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Last Updated: Monday, 1 October 2007, 18:10 GMT 19:10 UK
Are the good times gone for good?
By Steve Schifferes
Economics reporter, BBC News

Alan Greenspan
Mr Greenspan left the Federal Reserve in January 2006

One of the most influential figures in the world economy, former US central bank chairman Alan Greenspan, has warned that the good times are over for the world economy.

Mr Greenspan, who played a key role in managing the US economy as head of the Federal Reserve from 1986 to 2006, says that higher interest rates and higher inflation are more likely in the future, leading to slower economic growth and lower housing and share prices.

In a wide-ranging interview with BBC economics editor Evan Davis, he warns that the UK cannot escape from global economic pressures.

And he says that central bank governors, including the Bank of England's Mervyn King, face a far more difficult task in managing the economy in turbulent times.

Why is Mr Greenspan so gloomy for the world economy?

And why have his perceptions shifted so sharply, compared with his views when he was in charge of the Fed?

World slowdown

Mr Greenspan says that the outlook for the world economy over the next few years is highly uncertain.

The most credible worst-case scenario, he says, is a recession in the US, driven by further falls in US house prices as people feel less wealthy and spend less money.

Even in the best case, he predicts a substantial slowdown in the US, with repercussions across the globe.

In the long-term, he predicts that higher interest rates, greater pressures on public spending, and a revival of inflation through commodity prices could lead to a less affluent future for us all.

End of the "golden age' ?

In the 1990s, Mr Greenspan was one of the leading advocates of the concept of the "new economy", which was the belief that by using new technology such as computers, businesses could raise their productivity, and thus boost economic growth, without causing inflation.

As a result, the Fed kept interest rates low, and the US economy and stock market boomed.

Mr Greenspan now says that two other factors kept inflation and interest rates low: the rise of China as a source of cheap goods, which reduced inflation for US and European consumers, and the global glut of savings, again from Asia, which kept interest rates low.

But he argues that these have only given a temporary respite to the world economy, and he says that the price of Chinese goods is now beginning to rise.

Mr Greenspan now says that globalisation was more of a double-edged sword than he once believed, leading to growing inequality of income and wealth and growing protectionist pressures, as well as more efficient allocation of resources.

Bursting asset bubbles

In 1996, Mr Greenspan famously warned that the stock market was suffering from 'irrational exuberance', but the stock market boom continued.

And when the stock market crashed in 2000, the house price boom began, both in the US and the UK.

Mr Greenspan now says that he was perhaps a little too cryptic in his warnings about the 'frothy' nature of these asset bubbles.

But, he argues, there is little central bankers could have done to prevent asset bubbles from forming in the economy.

He says the bubbles were a side-effect of their successful efforts to keep interest rates low.

Even when the Fed raised short-term interest rates in 2004, the long-term money markets did not respond with higher rates, because the global downward pressures on interest rates were too strong.

Now that the bubbles seem likely to burst, there is little bankers can do to prevent them because it all depends on human psychology.

He says it is inevitable that house prices will fall or stabilise as global interest rates continue to rise, and he fears a sharp correction is possible.

Limits of intervention

Overall, Mr Greenspan - who was often characterised as the 'Maestro' - is now more humble about his role in shaping the world and US economy.

He says that financial panics and reverses, like the one we are experiencing at the moment, may be inevitable, and the best that policy-makers can do may be to wait for them to finish.

He argues, in fact, that attempts at further regulation by governments often have perverse effects, like the Bank of England intervention to help Northern Rock, which triggered the run on the bank.

He clearly believes that governments often do more harm than good.

He is surprisingly critical of the Bush administration, and deeply disappointed that it increased spending while also cutting taxes, thus boosting the budget deficit and adding to inflationary pressures.

Of course, it was Mr Greenspan's endorsement of the tax cuts in 2001 that proved crucial in getting them through a divided Congress, which is something he now regrets.

He now argues that the Clinton Administration, which put tackling the budget deficit at the top of its priorities, had a sounder approach.

With Hillary Clinton now the leading candidate for the Democratic nomination for the US Presidency, Mr Greenspan's words are likely to be influential for some time to come.

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