- The Washington Times - Friday, September 13, 2002

Federal Reserve Chairman Alan Greenspan yesterday warned Congress to get spending under control or risk driving up interest rates and ruining the economy.
"If we do not preserve the budget rules and reaffirm our commitment to fiscal responsibility, years of hard effort could be squandered," he told the House Budget Committee. His warning helped set off a 202-point decline in the Dow Jones Industrial Average.
Because a return to budget deficits would force up the rates on 30-year mortgages and other long-term loans, the housing market the strongest sector of an otherwise weak economy would be among the hardest hit, he said.
A sudden rise in mortgage rates would cut off the refinancing boom that has been an important source of strength for consumers, helping them to weather the recession and the severe and prolonged drop in the stock market, he said.
The lowest mortgage rates in a generation "have been a major factor in inducing the extraction of equity from homes, in itself a very large contributor to the support the economy has had through this period of very severe equity market contraction," he said.
Some legislators argue that more spending increases and tax cuts are needed to bolster the struggling economy. Mr. Greenspan said a rise in interest rates would be a much greater threat to the economy than restrained spending.
He said that overspending and the big drop in stocks since March 2000 are the culprits behind recent dramatic changes in the budget outlook. The Congressional Budget Office is now projecting deficits until 2006 after having foreseen large surpluses earlier this year.
"The sharp decline in stock prices appears to have markedly reduced final settlements for the 2001 tax year, as well as receipts on 2002 income," both because capital gains realizations on stock sales are down dramatically, and because of a drop in income taxes paid on the exercise of stock options, he said.
"The sharp drop in equity markets was not expected, and the fallout from it will damp tax revenues for some time," he said.
"The recent surge in discretionary spending, necessitated only in part by the war on terrorism and the need for enhanced homeland security, has also made the budget picture less sanguine."
Several committee Democrats sought to blame the budget deterioration on last year's $1.5 trillion of tax cuts, but Mr. Greenspan cautioned against rolling back those cuts. The tax cuts were passed before the budget outlook darkened significantly, and many economists have credited them with helping pull the economy out of recession.
Suspension of the tax cuts could set back economic activity, Mr. Greenspan said, as many small businesses have already made decisions in the expectation that cuts will take effect in future years.
But he said all future spending and tax bills should be subject to the kind of strict budget controls that were developed in the 1980s and 1990s to gain control over chronic triple-digit deficits that were holding back economic growth.
Mr. Greenspan deplored Congress' apparent abandonment of the pay-as-you-go rules, which required all increases in entitlement spending such as Medicare as well as tax cuts to be offset with spending cuts or tax increases elsewhere in the budget.
Those rules are due to expire at the end of the month, and no major effort has emerged in Congress to renew them. In addition, the Senate has not adopted a budget resolution setting out limits on spending and is drafting spending bills that are $15 billion over levels adopted by the House and recommended by President Bush.
Several committee members suggested that the House may "split the difference" with the Senate, paving the way for another year of double-digit spending increases.
Mr. Greenspan said Congress has an "inbuilt political bias" toward ever-higher spending and tax cuts as long as it is not forced to live within a budget and that this could lead once again to "entrenched" deficits.
"The budget rules worked far better than many skeptics, myself included, had expected," he said. "Rather than focusing solely on the benefits of a proposal, policy-makers were required to recognize the costs as well."
Congress has been "fortunate" that, despite the abandonment of previous budget disciplines and several years of double-digit spending increases, the financial markets still seem to get the budget back under control, he said.
The favorable impression of congressional discipline among investors has helped to stoke today's low interest rates, along with the weak economy, he said, but it may not continue for long.

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