Fed Independence Will Be Tested In Next 25 Years: Greenspan

Source : The Business Times, September 17, 2007

(NEW YORK) The Federal Reserve may have to double its benchmark interest rate to at least 10 per cent by 2030 to stem inflation, sparking a political showdown that could challenge its independence, according to former chairman Alan Greenspan.

Slowing productivity and rising wages abroad will probably cause US inflation to accelerate in the next quarter century, Mr Greenspan wrote in his book The Age of Turbulence: Adventures in a New World, to be published by Penguin Press today. His outlook included a reversal of many of the trends that aided the success of his own tenure at the Fed.

There are already some signs that political scrutiny is rising. Democrats including Barney Frank of Massachusetts, who heads the House Financial Services Committee, called two weeks ago for a 'meaningful' cut in interest rates.

'Federal Reserve independence is not set in stone,' wrote Mr Greenspan, 81, who led the Fed for 18 years until January 2006. 'The dysfunctional state of American politics does not give me great confidence in the short run' and there may be 'a return of populist, anti-Fed rhetoric', he wrote.

To keep inflation under 2 per cent, 'the Fed, given my scenario, would have to constrain monetary expansion so drastically that it could temporarily drive up interest rates into the double-digit range not seen since the days of Paul Volcker', Mr Greenspan wrote.

Mr Volcker was Mr Greenspan's predecessor, and faced criticism from members of Congress as he lifted borrowing costs to contain prices, sending the economy into a recession in 1980 and 1981.

Now, chairman Ben Bernanke, who took the Fed's helm in February last year, faces some pressure to cut rates after a housing recession spurred a sell-off in credit markets and the first loss of jobs in four years.

The economy will probably slow to a pace of under 2.5 per cent on average from now until 2030, Mr Greenspan forecast in the book. Consumer prices, which increased at an average annual rate of 3.1 per cent during Mr Greenspan's tenure, is likely to climb by 4.5 per cent or more a year in the future, he wrote.

The former chairman built his projection on three economic shifts. First, the 1990s boom in productivity, which allowed Americans to produce more goods and services without pushing up prices, is fading. Second, the disinflationary impact from the inclusion of China and other emerging economies into the global trading system is ending. The third source of inflation pressure is US government budget deficits, which absorb private savings, using them for less productive purposes, thus imparting 'a bias toward inflation', Mr Greenspan wrote. -- Bloomberg