Former US Federal Reserve chief Alan Greenspan said on Monday there is an increased risk of a recession but cautioned that the Fed must still be on guard for a rise in inflation.

"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 possibility of a large drop in house prices poses the biggest risk. A mild decline in home prices accompanied by a big pullback in construction that would help clear inventories would put the economy "in fairly good shape," Greenspan said.

"But if the whole thing festers, it will erode household balance sheets and eventually impact on what the critical support has been in the economy: consumer expenditures," he said.

Globalization Turns

Currently, the spotlight turns to Ben Bernanke, the former Princeton University professor who succeeded Greenspan on February 1, 2006, and who now faces the biggest test of his tenure.

The Bernanke-led Fed -- which has been criticized by some on Wall Street for a slow response as housing-related credit market stress mounted in August -- is widely expected to lower interest rates on Tuesday to protect the economy.

Greenspan said the Fed's decision-making comes against a more complicated backdrop than he faced as chairman when rapid globalization was keeping inflation in check, allowing the central bank to cut interest rates aggressively when the US economy stumbled in 2001.

"Disinflation is probably close to its peak now, and obviously as disinflation eases, inflation of necessity is picking up," he said. "I don't expect an inflation surge. I just think we're bottoming out on the disinflationary pressures."

"It's going to make monetary policy a lot more difficult than it was during most of the time 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," he said, adding that a 5 percent level fitted economies with a "paper" currency not linked to gold.