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

. 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