- The Washington Times - Thursday, November 3, 2005

Federal Reserve Chairman Alan Greenspan said yesterday that long-term interest rates are no longer responding as they have in the past to the central bank’s rate increases or to large federal budget deficits.

Although he warned that the rates on 10-year to 30-year mortgages and bonds may have a “delayed” reaction and jump in response to mounting deficits, he conceded the central bank remains “puzzled” as to why they remain so low.

The Fed no longer has much control over these rates, which have been stimulating a long-running housing boom, most likely because global market forces have become stronger than the Fed and are pushing rates lower in response to global deflation and excess savings overseas, he said in testimony before the Joint Economic Committee of Congress.

“It was a great surprise to us” and was not anticipated when the Fed started raising rates last year, he said. “We’re just now beginning to understand” the reasons.

Mr. Greenspan’s admissions this year that he is perplexed by the rate “conundrum” have created a stir in financial circles. The matter is highly important, since the Fed’s primary tool for influencing the economy is its control over short-term interest rates, which it has raised by three percentage points since June 2004.

Long-term rates usually have followed suit. But in the last year they have flattened and even declined at times in response to the Fed’s ministrations.

Mr. Greenspan’s wonderment is also remarkable because he has made warnings to Congress about the danger of budget deficits a hallmark of his 18-year career as Fed chairman, which comes to an end Jan. 31.

Yesterday, he repeated previous warnings that growing debt will force up interest rates, saying “unless the situation is reversed, at some point these budget trends will cause serious economic disruptions.”

Some economists say the Fed’s loss of control over long-term rates means it will have to jack short-term rates much higher than in the past to have much of an effect on the economy and slow inflation, as it is seeking to do.

Other analysts say that low bond-market rates are a signal that investors think the Fed not only will succeed in its mission of conquering inflation, but also will throw the economy into recession by raising short-term rates too much.

These analysts noted that the yield on 10-year Treasury notes, currently at 4.65 percent, is nearly equal to the 4.46 percent rate on two-year bills — a development that nearly always has signaled a recession is near.

But Mr. Greenspan vehemently rejected that view, maintaining that the relationship between the so-called “yield curve” and the economy has changed.

“That used to be one of the most accurate measures we used to have to indicate when a recession was about to occur and when a recovery was about to occur,” he said. “It’s lost its capability of doing so in recent years. The markets have become far more complex.”

The same global market forces that have been complicating the Fed’s job this year have been undercutting its message to Congress on the budget deficit, Mr. Greenspan said.

Republican economists who advocate deficit-financed tax cuts maintain they have been vindicated in their thought that “deficits don’t matter.” The relationship between budget deficits and interest rates never was close, they maintain, and experience in recent years has borne that out.

Mr. Greenspan said he has counseled presidents since the Reagan years, when he was a White House economic adviser, to reject that view.

“I disagreed with it then, I disagree with it now, and I disagree with it because the facts prove otherwise,” he said. Any attempt to enact both large tax cuts and spending increases without offsets will “create very serious backlashes in the system,” he said.

Mr. Greenspan said that for those in Congress seeking to pare the deficit with spending cuts, “there are no easy choices. The easy choices are long gone.”

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