If countries don't tackle fiscal problems, monetary policy will be "become utterly irrelevant," former Federal Reserve Chairman Alan Greenspan said Friday, as investors try to figure out whether the central bank will increase interest rates for the first time in nine years at its meeting later this month.
Gridlock by Democrats and Republican on solving the problems posed by the spiraling costs of entitlements, namely Social Security and Medicare, has created a situation the Fed can't solve, Greenspan said in an interview on CNBC. "Both [parties] have been afraid to touch the third rail of politics."
Greenspan also said he's "baffled" that a 25 basis point hike by the Fed would have a major impact on economic conditions around the world.
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"The real problem has got nothing to do with monetary policy—although I grant you it's a crucial issue short term—it's fiscal policy," he said. "If we [had] matched up to Simpson-Bowles basic recommendations of a few years ago, we'd be in a much better place now. And we could have a legitimate discussion about monetary policy ... which is a minor consideration relatively speaking."
The often-cited Simpson-Bowles plan to reducing the nation's debt—which fell short of approval from the bipartisan panel in 2010—was created by Republican Alan Simpson and Democrat Erskine Bowles, co-chairmen of President Barack Obama's debt commission.
The immediate Fed rate guessing-game has been complicated by the recent financial market volatility following concerns about China's economy, which has been undergoing a transformation from an investment- and export-oriented economy to one driven by consumption.
"They're now sitting with a very substantially market-oriented economy," said Greenspan. "The reason they're having troubles ... [is] they're not prepared for it."
"The way they handled the stock market break is indicative of the fact that they're not doing it the way it should be done," he said—referring to the measures Beijing has been taking to stem the recent plunge in Chinese stocks.
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Another wildcard for the timing of a rate liftoff is the lack of inflation, which is nowhere near the Fed's 2 percent target.
Greenspan appeared on CNBC's "Squawk Box" ahead of Friday morning's release of the closely watched August employment report. The report said the U.S. economy added a lower-than-expected 173,000 jobs. But the unemployment rate dropped to 5.1 percent, a better number than forecast, that put pressure on stocks at the open on Wall Street.
The jobs data are an important piece to the economic puzzle and perhaps evidence that may sway the decision of Fed policymakers, who've made it clear they'd like to hike rates from near zero percent this year if the strengthening economic numbers cooperate.
Greenspan served as Fed chairman for 19 years from 1987 to 2006. He was appointed by President Ronald Reagan, and ended up serving three other presidents in both parties: George H.W. Bush, Bill Clinton, and George W. Bush.
Looking at the upcoming presidential election, he said: "The Fed cannot be looking at the political calendar," when making decisions on rates or other monetary policy moves.
"If it does it's going to run into trouble. The Fed is going to get criticized no matter what we do," he said.