress. That
report, and my accompanying testimony, will give a detailed assessment of the outlook for the
US. economy and the implications for monetary policy. This morning, I would like to direct
most of my comments to the fiscal situation. But let me begin by offering a few observations
about the current direction of the economy.
First, it is clear that the U.S. economy has been exceptionally healthy, with robust
gains in output, employment, and income. At the same time, inflation has remained low
-indeed, declining by most measures -- over the past year.
Second, to date, we have as yet experienced only the peripheral winds of the
Asian crisis. But before spring is over, the abrupt current-account adjustments that financial
difficulties are forcing upon several of our Asian trading partners will be showing through here
in reductions in demand for our exports and intensified competition from imports. All of this
suggests that the growth of economic activity in this country will moderate from the recent brisk
pace.
Third, as I've noted previously, such a moderation would appear helpful at this
juncture. The growth of output has caused employment to rise much faster than the working-age
population and there are limits to how far this can go. Pressures in the labor market likely
contributed to the acceleration of wages in recent months. Since price inflation has been minimal
and domestic profit margins firm, productivity appears to have accelerated sufficiently last year
to damp increases in unit labor costs. How long that pattern can continue is still an unresolved
issue. The likelihood that we shall be seeing some lower prices on imported goods as a result of
the difficulties in Asia may afford some breathing room from inflation pressures. But they will
not permanently suppress the risks inherent in tightened labor markets. Conversely, a
continuation of the Asian crisis should give us pause in assuming that our economy will remain
robust indefinitely. As a consequence, we must be vigilant to the re-emergence of destabilizing
influences -- both higher inflation, and shortfalls in demand and decreases in some prices that
would press the disinflation process too far, too fast.
One very favorable aspect of our economic performance over the past few years
has been the remarkable improvement in the federal budget picture. The deficit dropped to its
lowest level in more than two decades in fiscal 1997, and yesterday the Congressional Budget
Office released projections that show the budget remaining essentially in balance over the next
few years, moving to annual surpluses equal to 1 percent of GDP by the middle of the next
decade. The reduction in federal borrowing to date and in prospect is already paying off for the
U.S. economy by helping hold down long-term interest rates and, in turn, providing support to
private capital spending and other interest-sensitive outlays.
But much hard work remains to be done to ensure that the projected surpluses
actually materialize and that we remain on track to address our longer-run fiscal and
demographic challenges. The CBO projections provide a good starting point: They are based on
sensible economic and technical assumptions and thus offer a reasonable indication of how the
budget is likely to evolve over the next 10 years if economic conditions remain favorable and
current budgetary policies remain in place. But, as CBO highlights in its latest report, such
forecasts are subject to considerable error. Indeed, as recently as last winter, when fiscal 1997
was already well under way, both CBO and OMB were still overestimating that year's deficit by
more than $100 billion.
In the case of CBO, about two-thirds of the error was in receipts, including nearly
$50 billion more tax receipts than would have been expected based on the actual behavior of
income as measured in the national income and product accounts. This overage helped lift the
receipts share of GDP to an historical high. Such "tax surprises" are nothing new -- in fact, in
the early 1990s, growth of receipts fell well short of expectations based on the trends in
aggregate income and the tax laws then in place. And, even after the fact, our knowledge about
the sources of such surprises has been limited. Thus, we cannot rule out the possibility that the
forces behind last year's tax surge will prove transitory and dissipate more rapidly than CBO has
assumed, implying lower receipts and renewed deficits for the years ahead. Indeed, all else
equal, had the surprise fallen on the other side -- downward instead of upward -- we would be
looking at non-trivial budget deficits at least through the beginning of the coming decade.
Moreover, the CBO projection assumes that discretionary spending will be held to
the statutory caps, which allow almost no growth in nominal outlays through fiscal 2002. Given
the declining support for further reductions in defense spending, keeping overall discretionary
spending within the caps is likely to require sizable, but as yet unspecified, real declines in
nondefense programs from current levels. Not surprisingly, many observers are skeptical that the
caps will hold, and battles over appropriations in coming years may well expose deep divisions
that could make the realization of the budget projections less likely. In addition, although last
year's legislation cut Medicare spending substantially, experience has highlighted the difficulty
of controlling this program, raising the possibility that the savings will not be so great as
anticipated -- especially if resistance develops among beneficiaries or providers.
Uncertainties such as these argue for caution as you begin work on the 1999
budget. We have no guarantee that the projected surpluses will actually materialize. An even
more important consideration, though, is the need to address the erosion of the budget after the
next decade, a task that will become increasingly difficult the longer it is postponed. The
favorable budget picture over the next decade, unless steps are taken, will almost inevitably turn
to large and sustained deficits as the baby boom generation moves into retirement, putting
massive strains on the social security and Medicare programs.
Indeed, especially in light of these inexorable demographic trends, I have always
emphasized that we should be aiming for budgetary surpluses and using the proceeds to retire
outstanding federal debt. This would put further downward pressure on long-term interest rates,
which would enhance private capital investment, labor productivity, and economic growth.
The outpouring of proposals for using the anticipated surplus does not bode well
for the prospect of maintaining fiscal discipline. In recent years the President and the Congress
have been quite successful, contrary to expectations, in placing, and especially holding, caps on
discretionary spending. More recently, they have started to confront the budget implications of
the surge in retirements that is only a decade away. We must not allow the recent good news on
the budget to lull us into letting down our guard. Although many of the individual budget
proposals may have merit, they must be considered in the context of a responsible budget
strategy for the longer run.
Over the decades our budgetary processes have been biased toward deficit
spending. Indeed, those processes are strewn with initiatives that had only a small projected
budgetary cost, but produced a sizable drain on the Treasury's coffers over time. As you are well
aware, programs can be easy to initiate or expand, but extraordinarily difficult to trim or shut
down once a constituency develops that has a stake in maintaining the status quo.
In closing, I want to commend Chairman Domenici and the committee for your
insistence on fiscal responsibility and for years of persistent effort. Your work has contributed
importantly to shrinking the budget deficit and bringing surpluses within sight. These
projections of surpluses, which are based on an extrapolation of steady economic growth and
subdued inflation over the coming years, implicitly assume that monetary and fiscal
policymakers will remain attentive to potential sources of instability. If this is the scenario that,
in fact, unfolds and the budget moves into surplus within the next few years, the increase in
national saving will pay off handsomely in preparing our economy and our budget for the
challenges of the twenty-first century.