Greenspan Says Inflation May Heat Up Again

Federal Reserve Chairman Alan S. Greenspan, hinting that the central bank may have to raise interest rates later this year, warned Tuesday that the U.S. economy is nearing a danger point at which inflation could begin to heat up again.

Issuing his strongest alarm against inflation since taking over from Paul A. Volcker as Fed chairman last August, Greenspan told the congressional Joint Economic Committee:

“Monetary policy needs to remain supportive of the expansion but also alert to the possibility of a re-emergence of inflation. . . . The cost of temporizing in the face of accumulating price pressures would be a far more serious and painful adjustment down the road.”

Greenspan said Fed officials are counting on relatively anemic economic growth of between 2% and 2.5% to keep the lid on inflationary pressures this year and to allow the central bank to maintain interest rates roughly at current levels.

Any move on the Fed’s part to boost interest rates would be particularly sensitive this year because of the political reverberations it could create in the presidential campaign.

“I don’t think the Fed likes to become the focus of attention in an election year,” said Barry Bosworth, a senior economist at the Brookings Institution here and a former federal official in President Jimmy Carter’s Administration. “They have to worry that they could be faced with the need to change policy directions at a very awkward time.”

But if growth in the U.S. economy exceeds the Fed’s relatively modest expectations, analysts noted, interest rates are likely to rise as the central bank tightens monetary policy in an effort to quell future inflation.

“We’re not into inflationary circumstances yet,” said Stephen Axilrod, vice chairman of Nikko Securities in New York and the former chief monetary policy staff member at the Fed. “But what concerns the Fed is that if there is any sign that consumer spending and housing are strengthening again, that could generate inflationary forces in the economy.”

In contrast to earlier congressional testimony last month, when the Fed chairman was careful to balance his concerns over the risks of recession and inflation, Greenspan made it clear that he now considers inflation the greater threat.

In response to a question from Rep. Stephen J. Solarz (D-N.Y.), Greenspan said the nation’s overall unemployment rate--currently 5.6%--could not fall much further without triggering higher wages and prices.

“You clearly have some modest room (to lower unemployment), but not a very great deal,” Greenspan said. At most, Greenspan suggested, the jobless rate has room to improve by no more than half a percentage point.

Greenspan also devoted a substantial part of his prepared testimony to discussing the “latent inflationary tendencies” that are likely as the U.S. trade deficit shrinks.

“As part of the move back toward external balance, export growth could place stronger demands on a domestic resource base that already is operating at high levels . . . in some areas,” Greenspan said. Experience, the Fed chairman said, “should make us cautious about thinking that this adjustment can be accomplished without some upward pressures on prices.”

Recession Fears Fade

As long as economic growth remains relatively modest, “one can conceive of a strengthening of exports meshing neatly with a slowing of domestic spending,” Greenspan said. In that case, he said, “overheating” of the economy would not become a serious problem.

“Realistically, however, one has to recognize that events in the real world may not mesh as neatly as contemplated,” he warned.

In contrast to his concerns over inflation, Greenspan suggested that he no longer is so worried that last year’s stock market crash will push the U.S. economy into a recession this year.

“Our economy was dealt a potentially severe shock last October,” Greenspan said, but “we seem to be weathering that shock perhaps better than might have been expected. . . . Overall, the chances appear relatively good for maintaining the current expansion through another year.”

Less Criticism

Earlier this year, several Administration officials, including Beryl W. Sprinkel, head of President Reagan’s Council of Economic Advisers, were worried that the Fed was risking an economic downturn by maintaining what they asserted was too tight a grip on the money supply.

As recent data produced evidence that the economy has performed well, however, Administration officials have curbed their public criticisms of the Fed, with Treasury Secretary James A. Baker III praising the central bank last week shortly after the Labor Department reported that the economy added more than 500,000 jobs in February.

And on Tuesday, Sprinkel said he is satisfied that the central bank’s money supply targets are consistent with Administration goals. “The current stance of monetary policy fulfills that objective,” Sprinkel told the House Appropriations Committee.