Greenspan Opens Door for a Lower Interest Rate

Federal Reserve Board Chairman Alan Greenspan said Friday that the Fed is concerned about the growing risks to the U.S. economy from the mounting world financial turmoil and is prepared to cut interest rates if necessary to prevent a recession.

In a speech at UC Berkeley, Greenspan said that while Fed policymakers earlier had viewed inflation as the economy’s primary threat, they since have become convinced that the risks have shifted and will now “need to consider” the recent market turmoil in deciding what to do.

Though Greenspan did not specify whether the Fed might lower or raise interest rates, he said he believes the condition that would call for higher rates--an inflation threat--has subsided. The corrective action for global economic turmoil would be to lower rates.

“It is just not credible that the United States can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress,” Greenspan said.

The Fed chairman’s comments, delivered after the close of U.S. financial markets, marked the first major attempt by a senior U.S. policymaker to try to calm world financial markets by directly addressing demands by some investors that the Fed act to cut interest rates now.

Although Greenspan did not promise that the Fed would cut interest rates when its policy-setting Federal Open Market Committee next meets, on Sept. 29, he opened the door to an interest-rate cut if the spreading Asian economic slump is threatening to cause a U.S. or worldwide recession.

Greenspan’s remarks were considered likely to drive up global financial markets.

U.S. financial markets, which will be closed for the entire Labor Day weekend, will not open until Tuesday morning, but they are expected to take their cue from what happens in Asia and Europe between now and then.

His speech came a few hours before he joined U.S. Treasury Secretary Robert E. Rubin in a dinner meeting with Japanese Finance Minister Kiichi Miyazawa for talks about how to bring Japan out of its recession before it worsens the economic slump in Asia.

No New Japanese Initiatives Offered

Although U.S. officials consider it urgent that Japan spur its economy and overhaul its fragile banking system, both sides said the two finance chiefs essentially reiterated their previous positions, and no new initiatives were offered.

U.S. officials hoped to ease Japanese resentment of Washington’s eight-month campaign to pressure Tokyo into acting more quickly by taking a more conciliatory approach that would not seem like badgering. Miyazawa conceded later he had not made any promises for more rapid action.

Fed officials have indicated they are reluctant to cut rates because there still is so much momentum in the U.S. economy that they fear continued tight labor markets and booming production in many factories will intensify inflation pressures here.

The Labor Department reported earlier Friday that the economy produced a spate of new jobs in August even though it is growing at a slower pace, while average wages also increased significantly. Some analysts believe that will begin to taper off soon, while others are uncertain.

But Greenspan’s remarks Friday suggested that while the Fed still would prefer to be cautious, it is willing to move quickly if the global economic situation continues to deteriorate--possibly cutting interest rates slightly, either in September or sometime in the next few months.

Fed policymakers slashed interest rates prematurely after the stock market crash of October 1987 and ended up allowing inflation to get out of hand again. That required them to tighten monetary policy later--a move that helped cause the 1990-91 recession.

Economists are divided over how much good an interest-rate cut would do for the world economy.

While some say hard-hit Asian countries would benefit from a rate cut in the United States--by lowering their own interest rates and reducing capital flight to the U.S.--others contend there would be little real impact because the premiums they must pay for borrowing are unusually high.

Even so, many analysts believe that even a signal that the Fed may be willing to cut interest rates would be enough to spur the markets in what has been a tumultuous period driven largely by volatile investor psychology. The Dow Jones industrial average lost more than 400 points last week alone.

The Fed last changed interest rates in March 1997, when it raised its target for the federal funds rate--the interest banks charge each other on overnight loans--to 5.5%, from 5.25%. By contrast, long-term interest rates have come down sharply during the last few months.

Although Greenspan did not mention it, the Fed’s new willingness to consider cutting interest rates in the United States if the domestic economy appears to be threatened could pave the way for a coordinated rate cut by the Group of 7 major industrial countries if they decide to go along.

Some analysts have suggested that the U.S., Europe and Canada should cut interest rates simultaneously, while Japan holds its interest rates steady, as a show that international economic policymakers are prepared to act to stave off a global slump. Washington, however, so far has rejected any such plan.

Greenspan peppered his speech with warnings to investors about being either too complacent or too pessimistic about the behavior of stock markets, noting that a bull market often seems “unending,” while when markets contract it can feel “that recovery is inconceivable.”

“Both are wrong,” he told the group.

“But because of the difficulty imagining a turnabout when such emotions take hold, periods of euphoria or distress tend to feed on themselves,” he said. “If this were not the case, the . . . psychologically driven ebbs and flows of economic activity we have observed would be unlikely to exist.”

Greenspan has been warning stock market investors for most of this year that the market had become overvalued and was heading for a major correction, but he was criticized by analysts who thought he was spoiling the boom. Last December, he cautioned that investors were showing “irrational exuberance.”

Crisis Not Foreseen, Greenspan Says

The Fed chairman made his remarks during a speech that traced the impact of global markets on the U.S. economy.

He conceded that while America has been largely insulated from the Asian crisis so far, “as dislocations mount abroad, feeding back on our financial markets, restraint [of economic growth in the United States] is likely to intensify.”

He also admitted that he and other top policymakers “did not foresee” the financial and economic breakdown in Asia, which he said was “virtually impossible to anticipate. It is like water pressing against a dam,” he said. “Everything appears normal until a crack brings a deluge.”

After Rubin and Miyazawa met, both told reporters that they had not discussed the question of the exchange rate between the U.S. dollar and the Japanese yen.

Asked whether the meeting had produced any change in Japan’s position on Washington’s plea that it stimulate its domestic economy, Rubin sidestepped the question.

NATION’S PAYROLL UP: U.S. jobs grew substantially in August, though at a slower pace than last winter. D1

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