April 21, 2005 -- Federal Reserve Chairman Alan Greenspan warned on Thursday that if America's budget deficit is not addressed interest rates could soar, which would stagnate the economy or "worse."
The danger, said Greenspan, is if the deficit continues to rise as a percentage of Gross Domestic Product (GDP). Between 2002 and 2004, the budget deficit as percent of GDP has grown from 1.3% to 3.6%.
"Unless that trend is reversed, at some point these deficits would cause the economy to stagnate or worse," Greenspan said in a testimony to the Senate Budget Committee.
If the necessary steps aren't taken--raising taxes or reducing spending or a combination of the two--interests rate will increase, which will make it evermore difficult to reduce the deficit, said the Fed Chairman.
"The federal budget is on an unsustainable path, in which large deficits result in rising interest rates and ever-growing interest payments that augment deficits in future years," Greenspan said.
Whether the deficit continues to grow as percent of output in 2005 depends on who is doing the estimating. According to the Bush Administration, the budget deficit is expected to grow to $427 billion, a record in dollar terms. The Congressional Budget Office (CBO), however, predicts that the 2005 budget deficit will decline to $362 billion from $412 billion in 2004.
But even if the CBO is correct, and the deficit shrinks this year, it will mean very little, Greenspan said. "As the latest projections from the (Bush) Administration and the Congressional Budget Office suggest, our budget position is unlikely to improve substantially in the coming years unless major deficit-reducing actions are taken," he said.