Perceptions that the United States has a large capacity to borrow are misleading and the government could have to pay higher interest rates to finance a growing deficit, Former Federal Reserve Chairman Alan Greenspan said in an opinion piece published by the Wall Street Journal.
"Despite the surge in federal debt to the public during the past 18 months — to $8.6 trillion from $5.5 trillion — inflation and long-term interest rates, the typical symptoms of fiscal excess, have remained remarkably subdued," he said.
Greenspan said the subdued symptoms of fiscal excesses are fostering a sense of complacency that could have dire consequences for the U.S. economy.
U.S. Treasuries are nevertheless free of credit risk. However, they are not free of interest rate risk, according to Greenspan, who is no longer a policymaker but is still listened to by the markets.
"If Treasury net debt issuance were to double overnight, for example, newly issued Treasury securities would continue free of credit risk, but the Treasury would have to pay much higher interest rates to market its newly issued securities," he said.
Greenspan, who was the chairman of Federal Reserve for about 19 years until his retirement in 2006, said he agreed that low long-term interest rates could continue for months.
"But just as easily, long-term rate increases can emerge with unexpected suddenness," he added.
Only politically toxic cuts or rationing of medical care, a marked rise in the eligible age for health and retirement benefits, or significant inflation, can close the deficit, according to Greenspan.
"I rule out large tax increases that would sap economic growth (and the tax base) and accordingly achieve little added revenues," he said.
The U.S. economy cannot afford a major mistake in underestimating the threat of growing fiscal crisis, Greenspan said.
“The federal government is currently saddled with commitments for the next three decades that it will be unable to meet in real terms,” Greenspan said. The “very severity of the pending crisis and growing analogies to Greece set the stage for a serious response.”
"That response needs to recognize that the range of error of long-term U.S. budget forecasts (especially of Medicare) is, in historic perspective, exceptionally wide. Our economy cannot afford a major mistake in underestimating the corrosive momentum of this fiscal crisis," he wrote.
"Our policy focus must therefore err significantly on the side of restraint," he added.
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