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Central bank governors have their own wars to fight

Deficits, higher interest rates, and fiscal responsibility? In a world focused on war and recession, who would even bring up such pedestrian concerns? The answer is U.S. Federal Reserve Board chairman Alan Greenspan, a man who has never wasted a moment worrying whether anyone thinks he's boring.

Mr. Greenspan addressed his concerns in testimony to the House of Representatives budget committee on Thursday morning. His comments came just before President George W. Bush's speech to the United Nations on Iraq. In one way, it was an unfortunate time to talk economics; surely his words would get lost in the drama of military rhetoric. On second glance, however, the timing was perfect. After all, a U.S. president and Congress contemplating war are unlikely to agonize much over the nickels and dimes. Mr. Greenspan clearly thinks they should, or face the consequences.

"Returning to a fiscal climate of continuous large deficits would risk returning to an era of high interest rates, low levels of investment, and slower growth of productivity," Mr. Greenspan said. "History suggests that an abandonment of fiscal discipline will eventually push up interest rates, crowd out capital spending, lower productivity growth, and force harder choices upon us in the future."

Although it seems like a distant memory now, it wasn't that long ago when both the United States and Canada were running enormous budget deficits. In both cases, government spending arguably crowded out private borrowing, depressing the amount of business and consumer spending. The "virtuous circle" of low deficits (and eventually surpluses), strong economic growth, solid employment creation and low interest rates really started in the mid-1990s. Then, with the economic boom in high gear, it seemed as if we'd seen the end of deficits altogether.

The past year has challenged that assumption. Indeed, with a slower economy and the need to spend on defence, Canada and the United States now appear perilously close to dipping into the red, maybe as soon as this fiscal year. It's still hard to get excited about what that could do to interest rates. Bond yields (and mortgage rates for that matter) are now close to multi-generation lows. It would take a lot of upward pressure before they reached alarming levels, a point acknowledged by Mr. Greenspan.

So why the think-tank speech right now? Well, that may have been the point: Central bank governors have their own wars to fight. Mr. Greenspan is a man who has watched military conflicts and business cycles come and go. Clearly he sees his job as partly being the voice of reason, the guy who reminds everyone that it's a slippery slope once the deficits start. And who better to remind than a group of people with the power to spend, all in the name of national defence?

Not to mention that the more the fiscal side of the table does to stimulate the economy, the less room for responsible monetary policy types to play. Tax cuts, spending increases and lower interest rates all together tend to be too much of a good thing. They could even lead to higher inflation, something we haven't troubled ourselves with for a while.

Clearly Mr. Greenspan likes having the ball in his court. His between-the-lines message to Congress seems to be this: "Hands off, and I'll take care of any stimulus the economy needs." It's not unlike recent murmurings from our own Bank of Canada governor, David Dodge. He has recently hinted that he would prefer not to see a fall budget from Jean Chrétien that is packed full of farewell presents in the form of big spending.

Given the track record of both central banks (or at least their track record compared with the politicians) it might not be a bad idea to let them handle things. That's unlikely to happen, however. In a world focused on much more immediate things, "fiscal responsibility" cannot be expected to capture much political attention. So kudos to Mr. Greenspan for trying, but he may do better with the same speech in a year or two.

Bay and Wall streets already understand that high spending will lead to higher interest rates. It may take far more evidence, however, to jog memories in Ottawa and Washington.
Linda Nazareth is senior economic analyst for Report on Business Television.
This column first appeared on For more exclusive analysis, please see the Web site.

© The Globe and Mail

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