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Former Fed Chairman Says U.S. Economic Recovery Underway

Former U.S. central bank chairman Alan Greenspan said Sunday he believes the U.S. economic downturn is near its end. “There has been a significant improvement in the financial system,” said Greenspan. Appearing on U.S. television, the former Federal Reserve chairman acknowledged unemployment is still a problem, but added that job losses are slowing.

He predicted that the economy would resume growth in the third quarter of 2009. "It strikes me", he says, "that we may very well have two and-a-half percent (economic growth) in the current quarter.” That compares with a 1% decline in the gross domestic product in the second quarter, 6.4% in this year’s first quarter and 5.4% in the fourth quarter of 2008.

Greenspan said the government’s purchase of hundreds of billions of dollars in troubled assets in the so-called TARP (Troubled Asset Relief) program was helpful in shoring up the capital stock of banks and other financial institutions. “And, not an insignificant event is the three and one-half trillion dollar increase in the stock market value of American corporations. Those are capital gains and they flow throughout the system and you could see their impact in the credit markets and equity markets.”

The former Fed chairman says he believes the economy began to improve in the middle of July. “And, the reason,” said Greenspan “is that there has been such an extraordinarily high rate of inventory liquidation that the production levels are well under consumption. And, as that slows down, production moves up and that could be quite significant.”

Greenspan said he sees short-term economic improvement, but "with caveats” including housing prices. “Unless home prices stabilize, maybe 5% down from here, it is possible, I don’t think it’s going to happen, but I do think it is possible that we could get a second wave down.” He warned that a further deterioration in housing prices, perhaps 10% or greater, would result in a second major round of foreclosures that could have a major impact on consumer spending.

The other caveat is government deficits. Greenspan agreed that health care reform is required as a long-term solution to government red ink. “There is no question, but that the core of the problem on the long-term deficit is (the government-run health insurance program) Medicare, specifically, and health care, more generally, in the sense that it affects revenue.” He said the government must also find additional sources of revenue to shore up Medicare and other government programs possibly including a value-added tax. Greenspan cautioned that the threat of inflation is very real and predicted the Federal Reserve will have to raise interest rates once the economic recovery is underway, perhaps in less than two years.