Fed Chairman Issues Cautious Outlook
Federal Reserve Chairman Alan Greenspan offered a surprisingly cautious assessment of the U.S. economy Wednesday, saying that the nation is poised to resume strong growth with the end of the Iraq war but warning that there are few signs of a much-needed pickup in business investment and hiring.
One week after President Bush signaled that he would nominate the 77-year-old central banker to a fifth term as Fed chairman, Greenspan sought to offer a kind word about the White House’s multibillion-dollar tax-cut proposal. But he ended up saying he could support the cuts only if they were accompanied by similar-sized spending cuts -- which would doom them politically and demolish their economic rationale as growth spurs.
The Fed took the unusual step this month of issuing a research paper that concluded that budget deficits, which tax cuts help produce, drive up long-term interest rates and so dampen growth.
Some White House officials and their Capitol Hill supporters have recently suggested that deficits are economically inconsequential.
On Wednesday, Greenspan reiterated his confidence in the nation’s economic prospects.
“I continue to believe the economy is positioned to expand at a noticeably better pace than it has during the past year,” he told the House Financial Services Committee.
But he coupled that assessment with a string of caveats. Among them: Although consumer confidence is recovering nicely with the war’s end, “reports from businesses have not exhibited a similar improvement in tone.”
And Greenspan raised eyebrows on Wall Street by suggesting the economy could be facing a new problem: deflation, or a general decline in prices.
“Core prices ... have increased very slowly over the last six months,” he said. “With price inflation already at a low level, substantial further disinflation would be an unwelcome development, especially to the extent it put pressure on profit margins and impeded the revival of business spending.”
As with other problems he identified, Greenspan told lawmakers they should leave it to the Fed to protect against deflation, rather than turn to tax-cutting fiscal policy.
Greenspan asserted that the central bank still has plenty of policy tools at its disposal, despite the fact that its signal-sending federal funds interest rate is at a four-decade low of 1.25%.
“We still have room in monetary policy if we choose to move and we decide that stimulus was required,” he said.
Investors generally focused Wednesday on Greenspan’s cautions, along with an industry report that showed manufacturing in the Chicago area shrank in April and a Treasury announcement that Washington will have to raise the federal debt limit by the end of May or stop borrowing.
The result was lower stock prices and higher bond prices. The Dow Jones industrial average lost 22.90 points, or 0.3%, to 8,480.09, while the broader Standard & Poor’s 500 index slipped almost a point, or 0.1%, to 916.92. The Nasdaq composite index fell 6.99, or 0.5%, to 1,464.31. All three market measures have rallied substantially since their mid-March lows.
Meanwhile, bonds posted some of their biggest gains in six months, pushing yields down sharply as traders bet that the Fed will cut interest rates again shortly.
Analysts said part of the reason for Greenspan’s caution in his congressional testimony was that he didn’t want to tip his hand before the meeting Tuesday of the central bank’s policymaking Federal Open Market Committee.
And Greenspan is looking at contradictory information about the economy’s condition. Although stocks have jumped, housing has remained hot and pollsters have found consumer confidence on the rise, “we haven’t seen much else in terms of real improvement so far,” said Goldman Sachs economist Edward F. McKelvey.
The government will announce April’s unemployment figures Friday and an industry group is set to release a key survey of the nation’s manufacturing sector today.
The hard-hit manufacturing sector showed tentative signs of recovering in early March, but began slumping as war worries mounted. Employers unexpectedly shed about 450,000 jobs in February and March.
