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. Last Updated: 07/27/2016

Fed Chief: Economy Unsustainable in U.S.

WASHINGTON -- Federal Reserve Chairman Alan Greenspan, who knocked down stock prices earlier this year with worries about "irrational exuberance," issued another warning Wednesday, expressing concerns that tight labor markets could soon translate into rising inflation.

Talking about "greater uncertainties" in the economy, Greenspan left no doubt that the central bank stood ready to tighten interest rates unless economic growth slowed enough to take pressures off tight labor markets.

"A re-emergence of inflation is, without question, the greatest threat to sustaining what has been a balanced economic expansion virtually without parallel in recent decades," Greenspan said.

"To be sure, job growth slowed significantly in August and September, but it did not slow enough," Greenspan told the House Budget Committee. "The performance of the labor markets this year suggests that the economy has been on an unsustainable track."

Greenspan's worries about tight labor markets and inflation sent financial markets into a tailspin with bond and stock prices both plummeting. The Dow Jones industrial average was off more than 100 points soon after the remarks were made public and was still down 90 points in late morning trading.

Greenspan linked the better-than-expected economic performance of recent years to the sharp advance in the stock market, but he bluntly stated that it would be "unrealistic" to look for a continuation of such huge gains in stock prices in coming years.

Financial analysts said Greenspan's comments greatly increased the likelihood that the Federal Reserve will raise rates before the end of the year.

"Nothing good can come from irrational exuberance in financial markets, and that has been worrying him," said David Jones, economist at Aubrey G. Lanston and Co. in New York. "He is saying he is prepared to tighten in order to limit the dangers of financial market excesses."

Federal Reserve policy-makers passed up the chance to raise interest rates last week, preferring to continue watching for signs that the best performance on inflation in three decades was starting to erode.

The central bank hasn't changed interest rates since March 25, when it nudged its benchmark rate for short-term bank lending up a quarter point to 5.5 percent.

In his remarks, Greenspan conceded that growth could slow on its own, but he clearly left the impression that if it did not, the Federal Reserve would act.

Greenspan said that it could be only a matter of time before an unemployment rate below 5 percent begins to show up in inflationary pressures.

"The law of supply and demand has not been repealed," he said. "If labor demand continues to outpace sustainable increases in supply, the question is surely when, not whether, labor costs will escalate more rapidly."

Greenspan, as he did in July in delivering his midyear assessment of the economy, cautioned against putting too much faith in views that rapid increases in technology had spurred huge gains in productivity and meant the economy can grow much faster than previously believed without generating inflation.