Greenspan Sees No Dip in Interest Rates : Fed Chairman Vows to Ease Tight-Money Policy if Deficit Is Cut

Federal Reserve Chairman Alan Greenspan on Tuesday said that the central bank plans to keep interest rates up to help curb inflation, but he assured lawmakers that rates will fall if they cut the budget deficit this year.

Greenspan told the House Banking, Finance and Urban Affairs Committee that the Fed cannot yet relax its tight-money stance, which has led to sharply higher short-term interest rates over the last few months. The current inflation rate of about 4.5%, he said, is “clearly too high and must be brought down.”

At the same time, however, Greenspan revised upward his estimate of the growth rate that the economy could sustain without triggering an inflationary spiral.

Investors apparently took heart from Greenspan’s remarks, and the stock market surged for the first time past its level just before Black Monday--Oct. 19, 1987--when the Dow Jones industrial average lost more than 500 points. Analysts said that stock and bond traders decided Greenspan was signaling that interest rates already are high enough to satisfy the Fed.

Since last spring, when fears evaporated that the 1987 stock market crash would cause an economic downturn, the Federal Reserve has engineered a series of credit-tightening moves that have pushed short-term interest rates up by about 2.5 percentage points. The goal is to prevent the relatively strong economy from overheating and igniting inflation.

Some Banking Committee members urged Greenspan Tuesday to push interest rates down to help potential home buyers. But the Fed chairman insisted that the central bank cannot relax its hold on credit without running the risk of a dangerous escalation in prices.

Administration Opposition

His determination to keep fighting inflation through relatively tight money could place him at odds with the Bush Administration, which is counting on the combination of strong growth and sharply lower interest rates to help narrow the budget deficit without a tax increase.

But the Fed chairman also fell in step behind Bush’s proposal to balance the budget through a “flexible freeze” on spending--a hold-down on overall spending growth to the rate of inflation.

Moving to overcome the impression that he supported a tax increase when he testified to the National Economic Commission last November, Greenspan firmly told lawmakers Tuesday that Congress should close the budget gap by devoting “all or virtually all” of its attention to curbing spending.

He appeared to promise lawmakers that, if they would endure the political pain of cutting government spending, they would be rewarded with lower interest rates.

Once Congress reaches agreement with Bush on a plan that would reduce the deficit significantly over the next few years, Greenspan said, “markets would react in ways to bring interest rates down.” If the federal government borrows less to finance the deficit, economists believe that would reduce upward pressure on interest rates.

However, if Congress and the White House fail to negotiate a budget compromise, Greenspan said he would rather swallow the automatic, nearly across-the-board spending cuts called for under the Gramm-Rudman budget law than abandon the law’s deficit-reduction targets.

Automatic Cuts Defended

“If all else fails,” he said, “as much as I dislike the thought of (automatic cuts), I would prefer it.”

Under Gramm-Rudman, the White House is required to impose automatic cuts designed to push the deficit down to $100 billion next year unless Congress adopts legislation before Oct. 15 that would result in a deficit no higher than $110 billion.

Without legislation to cut spending or raise revenue, the Bush Administration projects a deficit of $127 billion in fiscal 1990, which begins Oct. 1. The Congressional Budget Office, using a less optimistic economic forecast, sees a deficit of $141 billion.

Greenspan offered only one concession to lawmakers who would like to raise taxes as part of a deficit-reduction package. He said that he still supports a gasoline tax hike of as much as 30 cents a gallon, which might raise as much as $25 billion to $30 billion at the same time that it would conserve energy and reduce the nation’s dependence on foreign oil.

But Greenspan said that he opposes an oil import tax because, by raising the cost of all petroleum products, it would impose too costly a burden on U.S. industry locked in competition with foreign firms.

Greenspan, who has warned in the past of the dangers of spiraling inflation, acknowledged that the economy has achieved “surprising gains” over the last two years “without a flare-up of inflation.”

But he warned that economic growth needs to slow to avoid “a serious intensification of inflationary pressures at some not too distant point.” He also upset lawmakers when he said that any further significant decline in unemployment from its current 5.3% rate would point “to a high probability of stepped-up wage pressures.”

There was a hint, however, that Greenspan is willing to tolerate somewhat faster growth than he has indicated in the past.

Last summer, the Fed chairman told a congressional committee that the economy could not grow much faster than 2% to 2.5% a year without running the risk of higher inflation. But Tuesday he suggested that long-run growth of 2.5% to 3% might be achievable.

That still apparently leaves Greenspan at odds with the White House. The Bush Administration is expected to adopt the Reagan economic forecast calling for growth in excess of 3% a year over the next several years.

Inflation Warning

Greenspan said that it might be possible to achieve such robust growth if productivity improves unexpectedly, but he warned that “a policy that assumes such outcomes risks significant inflationary imbalances. I think it is wiser to have money in the bank before we spend it, so to speak.”

Nonetheless, Greenspan avoided any direct criticism of the new Administration. He told Rep. Thomas McMillen (D-Md.) that the Administration’s economic projections are “credible” if Congress swiftly approves the Administration’s proposed spending cuts designed to meet the Gramm-Rudman targets.