Risks of a recession have increased, but the Federal Reserve must be cautious in supporting the economy because global forces that have kept inflation in check are receding, former Fed Chairman Alan Greenspan said on Monday.
"Earlier in the year, I was talking about a one-third probability of a recession," Greenspan told Reuters. "It's come up somewhat, but it's still at this stage somewhat less than 50 (percent)."
He said the biggest risk to the outlook for the U.S. economy would be a substantial fall in house prices. The economy could weather a mild decline in home values as long as there is a decrease in new home construction and inventories of unsold homes clear, the former Fed chief said.
"But if the whole thing festers, it will erode household balance sheets and eventually impact on what the critical support has been in this economy: consumer expenditures," he said.
Greenspan spoke with Reuters and numerous other media outlets to publicize the release of his memoir, "The Age of Turbulence: Adventures in a New World."
His comments come a day before the Fed holds a policy-setting meeting. The central bank is widely expected to lower benchmark overnight interest rates by at least a quarter-percentage point to help the economy through a housing downturn and credit crunch. It has held the bellwether overnight rate at 5.25 percent since June 2006.
Greenspan said the Fed's decision-making comes against a more complicated backdrop than he faced as chairman when officials slashed interest rates from 6.50 percent to 1.75 percent to buffer against recession and the shock of the September 11 attacks on the United States. By June 2003, the Fed had dropped borrowing costs to a decades-low 1 percent.
"Disinflation is probably close to its peak now, and obviously as disinflation eases, inflation of necessity is picking up," he said. "It's going to make monetary policy a lot more difficult than it was during most of the time when I was chairman."
The integration into market economies of workers from former communist countries in Eastern Europe and low-cost goods from China and emerging markets kept U.S. inflation low, but those effects are now receding, he says in his book.
Greenspan said in interviews on Monday the U.S. economy appeared to be faring well, despite the bursting of a housing bubble and stress in financial markets.
"The economy at this stage .... despite the financial problem, is still holding up," he told NBC's "Today" program.
Greenspan said he expects mortgage delinquencies and home foreclosures to rise, both in the United States and other markets around the globe.
"I think we're going to have to go through this adjustment, as indeed all the other countries are in the process of going through it. There are going to be a lot of people who will have very tragic stories," he told NBC.
But in a separate interview with cable news network CNBC, he warned the Fed had to be careful to avoid stoking inflation with any future policy moves.
"It's very clear that the trade-offs between inflation and growth have altered," he said. "The Fed has to be more careful about inflation now than it did when I was chairman."
Greenspan told Dutch newspaper NRC Handelsblad that inflation could rise to about 5 percent in Europe and the United States over time.
"The normal inflation level is closer to 5 percent than the current 2 percent," Greenspan said, adding that 5 percent level fitted economies with a "paper" currency not linked to gold.
Some economists and investors have criticized Greenspan for slashing interest rates too much during past financial crises, including ones sparked by Russia's 1998 debt default and the bursting of the technology bubble in 2000-2001.
Greenspan told CNBC the Fed tried to raise mortgage rates in 2004 to weigh against an emerging housing bubble but was unsuccessful. Indeed, long-term interest rates set by markets actually moved lower in the early stages of a Fed tightening cycle that began in mid-2004.
(Additional reporting by Steven C. Johnson in New York)