Greenspan Sends Clear Signal: Rates Will Go Up
Leaving little doubt of an interest rate increase early next month, Federal Reserve Chairman Alan Greenspan on Thursday called higher rates the necessary medicine to bring down the temperature of an economy overheated by soaring stock prices.
But Greenspan, speaking to a group of prominent economists in New York, expressed hope that the Fed could reverse “the potential for inflationary distortions” while “avoiding the very recession that would complete a business cycle.”
Analysts said Greenspan was trying to walk the narrow line between raising rates too high, which could trigger a recession, and leaving them too low, which could let prices rise too fast.
“He’s saying, ‘My job is to maintain a steady expansion,’ ” said Rajeev Dhawan, director of economic forecasting for the UCLA Anderson Forecasting Project. “ ‘If you don’t let me cool it now, later the pain will be much worse.’ ”
Investors and economic analysts had widely expected Greenspan to use Thursday’s speech as a chance to signal whether the Fed’s policymaking Open Market Committee would raise interest rates when it meets on Feb. 1 and 2.
The Fed last year raised the federal funds rate, which banks charge each other for overnight loans, three times to its current level of 5.5%.
Although the Fed chairman spoke Thursday in typically measured language and admitted that no one thoroughly understood all the forces at work in the booming U.S. economy, he left no question that interest rates must go up.
“In the end, balance is achieved through higher borrowing rates,” he said. If the stock market does not grow at a more moderate pace, he said, interest rates must rise. “There is little evidence of the former,” he said.
Ideally, Greenspan said Thursday, the necessary rate increases would be achieved as a “natural consequence” of businesses’ competing for investment financing in the bond markets. But, he said, the process could be “supported by a central bank intent on defusing the imbalances that would undermine the expansion.”
David Jones, chief economist for the New York investment house Aubrey G. Lanston, said Greenspan “would like to let market forces work for him.”
Greenspan’s remarks followed the release Thursday of government economic data suggesting that consumer demand was galloping forward faster than analysts had expected, but that evidence of inflation remained hard to find.
The Commerce Department reported that retail sales in December grew at their fastest rate in 15 years, with Americans eagerly snapping up an estimated $259.6 billion worth of goods, ranging from cars and mobile homes to gasoline and meals in restaurants.
The Labor Department, at the same time, said wholesale prices--excluding food and energy--rose in 1999 at less than half the rate of 1998. Many analysts say that as long as rising energy prices do not spread out through the economy, they find no proof that inflation is about to surge.
In his speech, Greenspan praised American risk-taking and technological progress and said that, as the U.S. economy passes through its 105th straight month of growth, most Americans are enjoying unimagined new levels of material prosperity.
“Nonetheless,” he said, “this seemingly beneficial state of affairs is not without its own set of potential challenges.”
For Greenspan, the central challenge Thursday was the U.S. stock market and its seemingly endless upward momentum. Double-digit annual stock market gains have given Americans a new source of income, he said, and many investors seem to feel that the source will never dry up.
As a result, consumers have begun spending money they formerly did not have. Greenspan said this so-called wealth effect has contributed an estimated 1 percentage point to the economy’s 4% annual growth rate.
Greenspan tried in 1996 to bring stock prices down by characterizing the markets as having fallen prey to “irrational exuberance.” After a brief decline, prices went right on rising.
On Thursday, Greenspan said the resulting increase in U.S. aggregate demand was outpacing the increase in supply. “It is this imbalance between the growth of supply and growth of demand that contains the potential seeds of rising inflation,” he said.
The seed hasn’t grown yet because America has been able to tap unexpected new sources of supply, Greenspan said: It has attracted a wave of low-cost immigrant workers; it has opened its ports to a flood of inexpensive imports from economically troubled countries in Asia and Latin America, and it has lured new workers from the ranks of the elderly, homemakers, former welfare recipients, even prisoners.
But Greenspan said all of these buffers against inflation have their limits.
“Admittedly, we are groping to infer where those limits may be,” he said. “But that there are limits cannot be open to question.”
By admitting that the nation’s monetary policymakers are “groping” to find the limits of prudent growth, Greenspan seemed to be saying that he remains hawkish on inflation, but at the same time open-minded to new theories about technology’s ability to sustain inflation-free booms.
Hours before Greenspan spoke, President Clinton made an appearance at the New York Stock Exchange and said that dangerous inflation seemed still to be beyond the horizon.
Indeed, Thursday’s producer price data seemed to show there was nothing to fear. The Labor Department said producer prices increased by 0.3% in December, and by just 0.1% when volatile food and energy prices were excluded.
For all of 1999, wholesale prices rose by 3%, but by just 0.9% without food and energy. This was less than half the so-called core rate increase of 2.5% in 1998.
On the other hand, the Commerce Department’s figures on retail sales showed an unexpected 8.9% increase for the year, the largest since 1984.
