Greenspan Warns About Inflation, Pace of Growth

Describing the economy as in a “very crucial period,” Federal Reserve Chairman Alan Greenspan cautioned Thursday that inflation has been held back by forces that are only temporary and said that key decisions on interest rates will have to be made in the near future.

The mixed message nonetheless sparked a rally on Wall Street, where investors took comfort in the view that the Fed might refrain from a widely feared, imminent hike in interest rates. The stock market, wracked by turmoil earlier this week, shot upward, with the Dow Jones industrial average gaining 87.30 points, or 1.62%, to close at 5,464.18, its biggest gain since mid-March.

In a report to Congress, Greenspan offered an ambiguous portrayal of the economy, which he said could move in drastically different directions later this year and which has provided only “scant” evidence of price pressures despite a growth pace that has far exceeded most forecasts.

“There is a very legitimate concern at this particular point about where the economy is heading,” Greenspan said. “And I don’t think anybody knows for sure.”

Yet the nation’s top economic policymaker hinted that recent signs of robust growth, notably a booming labor market, are fueling concerns inside the Fed about future inflation and whether the economy--contrary to forecasts--might start to overheat in coming months. “The process of slowing down has to become apparent in the period immediately ahead,” Greenspan declared.

Greenspan’s testimony--always ambiguous and inevitably the occasion for tea-leaf reading about interest rates--prompted even more anticipation than usual, coming in the wake of wild turbulence on Wall Street and growing questions about the strength of the economy.

Signs of brisk growth, including a strong job market, have convinced many analysts that Federal Reserve officials might push up interest rates soon to prevent a new round of inflation, even if such action puts the aging U.S. recovery in jeopardy.

Greenspan sought to calm jitters in the investment world by pointing out that the central bank’s official forecast is for growth to slow substantially from the recent pace that many believe is in the range of 4%. He was quick to add, however, that the long-expected slowdown “hasn’t happened yet.”

Uncertainties about the future, the chairman said, are reflected in Wall Street’s recent turmoil, as reports of booming economic activity sparked “a serious question” about whether long-term interest rates would rise in the future.

Analysts peered into Greenspan’s carefully worded testimony and perceived varying messages.

Some took heart in the evidence that the economy will slow soon, suggesting that even if the Federal Reserve chooses to hike rates, the move might be modest. “We judge that the odds of a Fed tightening in August are reduced but not eliminated,” concluded economists at the Merrill Lynch investment firm, who also pointed to what they called Greenspan’s “guarded optimism” on inflation.

Such interpretations were pervasive on Wall Street, where interest rates tumbled as word of Greenspan’s remarks spread rapidly.

Overall, Federal Reserve officials are forecasting economic growth in the moderate range of 2.5% or slightly higher this year and about 2% in 1997. Consumer inflation, they said, is hovering around 3% or a bit higher this year and will decline slightly in 1997.

“There are a number of reasons to expect . . . economic activity to settle back toward a more sustainable pace in the months ahead,” Greenspan said, alluding to higher long-term interest rates, household debt levels and other factors.

Other analysts focused on the chairman’s not-so-veiled warning that interest rates will be raised if the economy continues to gallop faster than Federal Reserve officials believe can be sustained without inflation, an unofficial target that is possibly in the range of 2% to 2.5%.

“He didn’t say it [raising rates] was a done deal, but he expressed concern about the early warning signs of inflation,” said Stephen S. Roach, chief economist at Morgan Stanley. “The next few weeks and months will hold the key.”

Despite the recent financial turbulence, Roach maintained that Wall Street investors remain “very, very optimistic” when it comes to inflation, which would explain the stock market’s upbeat behavior Thursday.

Speaking to the Senate Banking, Housing and Urban Affairs Committee, Greenspan sought to underscore the many cross-currents in the economy and the puzzling position in which they have left policymakers.

Inflation has remained “quiescent,” he said, and by some measures has slowed down from a year ago.

Moreover, there is reason to anticipate slower growth in the months ahead, he said, further reducing inflationary worries. One key reason is that long-term interest rates have risen one percentage point or more since the start of the year, a development that would be expected to subdue activity in housing and other key sectors of the economy that are influenced by interest rates.

A stronger dollar helps ease price pressures, added Greenspan, 70, who was confirmed by the Senate last month to a third four-year term. On top of that, many households are saddled with debt, a factor that could restrain future spending by consumers.

Nonetheless, the central bank chairman made it clear that the slower growth scenario remains unproven and there are various reasons to believe that the economy might continue to expand at a more robust rate. If that happens, he suggested, the Federal Reserve might have to combat latent inflation with a hike in interest rates. It is “too early to basically argue that the relative [economic] exuberance we saw in the spring and the early summer has simmered down yet,” he said.

In describing his concerns about inflation, Greenspan said that pressures which have acted to keep prices in check in recent years are only temporary. For example, workers insecure about their jobs might have been willing to accept small pay increases without complaint but such attitudes might not continue.