Greenspan: Lifting Caution May Aid Economy

WASHINGTON – The U.S. economy will benefit next year should businesses shed their lingering and unusual reluctance to spend and hire, Federal Reserve (search) Chairman Alan Greenspan (search) told Congress Wednesday.

In a second day of testimony on the central bank's semiannual monetary policy report, Greenspan told the House Financial Services Committee (search) that even with the recovery gaining pace, corporate America has held back from new capital investments, inventory building and permanent hires.

"We are far from behaving the way we typically did (in other expansions)," the Fed chief said in answering questions from the panel. He pinned the corporate restraint on a number of "caution-creating factors."

"To the extent these are capable of being assuaged, what it probably will be doing is rather than creating a large surge in economic activity, is to gradually stretch it out, if indeed a degree of confidence gradually returns," Greenspan said. "That would be one of the reasons why a gradual expansion which we now seem to be experiencing does bode well for next year."

Greenspan cited the bursting of the U.S. stock market bubble in 2000, a spate of corporate scandals and latent fears of terrorist attacks as factors that had made businesses less willing to take risks.

In his opening remarks, Greenspan stuck to the upbeat script he used Tuesday before the Senate Banking Committee (search) that led markets to brace for a slightly swifter rise in interest rates than they had been expecting.

U.S. bond prices extended Tuesday's losses on Wednesday, while the dollar built on gains. Stock prices, which had risen on Tuesday, slipped on corporate profit concerns.

A Reuters poll of the 22 top bond firms that deal directly with the Fed showed all expect a quarter-percentage point rate hike at the central bank's next policy session on August 10.

Most expect overnight rates, now at 1.25 percent after a quarter percentage point rise last month, to hit 2 percent or higher by year end.

Lawmakers from both parties did their best to draw the influential Fed chief into an election-year debate over fiscal policy, with limited success.

Greenspan said the sizable tax cuts President Bush pushed through Congress had provided a welcome economic boost, but offered a warning on the long-term budget outlook.

"I think the tax cuts were effective in stemming the extent of decline in the weakness of the economy," he said. "Looking forward, fiscal policy is going to become a very critical issue on the agenda for macroeconomic policy."

"I would prefer lower spending and lower taxes and lower deficits," Greenspan said.

He renewed a call for restoration of budget discipline rules, including spending caps and so-called pay-go restrictions that require new expenditures or tax cuts be paid for elsewhere in the budget.

The Bush administration wants pay-go rules to apply only to new spending, not tax cuts.

Greenspan also said Congress should find ways to rein in programs or tax cuts that prove more costly than expected.

As Tuesday, Greenspan said the economy was in a self-sustaining expansion that no longer needs the hefty monetary stimulus the Fed put in place with 13 interest-rate cuts dating to 2001.

The Fed began withdrawing that stimulus last month, when it bumped the overnight federal funds rate up from a 1958 low of 1 percent. More "measured" rises are expected to follow.

Other Fed officials speaking Wednesday echoed Greenspan's tone.

Fed Vice Chairman Roger Ferguson said the recovery appeared "firmly on track" and Philadelphia Fed President Anthony Santomero said a recent soft patch did not reflect "a significant change for the broad outlook."

Dallas Fed President Robert McTeer (search) also weighed in, saying inflation was likely to stay muted, but that officials were ready to do what was needed to keep prices in check.