Fed Chief Hints Interest Rates Won’t Fall Soon

Federal Reserve Chairman Alan Greenspan, hinting that interest rates will not be heading down anytime soon, predicted Tuesday that the U.S. economy will stage a modest rebound during the rest of this year.

“Available indicators of near-term economic performance suggest that the weakest point may have passed . . . ,” Greenspan told a House Banking subcommittee in his semiannual report on monetary policy. “While we cannot be certain that we are as yet out of the recessionary woods, such evidence warrants at least guarded optimism.”

The economy grew at a scant 0.5% annual rate in the fourth quarter of last year, and many analysts expect similarly anemic real growth during the current three-month period.

Greenspan’s comments, coming on top of another round of interest rate hikes in West Germany and Japan, helped send stock and bond prices skidding over concerns that interest rates are unlikely to fall. The Dow Jones Industrial Average fell 38.74 points Tuesday.

Rising interest rates abroad have left the Fed with little room to ease rates at home, lest investment funds flow out of the United States. And Greenspan’s positive evaluation of the domestic economy’s future means that he would not use the threat of recession to justify a relaxation of credit policy.

The modest 1.75% to 2% annual growth rate projected by central bankers at the Fed, however, is slower than the Bush Administration’s somewhat rosier 2.6% forecast. That points to the likelihood of further economic policy clashes between the White House and the central bank over the prospects for reviving more robust growth without higher inflation.

Greenspan repeatedly emphasized the Fed’s intention to squeeze inflation gradually out of the economy, even if it requires a sustained period of sub-par economic performance. In so doing, he appeared to throw cold water on Administration expectations that stronger growth and lower interest rates would come together nicely to help slash future federal budget deficits.

While conceding that the White House economic forecast is “internally consistent” in that it relies on the assumption Congress will accept White House spending cuts and tax proposals, “obviously we don’t agree with that forecast,” Greenspan said. The Fed, he added, “is not required to assume what they assumed.”

Greenspan focused more attention on the risks of higher inflation than fears of a recession. The Fed chairman’s comments so far this year stand in sharp contrast to testimony he offered last summer, when the central bank was in the midst of engineering lower interest rates because of the perceived risk that economic growth was collapsing.

“The message,” said Alan Sinai, chief economist of the Boston Co., a forecasting firm that is a unit of American Express, “is that interest rates will stay high and perhaps go higher as the central bank keeps the economy throttled back to bring down inflation.”

The only thing that would convince the Fed to ease its grip on credit, several economists added, would be unexpected new evidence that the economy is slipping into recession.

“To me, the economy looks pretty weak, and I don’t see much growth ahead,” said Stephen Axilrod, vice chairman of Nikko Securities in New York and the Fed’s former chief monetary policy staff member. “While I don’t see them easing right away, if the Fed is reading the economy wrong, they would probably have to reconsider their stance.”

Greenspan also made a strong point of arguing with those who contend the United States has lost control of its economic destiny as a result of running up big trade deficits in the 1980s.

“The U.S. economy is influenced from abroad to a substantially greater degree than, say, two or three decades ago, but U.S. monetary policy is, nonetheless, able to carry out its responsibilities effectively,” Greenspan said.

“Just as U.S. markets are influenced by developments in markets abroad, foreign markets are influenced by events here,” he added. “These channels of influence do not depend on whether a country is experiencing a deficit or a surplus in its current account.”

Nonetheless, several analysts contend that Greenspan’s room to maneuver has narrowed because of rising interest rates abroad.

“The economy is weak, and that would normally call for lower interest rates, but Greenspan is no longer entirely captain of his own ship,” said Irwin Kellner, chief economist for Manufacturers Hanover Bank in New York. “What he is doing is standing pat, hoping the worst is over and praying the markets will cooperate in making his prediction a self-fulfilling prophecy. It’s quite a high-wire act.”

The Fed slightly lowered its earlier prediction of inflation, calling for a consumer price rise of 4% to 4.5% compared with a June forecast of 4.5% to 5%.