Greenspan -Imperative to restore fiscal discipline

[Almighty Colin]

NEW YORK (CNN/Money) - Federal Reserve Chairman Alan Greenspan said Wednesday that the economy started the year in good shape but warned that the United States urgently needed to get its finances in order.

Greenspan said the central bank's recent policy of gradually raising interest rates to end an era of cheap money has worked well in keeping the economy growing while keeping inflation in check.

But he tempered his optimism by warning that the relatively tranquil economic conditions of recent decades must not be taken for granted.

"History cautions that people experiencing long periods of relative stability are prone to excess," he said in his prepared remarks. "We must thus remain vigilant against complacency, especially since several important economic challenges confront policymakers in the years ahead."

He said it was "imperative to restore fiscal discipline" in the United States to help narrow the huge trade deficit, and that the country had to act before 2008 to prepare Social Security for a coming wave of retiring "baby boomers."

"All told, the economy seems to have entered 2005 expanding at a reasonably good pace, with inflation and inflation expectations well anchored," he said in his remarks prepared for delivery to the Senate Banking Committee. "On the whole, financial markets appear to share this view."

Before Greenspan began testifying, he heard opening statements from senators on the panel. Some of them, including ranking Democrat Paul Sarbanes of Maryland and frequent Greenspan critic Jim Bunning, a Republican from Kentucky, urged the Fed to pause on its path of measured rate hikes.

"If you don't see any evidence of inflation, I would hope you take that into consideration at the next meeting," said Bunning. "You don't have to raise rates just because many expect you to do so. Low interest rates are not necessarily a bad thing."

Greenspan's prepared remarks acknowledged some problems, including the low savings rate by consumers.

He also acknowledged that business spending has lagged behind corporate profits, adding that caution has depressed hiring compared to other post-war recoveries.

"In contrast to the typical pattern early in previous business-cycle recoveries, firms have appeared reluctant to take on new workers and have remained focused on cost containment."

Greenspan was expected to face questioning by senators on proposals to reform the Social Security system, particularly about the administration's proposal to divert some taxes to private accounts. Greenspan did side with those who are calling for changes.

"Real progress on these issues will unavoidably entail many difficult choices," he said. "But the demographics are inexorable, and call for action before the leading edge of baby boomer retirement becomes evident in 2008."

But his prepared remarks did not take a position on whether individual accounts would help or hurt Social Security or the broader economy.