Greenspan says Fed balance sheet an inflation risk

WASHINGTON Fri Oct 2, 2009 4:12pm EDT

Former Chairman of the Federal Reserve Alan Greenspan testifies before the House Oversight and Government Reform Committee on Capitol Hill in Washington October 23, 2008. REUTERS/Kevin Lamarque

Former Chairman of the Federal Reserve Alan Greenspan testifies before the House Oversight and Government Reform Committee on Capitol Hill in Washington October 23, 2008.

Credit: Reuters/Kevin Lamarque

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WASHINGTON (Reuters) - Former Federal Reserve Chairman Alan Greenspan said on Friday that the Fed risks igniting a burst of inflation if it does not withdraw its extensive support for the economy at the right moment.

"You cannot afford to get behind the curve on reining in this extraordinary amount of liquidity because that will create an enormous inflation down the road," Greenspan said at a forum hosted by The Atlantic magazine, the Aspen Institute and the Newseum.

In its battle against the worst financial crisis in 70 years, the Fed has chopped interest rates to zero and flooded the financial system with hundreds of billions of dollars in the process. In so doing, it has more than doubled the size of its balance sheet to over $2 trillion.

The Fed has said that with high unemployment and a record level of factory idleness, none of the pressures that would ignite inflation is on the horizon. A government report on Friday that showed a weaker-than-expected job market in September is likely to provide additional support for that view.

Greenspan said the economy is "undergoing a disinflationary process," and stressed that the Fed faces no urgent need at the moment to unwind its monetary stimulus.

Still, his comments echo concerns raised by some policymakers who worry that delays in shrinking the Fed's bloated balance sheet will tempt fate and recommend action sooner rather than later.

"It's critically important the Fed's doubling of its balance sheet be reversed," Greenspan said. "If you allow it to sit and fester, it would create a serious problem.

Greenspan chaired the Fed from 1987 until his retirement in 2006. Hailed by many as a sage during his Fed tenure for a long period of prosperity, his legacy has been called into question over the long period of ultra-low interest rates and the Fed's hands-off approach to overseeing the financial industry before the global economic crisis.

(Reporting by Mark Felsenthal; Editing by Kenneth Barry)

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