Greenspan Says Rate Hikes Haven’t Worked
Federal Reserve Chairman Alan Greenspan said Thursday that higher interest rates have done little or nothing to correct the “imbalances” in the U.S. economy, sending an unmistakable signal that more rate hikes are imminent.
Even as new government data were being released that showed few signs of inflation, Greenspan warned that “interest-sensitive spending has remained robust” and that the Fed “will have to stay alert for signs that real interest rates have not yet risen enough.”
Though Greenspan acknowledged that inflation “remains largely contained,” he still conveyed a heightened sense of urgency about the soaring stock market and the risks it may pose to America’s economic health.
The Fed chairman made his remarks to the House Banking Committee in the first segment of the twice-yearly testimony he is required to deliver to Congress.
“Any time you see the word ‘alert’ from Alan Greenspan, watch out,” said David M. Jones, chief economist at Aubrey G. Lanston & Co., a New York bond firm.
Jones recalled that in January, the Fed chairman expressed confidence that economic imbalances were being corrected through rises in interest rates. “That process is already well advanced,” Greenspan said at the time.
But in Thursday’s testimony, Greenspan pulled back from such expressions of confidence. He noted that stock market expectations had risen even higher, offsetting the medicinal effect that rising interest rates were supposed to have had.
“In this testimony, he’s saying rates have gone up but we haven’t seen that much effect,” Jones said. “That implies that they’ve got to do more.”
Greenspan reassured committee members that his quest for “sustainable growth” doesn’t necessarily mean he intends to trigger a major stock market correction. But he did warn that such a correction could “happen at any time, for any number of reasons.”
“He wants to ‘talk down’ the stock market,” said Rajeev Dhawan, director of the UCLA Anderson Forecasting Project. “That’s his only option.”
With stock prices at extraordinary levels, Dhawan said, there is rising concern that the U.S. economy is a “bubble” waiting to be burst--and although Greenspan believes he needs to bring investors back to their senses, he risks bursting their bubble himself if he increases interest rates too suddenly or too high.
“Damned if you do, damned if you don’t,” Dhawan said. “What’s the best action? Take the bully pulpit.”
Despite Greenspan’s more hawkish tone, Dhawan stood by his previous forecast of one or two more quarter-point interest rate increases by this summer. Jones said he still expects two such increases. The Fed’s key short-term rate is now 5.75%.
Greenspan is required to appear twice a year before the House and Senate banking committees to explain his monetary policy within the current economic context. He will address the Senate Banking Committee on Wednesday.
Though the legislation mandating his appearances was passed at a time of frighteningly high inflation and unemployment, Greenspan delivered Thursday’s remarks in a climate of unparalleled prosperity, when seemingly every new economic indicator reinforces the sense that America is on a roll.
Even as he spoke, for instance, the Commerce Department released its producer price index for January, revealing no price increase at all for finished goods. And although economists noted that the zero rate was in part the result of an unusual drop in tobacco prices, which dragged down the whole average, they said the “core” rate of increase for finished goods was a modest 0.1% when tobacco was excluded. The core rate excludes food and energy prices.
In another sign of continued economic strength, home building grew robustly in January despite the recent run-up in mortgage rates. The Commerce Department said permits for new-home construction jumped 8.7% in January.
Despite these glowing data, many committee members expressed concern about rising oil prices, growing wealth disparities in America and what to do with the federal budget surplus. But the Fed chairman indicated that his central preoccupation--and an area over which he has jurisdiction--is the so-called wealth effect.
He meant the aggressive spending by investors of their double-digit gains from the booming stock market and even borrowing against them to invest in even more stocks. Greenspan said the wealth effect has added about 1 percentage point to gross domestic product growth per year in recent years.
The cycle is dangerous, he testified, because it is “creating additional purchasing power for which no additional goods or services have yet been produced.”
And in old-fashioned economics, he reminded them, imbalances between supply and demand eventually always lead to trouble.
“Short of the repeal of the law of supply and demand,” he said, an untamed wealth effect must either “intensify inflationary pressures or squeeze profit margins, with either outcome capable of bringing our growing prosperity to an end.”
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Produce Prices
Index of finished goods prices; 1982=100; seasonally adjusted:January:
135.0Break in scaleSource: Bureau of Labor Statistics
