Greenspan Signals Interest Rate Hike : Economy: Central bank may have to raise borrowing costs to prevent a new spurt in inflation, Fed chief warns. Action is not expected until March at earliest.

Federal Reserve Board Chairman Alan Greenspan warned Congress Monday that his agency may have to raise interest rates to prevent the economic recovery from triggering a new spurt of inflation.

Describing the current short-term rates--less than 3% for three-month Treasury bills--as “abnormally low,” he said that, unless there is an “unexpected and prolonged weakening of economic activity, we will need to move them to a more neutral stance.”

The Federal Reserve’s policy-making committee, which is scheduled to meet Thursday and Friday, must consider “when is the appropriate time to move to a somewhat less accommodative level of short-term interest rates,” Greenspan said in testimony before Congress’ Joint Economics Committee.

He said that the Fed will have to decide how long to “continue monetary accommodation without sowing the seeds of another bout of inflationary instability accompanied by steeply rising long-term rates.” However, action on interest rates is not expected by economists until March at the earliest.

President Clinton, responding to Greenspan’s remarks, told reporters at the White House later Monday that he hoped any increase in short-term rates would not be followed by an increase in long-term rates, “because there’s no need to do it.”

“We’ve still got good, strong growth in this economy,” he said. “But we want to manage it with real discipline; that is, we don’t want to have one of these roller-coaster things. We want the economy to grow in a very stable, solid way and, obviously, low interest rates are critical to that.”

Clinton made it clear that he expects cooperation in the effort to hold down both inflation and interest rates:

“I consider that part of the kind of compact that we’ve all made where we’ll continue to reduce the deficit, and we’ve got to keep inflation down and interest rates down so that people can afford to borrow money and invest.”

Greenspan’s comments were couched in the customary cautious language that members of the Federal Reserve Board use when addressing the sensitive issue of interest rates. But they nevertheless signaled a readiness to move toward higher interest rates, as well as a heightened concern that the economic muscle being exercised throughout much of the nation--struggling Southern California is the major exception--must be watched carefully so that growth is not allowed to ignite inflation.

The Federal Reserve chairman and other economists emphasized the need to shift from longstanding policy and strike preemptively against inflation because, once prices begin to rise, the dramatic steps needed to bring them under control risk creating a recession. Taking action in advance of solid evidence that inflation is occurring, however, goes against conventional economic procedure, in which measures are put in place only after specific data indicates they are needed.

The Federal Reserve’s decisions have impact far beyond the financial instruments it controls--its own short-term loans to commercial banks, for example. Other short-term rates usually follow the Fed’s lead.

Higher rates make it more expensive for businesses to borrow and expand; they put a leash on inflation, but also on the creation of jobs by retarding overall economic activity. On the consumer level, increases imposed by the Federal Reserve eventually can translate into higher rates for auto loans and adjustable-rate mortgages, as well as for bank deposits.

More generally, statements by Federal Reserve officials are so widely respected that they tend to become self-fulfilling prophecies. A forecast of good times ahead, for example, can send Americans scurrying to make just the kinds of investments that promote economic growth.

The federal funds rate, the rate charged for overnight loans among banks, hit a peak of 9.75% in 1989. The rate has held steady since September, 1992, when it fell to a nearly 30-year low of 3%.

Even as he said that “the foundations of the economic expansion are looking increasingly well-entrenched,” Greenspan said that the expansion has been uneven and that weakness abroad has restrained U.S. exports.

But, he said, accelerating domestic economic activity “has put some upward pressure on prices.”

“By the time inflation pressures are evident, many imbalances that are costly to rectify have already developed and only harsh monetary therapy can restore the financial stability necessary to sustain growth,” he said.

Inflation in 1993 was 2.7%, the lowest rate since 1965, with the exception of 1986.

Greenspan’s comments coincided with a high-flying day on Wall Street, during which the Dow Jones industrial average rose 32.93 points, to close at a record high of 3,978.36. At the same time, the bond market was mixed, with traders largely discounting the prediction of higher interest rates because anxious investors already had anticipated such increases.

During Monday’s hearing, Rep. David R. Obey (D-Wis.), chairman of the Joint Economic Committee, urged Greenspan to delay as much as possible imposing any increase in interest rates, “given the limited number of indicators that inflation is around the corner.”

Greenspan did not respond.

Allen Sinai, chief economist at Lehman Bros. in New York, praised efforts to take action in advance of clear evidence that inflation is occurring.

But he said that any action before March is unlikely, because the next set of economic figures--those for January--would be skewed by the freezing temperatures in the East and the earthquake in California.