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Friday, April 22, 2005

Greenspan: Stagflation Not in Evidence

Greenspan said today that he does not expect stagflation, that China should allow its currency to float, he repeated his warning on deficits, and he said for the first time that he expects taxes to increase in the future.

The news here is that the Greenspan does not see signs of stagflation. Since, in his view, output growth appears robust, this reduces the chance that the Fed will back off of raising the federal funds rate at its next meeting. From The Los Angeles Times:

Fed Chief Downplays 'Stagflation' Risk but Warns of Danger in Budget Deficits

… The Fed chairman downplayed the prospect for "stagflation"— an economic malady in which inflation rises despite sluggish growth. Asked whether the economy was entering a period of stagflation, Greenspan told the Senate panel: "It certainly doesn't seem that way." …

… In addition, Greenspan urged China to stop pegging its currency to the dollar, a practice blamed for a widening U.S. trade deficit with China. …

…Citing a long-term concern, the Fed chairman repeated warnings about the danger of U.S. budget deficits, a problem that he said would require significant actions by Congress to fix. The federal budget is on "an unsustainable path," he testified. "Unless that trend is reversed, at some point these deficits would cause the economy to stagnate or worse." …

... "The positive short-term economic outlook is playing out against a backdrop of concern about the prospects for the federal budget, especially over the longer run," ...

… "The uncertainty about future medical spending is daunting," he said.

To meet even currently projected spending, Congress would have to raise Medicare taxes, cut benefits or both, he said. "I do not see how we can avoid significant curtailment of benefits currently promised," Greenspan said. "At the end of the day, we are going to end up with many people who are going to have very large co-payments and probably should." …

Also, in a separate story from the Washington Post, Greenspan says he expects taxes to increase in the future:

Greenspan Says He Expects Tax Increases

Federal Reserve Chairman Alan Greenspan said yesterday, for the first time explicitly, that he expects tax increases to be part of any eventual agreement to reduce the federal budget deficit...

[Update:  With respect to Greenspan's comments on stagflation, there is a danger here. If the Fed misperceives the effect of negative supply shocks such as increases in the relative price of oil, then there is a danger, as I've commented elsewhere, that the Fed will aim for a target that is higher than the natural rate of output inadvertently increasing inflation and, in the worst case, lifting the anchor on inflationary expectations. However, this is not something I'm particularly worried about at this point, but it is area to watch in case correction is needed down the road as new evidence accumulates.]

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