The Federal Reserve slightly eased its grip on credit a few weeks ago, Fed Chairman Alan S. Greenspan acknowledged Tuesday, but the central bank is unlikely to let interest rates drop much further unless economic growth falls short of the Fed’s relatively modest expectations.
Greenspan, testifying before Congress on the conduct of monetary policy for the first time since he took over as Fed chairman from Paul A. Volcker last August, said he does not expect a recession during this election year.
Instead, he forecast growth in 1988 of 2% to 2.5% after last year’s robust 3.8% growth rate.
Although the U.S. economy has expanded for 63 consecutive months, one of the longest uninterrupted growth periods on record, “the economy does not exhibit the geriatric character of the very late stages of the business cycle expansion,” Greenspan told the House Banking, Finance and Urban Affairs Committee.
Comfortable With Level of Dollar
“We do not as yet see any indications (of) weakening. . . . While we envisage sluggish growth for the period immediately ahead, there just are very few signs that we are about to fall off.”
Greenspan, whose decisions at the helm of the quasi-independent Federal Reserve can be expected to play the most crucial government role this year in affecting the health of the U.S. economy, also said he is comfortable with the current level of the dollar in currency markets. He pointed out that private foreign investors have resumed pumping capital into the United States, helping to brake the recent fall of the dollar.
Citing continuing uneasiness over the effects of October’s stock market crash, Greenspan said “indications of some softening in the economy as the year began, against the background of a more stable dollar in foreign exchange markets, led us to take a further small easing step a few weeks ago.”
But displaying Delphic obscurity that seems to be characteristic of Fed chairmen, Greenspan did his best to give lawmakers only the faintest clues about the direction he will lead the central bank in the months ahead. Asked by Rep. Charles E. Schumer (D-N.Y.) whether he sees a greater risk of inflation or recession this year, Greenspan replied: “At the moment I would say the dangers are probably equal. It’s very difficult to judge.”
Analysts said the nation’s central bankers appear to be basically satisfied with the economy’s recent performance and that they see little need at the moment to push interest rates up or down.
If the United States appears to be slipping into a recession, the Fed is likely to respond quickly by lowering its discount rate to signal an easier monetary stance, economists believe. But if the economy grows much faster than the Fed’s forecast, interest rates are likely to begin moving back up.
“They don’t see any particular point in moving one way or another right now,” said Ira Kaminow, chief economist at the private Government Research Corp. in Washington. “Until there is evidence that the economy is way out of whack with the Fed’s understanding, I don’t expect to see interest rates change much in either direction.”
On Wall Street, investors took heart from Greenspan’s statement confirming suspicions that the Fed had eased its credit grip slightly and reacted by pushing up bond prices modestly, apparently on the expectation that interest rates are unlikely to rise in the near future.
Greenspan, responding to a question from Rep. Barney Frank (D-Mass.), rejected criticism of the central bank by White House economic adviser Beryl Sprinkel. Sprinkel publicly blamed the Fed in his economic report last week for pursuing an overly restrictive monetary policy in 1987 that “may have underestimated the risks to adequate economic growth.”
Critical of Sprinkel
“We did not perceive ourselves as being tight,” Greenspan said. He accused Sprinkel, who is widely identified with the “monetarist” school of economists, of relying far too much on the money supply to predict future economic activity and said there are valid reasons that the growth of the most important monetary measure was below the Fed’s target last year.
If the money supply had grown as fast as Sprinkel advocated, Greenspan said, it would have triggered “an unduly inflationary environment. . . . There is a difference of opinion between Mr. Sprinkel and myself on this issue.”
Greenspan, however, said the White House forecast of 2.4% economic growth this year is likely to prove more accurate than the more pessimistic predictions of some private economists and the Congressional Budget Office.
Greenspan said the Fed has set wider targets than usual for the growth of the money supply in 1988. That is the consequence of both an “unusual degree of uncertainty in the economic outlook” and the unpredictable recent behavior of the money supply, he said.
The Fed established a target of 4% to 8% growth for both M2--a number that measures the amount of money the public holds in cash, checking accounts and a variety of money market instruments--and M3--a broader measure of the money supply that includes M2 and most other assets easily convertible to cash.
Won’t Set M1 Range
The midpoint of these targets was set one percentage point lower than last year “as another step in the longer-term process of reducing targeted money growth to rates more in line with reasonable price stability,” Greenspan said.
Last year M2 fell short of the Fed’s 5.5% to 8% growth path, and M3 was at the bottom of its similar target range. Greenspan said the Fed “expects some acceleration of monetary expansion in 1988, perhaps to around the middle of the ranges. But changing circumstances could easily require a considerably different outcome.”
The Fed once again decided against setting a range for M1, the narrowest measure of the money supply consisting of cash and all types of checking accounts, because of the “decreasing usefulness of M1 as a monetary target.”
Greenspan said the United States had “turned the corner” on the trade deficit, which he said “is on its way to adjustment,” but cautioned that in “trending downward it will be slow and erratic.” He warned Congress that any protectionist legislation “would only . . . reduce living standards at home as well as around the world.”
Taking a well-worn page from the playbook of his predecessor at the Fed, Greenspan said Congress should focus on reducing the federal budget deficit. But unlike Volcker, he refused directly to recommend higher taxes to accomplish that goal.
Time of Circumspection
Greenspan expressed confidence about the inflation outlook for 1988 but warned that it would be dangerous to “become complacent about even the 3% to 4%" inflation rate of last year because “inflation sneaks up on you and then it’s too late.”
Some analysts, discounting Greenspan’s attacks on inflation as the expected comments of any Fed chairman, said they still expect the Fed’s board, all of whom were appointed by President Reagan, to shift toward fighting against the possibility of recession soon.
“Greenspan has to be very careful what he says because this is an election year and the Fed is afraid of being accused of playing election-year politics,” said Irwin Kellner, chief economist at Manufacturers Hanover Bank in New York. “I think they are looking for a way out of that dilemma.”
But other analysts said they expect the Fed to react almost exclusively to emerging economic statistics over the next few months in its moves to influence the economy’s performance through changes in the level of interest rates.
“Greenspan doesn’t want to commit himself in advance,” said David Levine, chief economist at Sanford C. Bernstein & Co., a New York investment firm. “I think you can count on the Fed to react in response to whether the economy falls short or exceeds their own expectations.”