Greenspan Vows Fast Rate Hike if Inflation Builds

Federal Reserve Board Chairman Alan Greenspan said Wednesday that the U.S. economy shows no signs of accelerating inflation, but he warned that the central bank will move quickly to boost interest rates again if it appears that price pressures are building.

Greenspan told the Senate Banking, Housing and Urban Affairs Committee that he sees scattered evidence of the kinds of scarcities that eventually can fuel inflation: shortages of certain workers, such as truck drivers and construction specialists, and increases in the costs of some raw materials.

But so far, he said, “we do not see any evidence of costs flowing through into final prices.”

“I said it back in May and I say it again today,” Greenspan told the committee, recalling his recent congressional testimony and underlining his insistence that the economy is in good shape and growing at a reasonable pace without overheating, even after absorbing four interest-rate increases engineered by the Federal Reserve between February and May.

However, he acknowledged that the decline in the dollar against the Japanese yen and the German mark, about 5% since he last testified, will raise the price of imported goods, increasing inflationary pressures.

The Fed must remain vigilant, he said, because the United States has only a small amount of slack industrial capacity and “it is an open question whether our actions to date have been sufficient to head off inflationary pressures and thus maintain favorable trends in the economy.”

Greenspan’s warnings about possible further interest rate hikes took a toll in the financial markets. Stocks declined, as the Dow Jones average of key industrial issues dropped 21.04 points to close at 3,727.27. Interest rates in the bond market had been falling for three weeks, but began rising after Greenspan’s testimony. Yields rose across the board, with the key 30-year Treasury bond closing at 7.54%, up from 7.46% on Tuesday.

Greenspan’s testimony was accompanied by the issuance of the central bank’s semiannual report, which disclosed the Federal Reserve’s strategy of keeping its targets for monetary growth basically unchanged from this year.

The Fed expects that its efforts will restrain the “central tendency” of inflation to a range between 2.75% and 3% for this year, and between 2.75% and 3.5% for 1995, the report said. Retail prices paid by consumers rose 2.7% last year, the best performance in the fight against inflation since 1986.

Greenspan and his Federal Reserve colleagues are engaged in a delicate and difficult balancing act, hoping that this year’s interest rate hikes have taken the speculative steam out of the financial markets and slowed the rapidly expanding economy to a healthier pace of moderate growth.

The Fed’s offensive in raising rates was an early strike to head off future troubles. There was no imminent inflationary threat, but the Fed governors were fearful that the rapid growth in business output and consumption during the final quarter of 1993 and early this year could have produced a burst of higher prices a year or 18 months later.

However, if the economy’s performance seems “unduly constrained” later, the Fed can reverse policy with minimal risk and quickly drive down interest rates, providing a rapid stimulus to growth, Greenspan told the committee. Easing up on the monetary brakes is much easier to do than combatting inflation after it already has spread through the economy, a painful lesson learned during the last 15 years, the Fed governors believe.

“We are looking at a complex economy with a rate of growth which has been extraordinary,” Greenspan said. “If we are simmering down to more long-term, sustainable levels (of growth), that is all to the good. We’re trying to get an economy which is balanced over time.”

This approach--hiking rates now to avoid inflation later--was berated as unduly cautious by two Democratic members of the committee, Sens. Paul S. Sarbanes of Maryland and Jim Sasser of Tennessee.

“I strongly disagree with the Federal Reserve policy--I am still at a loss to find evidence of an overheating economy,” Sasser said. Sarbanes held up several large-scale reproductions of editorial cartoons, each showing a caricature of Greenspan as worried and fearful of economic growth.

Sasser and Sarbanes were particularly critical of the higher interest rates because of the impact on the housing industry, where some customers are priced out of the market with any upward move in mortgage rates. The rising cost of a mortgage has forced many Americans, “especially young couples,” to forgo their dream of homeownership, Sasser said.

Housing starts plunged 9.8% in June to a seasonally adjusted annual rate of 1.35 million, down from a revised figure of 1.5 million in May, the Commerce Department reported Wednesday. Housing starts have fallen for three straight months. Home mortgage rates, which fell to 6.74% last fall, a 25-year low, reached 8.7% last week.

Sen. Barbara Boxer (D-Calif.), was more diplomatic in her dialogue with Greenspan, avoiding any direct criticism of the Fed chairman. She urged him to avoid cracking down too hard on business expansion.

“We look to your leadership; we don’t want to choke off a recovery that in our state is nascent,” Boxer said. “We can’t go back to high interest rates.”

California is lagging behind the rest of the nation in economic recovery as it slowly moves away from a dependence on military contracts, Boxer said.

* MARKET REACTION: Bond yields rose and stocks fell after Greenspan’s remarks. D1

Greenspan Impact

Federal Reserve Chairman Alan Greenspan’s talk of higher interest rates ahead this year depressed financial markets, which had been rallying in recent days. A glance at what happened:

STOCKS: Prices fell, with the Dow Jones industrial average ending down 20.40 points at 3,727.91. Declining issues outnumbered advancing stocks about 2-to-1 on the New York Stock Exchange.

BONDS: Treasury bond prices, a barometer of investor confidence and inflation fear, were sharply lower in late afternoon trading. The benchmark 30-year bond fell nearly $9 per $1,000 in face value, as its yield rose to 7.54%.

DOLLAR: The dollar fell against major currencies in New York trading following the stock and bond market drops. In New York, the dollar traded at 98.65 Japanese yen, down from 99.25 late Tuesday, and 1.5650 German marks, down from 1.5680 marks Tuesday.

COMMODITIES: Most commodity markets seemed little affected by Greenspan’s comments. Gold prices declined; corn and soybean futures prices fell sharply; and wheat futures were mostly lower. The Commodity Research Bureau index, an indicator of inflationary trends in basics ranging from grain to oil, was down 2.30 to 231.90.