One has to pity Alan Greenspan’s difficult policy choices in his past eight months as chairman of the Federal Reserve board.

For he remains mandated by Congress to simultaneously aim at price stability, maximum employment levels and moderate long-term interest rates.

Yet, in this endeavor, he is receiving little help from a profligate United States administration.

Indeed, based on present budget policies of heavy defence spending and permanent tax cuts, there is little reason to expect that the US budget deficit in 2005 will be very different from the 3.5 per cent of GDP deficit recorded in 2004.

Greenspan’s policy choices are made all the more difficult by an international oil price, which remains stubbornly at about $US50 a barrel.

Higher international oil prices have already fed through into headline consumer prices, which are now rising at an annual rate in excess of 3 per cent.

More disturbing still is the fact that pressures on inflation appear to have picked up and pricing power is now more evident throughout the economy.

Even core inflation, which excludes energy and food prices and which is Greenspan’s preferred inflation indicator, is now approaching 2 per cent. This is at the upper end of the Fed’s implicit 1.5 to 2 per cent core inflation target.

The recent uptick in inflation is rightly giving the Federal Reserve pause that higher international oil prices could begin influencing longer-run inflation expectations.

It is also understandably making the Fed most reluctant to back off from its present policy of measured 25 basis point increases in interest rates at six-weekly intervals.

At the same time that stubbornly high international oil prices are adding to inflation pressures, they are also pushing the US economy into a new soft patch.

First-quarter GDP data suggest that the US economy slowed to a 3 per cent annual pace, which is somewhat below the country’s 3.5 per cent potential growth rate.

In addition, partial indicators leave little doubt that US growth has tailed off markedly since the beginning of March.

This loss of economic momentum could very well help moderate the inflation pressures that appear to have been building in the economy.

While Greenspan is hoping that the economy’s soft patch proves to be relatively short-lived, as was the case last year, the composition of the first quarter’s GDP data suggest a different story.

That data indicates that the long awaited investment pick-up needed to take over from the much overextended US consumer is yet to materialize.

It also indicates that business inventories are being built up at a faster than desired pace. All of this does not bode well for second-quarter production growth.

Greenspan’s room to respond to a slackening US economy by lowering interest rates is highly constrained by the large degree of leverage that already characterizes the US economy.

This leverage is the direct result of the prolonged period of low interest rates that followed the equity meltdown in 2000.

Greenspan is painfully aware that if interest rates are not soon restored to more normal levels, there is the real risk that this leverage will only increase.

Already there are signs that the US property market might be in a bubble.

At the same time, Wall Street has been encouraged to take on an excessive amount of risk by the measured pace of interest rate increases from extraordinarily low levels.

An even more ominous factor which is adding to the Fed’s difficult policy choices is the ballooning US external current account deficit. At 6.25 per cent of GDP, the present current account deficit has no precedent in US economic history.

This deficit will only widen in the period ahead given the more rapid economic growth that might be expected of the US than of Europe and Japan.

More disturbing still is the fact that more than half of the current account deficit is being financed by foreign central banks, which have already accumulated close to $US2 trillion ($2.6 trillion) in US Treasury bonds.

Greenspan’s nightmare scenario has to be a significant loss of appetite by foreign central banks for US Treasury paper.

In such an event, the US dollar could be expected to swoon, while long-term Treasury yields would be forced up for want of buyers.

It is for this reason that Greenspan keeps exhorting Congress to mend its profligate fiscal ways and to play its part in weaning the US from an overdependence on external savings.

All too sadly, Greenspan’s exhortations to Congress are falling on deaf ears. This is prompting Paul Volcker, Greenspan’s illustrious predecessor, to publicly muse about a global economy that is skating on thin ice.

Hopefully, Congress will mend its ways before it is too late for both the US and the global economies.

Desmond Lachman is a resident fellow at AEI.