Fed Chairman Prepared to Cut Interest Rates

Federal Reserve Chairman Alan Greenspan said Wednesday that the central bank is prepared to push interest rates down again to offset any further lending squeeze by banks and that it will act quickly to keep the country out of a recession by cutting interest rates, if lawmakers agree on a major deficit-reduction package.

In testimony to the Senate Banking, Housing and Urban Affairs Committee, Greenspan made it clear that he is looking for reasons to lower interest rates that will not raise fears on Wall Street that he is abandoning the fight against inflation.

The Fed is now worried enough about the “unwelcome effects” caused by banks’ imposition of stiffer lending standards that it “must remain alert to the possibility that an adjustment . . . might be needed to maintain stable overall financial conditions,” Greenspan said.

Late last week, citing similar concerns, Greenspan disclosed in advance a move by the Fed to cut its bellwether federal funds rate by one-fourth of a percentage point to about 8%.

Only a month ago, the Fed chairman had dismissed widespread complaints that banks were creating a “credit crunch” by cutting back on loans to riskier borrowers.

Although applauding tighter bank lending rules as necessary to put “the financial system on a sounder footing and contribute to economic stability in the long run,” Greenspan argued that in recent weeks many banks “may have slipped over (the) line” in cutting off loans to some credit-worthy borrowers.

By stating that the Fed intends merely to counter a tightening of credit by banks, analysts said, Greenspan is trying to avoid the impression that the central bank is bowing to pressure from the White House to stimulate the economy.

Greenspan “has been very clever in explaining the Fed’s move,” said Jerry Jordan, chief economist at First Interstate Bank in Los Angeles. The Fed chairman’s intention, Jordan said, is to prevent “any perception (that) he’s caved in on the long-run inflation battle.”

At the same time, Greenspan held out a carrot to budget negotiators by making his strongest statement yet that the Fed intends to make sure interest rates fall to offset any drag on the economy that might be caused by raising taxes and cutting spending.

His testimony was welcomed by the White House, which has been publicly critical of the Fed for keeping rates firm in the face of a slowing economy.

“One of the reasons we need to get the deficit down is to take pressure off interest rates and to help bring them down,” Marlin Fitzwater, Bush’s chief spokesman, told reporters. It is “helpful just in knowing that others see the goal of this process the same as we do, which is to get interest rates down and to keep the economy growing.”

Some conservative economists argue that the Fed could undermine its efforts to control inflation if it agrees to cut interest rates in response to a deficit-reduction deal. And Greenspan cautioned that any easing of monetary policy by the Fed in response to a tighter fiscal policy from Congress and the White House “cannot be spelled out before the fact.”

Nonetheless, he promised that “major, substantive, credible cuts in the budget deficit would present the Federal Reserve with a situation that would call for a careful reconsideration of its policy stance . . . . I can only offer the assurance that the Federal Reserve will act, as it has in the past, to endeavor to keep the economic expansion on track.”

In a series of confusing, back-and-forth comments on the state of the economy, Greenspan left the overall impression that, at least for now, he is prepared to ignore minor inflationary risks to help keep the economy growing.

Although Greenspan conceded under sharp questioning by Sen. Paul S. Sarbanes (D-Md.) that the “current situation is balanced with perhaps a shade tilt toward recession,” he immediately followed up with a comment that he does not “see any cumulative evidence (that the economy) is working towards a recession.”

More to the point, Greenspan dismissed as a temporary blip Wednesday’s report that June consumer prices jumped by an unexpectedly sharp 0.5%. “While the figures that were released today . . . were higher than one would like to see,” he said, “it doesn’t, in my judgment, fundamentally affect the underlying trends.”

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