Federal Reserve Chairman Alan Greenspan lent his considerable endorsement to the bipartisan budget agreement yesterday, saying it would produce "a credible, enforceable reduction in the budget deficit" and lower interest rates.
Failure to pass it, he warned a House Government Operations subcommittee, "would produce an adverse reaction in financial markets that could undercut the economy already significantly weakened by the shock of the Middle East crisis and problems in our financial system."
Later, Treasury Secretary Nicholas F. Brady issued a statement agreeing with Greenspan's interpretation, declaring, "It's simple: If Congress passes the budget agreement, interest rates will go down. If they don't pass it, interest rates will go up."
Greenspan and other Federal Reserve officials have indicated that if such a budget deal becomes law, they would act to lower short-term rates, provided financial markets also responded favorably to the package. In his testimony, Greenspan said "The initial reaction of financial markets has been quite positive, though perhaps restrained by criticism that seemed to make prospects for enactment less certain."
The Fed's own reaction has been restrained by the same doubts about enactment. Top Fed policy makers met Tuesday to set a course for monetary policy for coming weeks and most financial analysts believe they agreed to cut short-term rates -- but only after Congress passes the budget package.
Long-term interest rates have dipped by about a quarter of a percentage point since it became clear that budget negotiators were heading toward agreement late last week. Financial market analysts attribute the decline both to the budget deal and to a drop in world oil prices.
"Failure to enact the agreement would, in my estimation, be a grave mistake," Greenspan declared.
"Many, myself included, might have preferred a somewhat different deficit-reduction mix than has been agreed to by the members of the summit group. However ... I suspect that the process probably has unearthed the maximum cut in the deficit feasible at this time, with about the only mix possible, given the political context.
"If this agreement is voted down, prospects for coming to grips with the corrosive effects of budget deficits on our economy would be dim indeed."