Greenspan Says Fed Will Keep Hiking Interest Rates

Federal Reserve Chairman Alan Greenspan said Tuesday that fears over shaky savings and loan firms, highly leveraged corporations and Third World debt will not deter the central bank from its policy of gradually pushing up interest rates to fight inflation.

But Greenspan disappointed traders in financial markets, where both the U.S. dollar and long-term bonds lost some of their early gains, because the Fed chairman failed to prescribe any immediate doses of anti-inflation medicine.

“Some have argued that these financial stresses, taken together, could hamstring the Federal Reserve’s anti-inflationary policy,” Greenspan told the Senate Banking, Housing and Urban Affairs Committee in his twice-yearly testimony to Congress on monetary policy.

But the Fed’s monetary policy, Greenspan told lawmakers, is “not the instrument to deal with structural financial stresses” that might be faced by troubled savings institutions, corporations financed by junk bonds and debt-ridden Latin American countries as higher interest payments push up their borrowing costs.

Indeed, Greenspan argued, it would be self-defeating for the Fed to back away from its nearly year-old policy of credit tightening. “Attempting to lower interest rates in the short run,” he said, “would quickly raise inflationary expectations, leading soon to higher, not lower, interest rates.”

But Greenspan’s testimony was not tough enough for many investors worried about future inflation.

“(U.S.) monetary policy remains unchanged,” a currency trader in Frankfurt, West Germany, told an Associated Press reporter. Dismissing Greenspan’s testimony because he simply repeated many of his earlier statements, many dealers interpreted his remarks as indicating that “further interest rate increases are out of the question for the time being,” the Frankfurt trader said.

In his testimony, Greenspan defended the Fed’s measured anti-inflation approach, which has resulted in step-by-step interest rate hikes since last spring from 6.5% to about 9.3% today.

“Monetary policy, at least for the moment, appears on track in the United States,” Greenspan said.

Greenspan acknowledged, however, that Fed officials expect inflation to rise “slightly” this year. He conceded that the “wage and price process may have developed some momentum.” By acknowledging that inflation is likely to rise further, complained Allen Sinai, head of the Boston Co. economic group, the Fed “has bent toward the Administration’s position” of opposition to sharp, immediate interest rate hikes.

The Fed, he argued, “is showing less resolve on inflation than I would have expected.”

But Greenspan insisted that the Fed will seek to maintain a tight grip on credit, saying that its restrictive monetary policy would lead to “some slowing in the underlying rate of growth of real GNP.”

Overall, central bankers expect economic growth to average between 2.5% and 3% this year, Greenspan said. But taking into account the expected bouncing back of the economy after last year’s widespread drought, Greenspan said that the Fed’s policy is aimed at holding growth in the non-farm economy to roughly 2% in 1989, down sharply from the 3.3% gain, excluding drought, chalked up last year.

The Fed’s latest forecast is slightly higher than its prediction of last summer but still somewhat lower than the Bush Administration’s forecast for this year of more than 3% growth above the inflation rate.

In a move to slow inflation, the Fed’s monetary policy committee--consisting of the seven Washington-based Fed governors and 12 regional bank presidents with five votes on the panel--lowered from last year the target ranges for key money supply measures by a full percentage point.

But a number of analysts expressed skepticism about the ability of the Fed to fine-tune the economy.

“GNP growth in the first half of 1989 could be roughly double the target range sought by the Fed,” said David Levine, chief economist at Sanford C. Bernstein & Co., a New York investment house. “The upshot is that the Fed’s latest tightening moves will not be the final ones.”

And Sinai contended that the Fed is “caught between two deficits--budget and trade.” Continuing budget deficits mean that higher interest rates are the only tool to fight inflation, Sinai said, but the “high trade deficit discourages resolute action . . . since higher U.S. short-term interest rates raise the dollar and make the trade deficit worse.”

Greenspan, defending the arrangement under which the United States and its major trading partners have worked together to stabilize the dollar’s value over the last year, said he expects that such stability “will continue.”

The Fed chairman also sought to downplay any potential differences over economic policy between the Fed and the White House. The White House is relying on a highly optimistic combination of lower interest rates and stronger growth to help reduce the deficit.

While arguing that the Fed’s forecast for economic growth “is somewhat more probable than theirs,” Greenspan said that the “differences between the forecasts are not large.”

Moreover, Greenspan agreed with White House officials that their forecast of sharply falling interest rates might be achievable in the unlikely event that Congress quickly ratified Bush’s budget proposals.

The Fed chairman again endorsed Bush’s strategy of seeking to reduce the budget deficit largely through spending cuts, adding that he is relatively optimistic that lawmakers will work out their differences with the White House over spending priorities after a lengthy political struggle this year.

And Greenspan repeated his plea to Congress to stick with the Gramm-Rudman law’s target calling for a federal deficit ceiling of $110 billion next year. “Markets would view (any relaxation of the Gramm-Rudman targets) most unfavorably,” he said.