Q: We've been through an eventful week here. We started with a Senate proposal that would have made a fairly substantial beginning on deficit reduction involving a tax increase. The president refused to accept the idea of a tax increase. Where does the week leave the budget and the budget deficit?

A: I believe it leaves it essentially where it's been for quite a significant period of time. I find last week's episode, not only with respect to questions of the deficit but with respect to the way our institutions are functioning on this issue, very frightening in a sense. We're learning that our worst fears about the inability of our institutions to function are turning out to be right. It's not that I think the president is wrong on the issue of taxes. In the longer- term sense, he is right in that the issue is really spending. Taxes are only a stopgap solution to a very much more deep-seated problem of expenditure growth.

Q:How do you assess the budget resolution Congress finally passed Thursday night?

A:There are too many soft cuts in the package which will surely be reversed when the political climate changes. The congressional package does little to break us out of the $150 to $250 billion annual deficit range for the foreseeable future.

Q:How long is this deadlock likely to go on? Are you suggesting that it may take a crisis of some sort to force action here?

A:What the last week is telling us is that the only way we will address this problem is in reaction to some form of crisis, which by its nature means we will get the wrong solution. It will be a short-term, not a long-term, solution. What's happening to us is something akin to a Greek tragedy, where we seem to be drifting in a direction that is dangerous to the economy's longer-term future and we don't seem to have the ability to divert it.

Q:Do you have any idea how far off that crisis might be? Would you care to make any guesses what the nature of the crisis toward which we're heading might be?

A:There are two basic problems with respect to budget deficits. One is a financing and an inflation problem, which relates strictly to the size of the deficit. That, in the short term, can be alleviated by a tax increase as well as expenditure cuts. And clearly that's a problem that will emerge if we don't address it within the next two or three years.

However, there is another deep-seated problem that, I think, is guiding the president's philosophy: if you solve the budget deficit problem from the tax side, while you do resolve the inflation and financing problems, you probably create the type of problem that Europe is experiencing -- namely, economic stagnation owing to very large percentages of gross national product going to government spending. So, as I see the problem, what we have got to come to grips with, and seemingly are unable to do, is the inexorable growth in expenditures. We are showing very little evidence of being able to address the question. I think the Senate was as close to being courageous in eliminating programs as our political system allows. If you eliminate programs, you do tend to undercut the basic constituency support that gathers under these programs. However, the week's budget agreement is likely to be as ineffectual in restraining long-term expenditure growth as cutting off the tops of weeds is in preventing their spread.

Q:You think the time has come to cut closer down to the roots?

A:Yes. In other words, I think the Senate was correct in its original COLA proposal, which endeavered to restrict the growth in entitlement programs in a way that is modest and would not undercut the pension population to the extent that a lot of political posturing suggests. The truth of the matter is that our economy cannot afford the long-term costs of current entitlement programs. The Senate and some within the administration have recognized that, but we've done nothing.

Q:Let me ask about the political implication of what happened this past week. You're not only an economist; you're a pretty seasoned watcher of Washington at work. What the president seems to have done in the view of many of the people in the Senate is to undercut that Senate initiative and strike a separate deal with the House Democrats. Where does this leave the politics of deficit control as we look out toward the next budget and the years beyond?

A:It clearly undercuts any serious attempt to come to grips with the long-term expenditure problems. The difficulty is that the House -- and, I fear, in part the president -- is trying in some way or another to be responsive to constituents' views on this budget. The problem, unfortunately, is that the polls very obviously tell us that the public is for a lower deficit, no tax increase and only negligible cuts in outlays, which is another way of saying they are also implicitly for the repeal of the laws of arithmetic.

Responsible representative government must lead on issues like this, and I'm fearful that the president after being strongly out front on this question in the early part of his first term has been pulling away. And when the Senate Republicans, and indeed the Senate as a whole, have tried to take the lead on some of these very tough political issues, the president has not backed them. If he's not going to back them now -- and the Senate has been left high and dry on this question -- I just don't see how, other than under a crisis atmosphere, we can address the deficit. And, as I indicated before, crisis solutions to long-term fiscal problems invariably tend to be short term -- that is, addressing only the immediate crisis.

Q:And your view is that coming to grips with the deficit in any fundamental way really requires that we form a new national consensus on the entitlements first?


Q:And then you work to the other questions?

A:I think we learned something in our attempt to resolve the so-called Social Security crisis of a few years ago. We learned that even though there seemed to be an extraordinary set of pressures against cutting such benefits, Congress did cut them in part, not a great deal, but some. That occurred despite earlier overwhelming majorities in the Senate and the House representing the sense of the Congress that that should not be done. When a bipartisan agreement was reached on benefit cuts as well as tax increases, small as they were, they were nonetheless quickly implemented. (Editor's note: Mr. Greenspan chaired the commission that worked out the Social Security compromise.)

Q:And furthermore, there was virtually no political reaction to that.

A:Exactly. None. And I suspect that, were we able to get bipartisan agreement on very modest adjustments in entitlement programs, we would resolve this very serious budget outlay problem without political fallout of any signficance.

Q:And that means starting with Social Security once again, doesn't it?

A:It does indeed, and that's the reason why I thought that the Senate's attempt to come to grips first with a COLA freeze and more interestingly the recent alternate- year adjustment was at least approaching the problem. I'm fearful that we are currently not coming to grips with the real long-term budget problem, but endeavoring rather to address a short-term political problem. Congress believes that its constituents want some evidence of a cut in the budget. But what we're likely to get is more in the way of imaginative bookkeeping than any real attempt to resolve the deep-seated expenditure updrift.

Q:And, as you say, until the financial pressures that are building now, suddenly begin to crack the structure.