Federal Reserve Chairman Mr Alan Greenspan said today the US economy entered 2005 in good shape but warned fiscal discipline was essential to meet future challenges.
"All told, the economy seems to have entered 2005 expanding at a reasonably good pace, with inflation and inflation expectations well-anchored," Mr Greenspan said remarks prepared for delivery to the Senate Banking Committee.
He gave no direct hint on the direction of future monetary policy, other than to note that even after six quarter-percentage point hikes since last June, the official federal funds rate "remains fairly low."
Treasury bond prices slipped as investors seized on this as a signal of more rate rises ahead. The dollar gained against the euro as higher rates give the currency greater appeal.
Mr Greenspan tempered his economic optimism by warning that the relatively tranquil economic conditions of recent decades must not be taken for granted. "History cautions that people experiencing long periods of relative stability are prone to excess," he said. "We must thus remain vigilant against complacency."
Mr Greenspan said it was "imperative to restore fiscal discipline" in the United States to help narrow its huge current account deficit.
He also said the country had to act before 2008 to prepare its finances for a coming wave of retiring "baby boomers" and said if it failed to do so, there could be an adverse impact on bond markets.
The Fed chief said it was hard to explain why long-term interest rates have declined in the face of the US central bank's short-term rate increases. He noted, however, that yields and risk spreads "have narrowed globally" - not just in the United States.
"For the moment, the broadly unanticipated behaviour of world bond markets remains a conundrum," Mr Greenspan said.
"Bond price movements may be a short-term aberration, but it will be some time before we are able to better judge the forces underlying recent experience."
He said, "a pervasive sense of confidence among investors and an associated greater willingness to bear risk" contrasted with continued business caution. Some of that might stem from business wariness on potential legal liabilities, he added.
The inflation outlook "will be influenced by the extent and persistence of any slowdown in productivity," Mr Greenspan said. But so far, intense competition has limited businesses' apparent ability to pass on higher production costs in the form of rising prices, Mr Greenspan said.