The resolution of our current account deficit and household debt burdens does not strike me as overly worrisome, but that is certainly not the case for our fiscal deficit, which...will rise significantly as the baby boomers start to retire in 2008. Our fiscal prospects are, in my judgment, a significant obstacle to long-term stability because the budget deficit is not readily subject to correction by market forces that stabilize other imbalances.

Currently projected budget deficits are unsustainable and will ensure a low level of national saving. Conventional economic analysis suggest that this situation is likely to raise long-term interest rates, crowd-out business capital investment, depress productivity growth, and exacerbate the current account deficit.

The fundamental fiscal issue is the need to make difficult choices among budget priorities, and this need is becoming ever more pressing in light of the unprecedented number of individuals approaching retirement age.

The combination of an aging population and the soaring costs of its medical care is certain to place enormous demands on our nation's resources and to exert pressure on the budget that economic growth alone is unlikely to eliminate.

Favorable productivity developments would help to alleviate the impending budgetary strains. But unless productivity growth far outstrips that embodied in current budget forecasts, it is unlikely to represent more than part of the answer.

So long as health-care costs continue to grow faster than the economy as a whole, the additional resources needed for such programs will exert pressure on the federal budget that seems increasingly likely to make current fiscal policy unsustainable. The likelihood of escalating unified budget deficits is of especially great concern because they would drain an inexorably growing volume of real resources away from private capital formation over time and cast an ever-larger shadow over the growth of living standards.

Tax increases of sufficient dimension to deal with our looming fiscal problems arguably pose significant risks to economic growth and the revenue base. The exact magnitude of such risks is very difficult to estimate, but, in my judgment, they are sufficiently worrisome to warrant aiming, if at all possible, to close the fiscal gap primarily, if not wholly, from the outlay side.

Crafting a budget strategy that meets the nation's longer-run needs will become ever more difficult the more we delay.

Deficits can indeed be a problem...Real interest rates could rise as government deficits crowd out business and consumer investment. But...there is no need for deficits to be inflationary. The prospect of inflation arises only if the central bank tries to resist the rise in real interest rates, thereby keeping its policy rates too low and inadvertently easing monetary policy.

If [the] unified budget deficit is two percent of GDP or less, it stabilizes the ratio of debt to GDP. So, if you are looking at a straightforward numerical type, that's not a bad one. But again, I want to caution you that it's a little simplistic and I wouldn't want to press it too far.

We face a delicate balance between genuinely positive near-term economic conditions, and some fundamental challenges...Even with good policy choices, and with considerable luck, these imbalances [in our economy] will take time to unwind. During this time we face some risk of a more volatile and less benign overall financial environment. This makes it important that we continue to invest in making our financial system stronger and more resilient.

We now face a substantial and unsustainable gap between our fiscal commitments and our resources, not just over the longer term with respect to Social Security and Medicare, but also with respect to budget projections for the coming ten years. Reducing this gap to a more sustainable level is vital.

Achieving a substantial and sustainable reduction in our fiscal imbalance is important to decrease the risk of lower future growth in private investment which could dampen future productivity gains. Reducing our fiscal imbalances is also important for reducing the risk of adverse shocks to financial markets, and for maintaining the willingness of investors to invest in our economic future. Improving the credibility of our commitment to this fiscal challenge is the most important contribution we can make towards improving the chance of a more benign adjustment in our external imbalance.

External imbalances have reached unprecedented levels, most dramatically in the case of the U.S. current account deficit, which is on a path to exceed six percent of GDP. These imbalances – fiscal and external – cannot be sustained indefinitely.

This combination of fiscal sustainability problems, large external imbalances, and the tension in the existing exchange rate system creates the risk of unanticipated shocks to financial prices, even in a context where monetary policy credibility is strong. The probability of these shocks may be low, but it is higher than it has been, and higher than we should be comfortable with. These shocks could be large enough to lower future growth outcomes.