Greenspan: Fed Must Be Wary of Inflation
WASHINGTON – Although the economy is going through a “soft patch,” the Federal Reserve must be on constant guard against an unwanted pickup in inflation, Federal Reserve Chairman Alan Greenspan says.
Greenspan, appearing before the Senate Banking Committee on Tuesday, said if inflation should suddenly worsen, Fed policy-makers would abandon their current strategy of gradually raising interest rates and take more aggressive action.
For now, rising inflation is not an immediate problem, the Fed chief suggested. He said that part of the recent increase has been due to impermanent factors, such as a spike in energy prices.
Still, higher prices for energy and other goods has contributed to a recent slowdown in consumer spending, which accounts for roughly two-thirds of all economic activity, he said.
“The little bulge in inflationary pressures seems to have created a soft patch here,” Greenspan said. “And, it is something, obviously, we are watching very closely.”
Greenspan, delivering the Fed’s midyear economic outlook to Congress, was to appear Wednesday morning before the House Financial Services Committee.
Recent economic data, including retail sales, the nation’s payroll situation, industrial production and housing construction, suggested the economy hit a rough patch in June. Sen. Jim Bunning, R-Ky., worried that June’s economic “hiccup” could “turn into the flu.”
But Greenspan expressed confidence that June was just a temporary lull rather than a sign of trouble ahead for the economy.
“While there has been weakness in June, … I might say that July seems to be somewhat better, even though we are going through a soft patch,” Greenspan told the Senate panel. He noted that auto sales, which were sluggish in June, are rebounding now that discounts and other incentives have been expanded again.
“There is no real underlying evidence of any cumulative weakness here,” Greenspan said of the national economy.
Economic conditions through the first half of the year have “been generally quite favorable,” with overall growth at a strong rate that has finally generated a significant rebound in job growth, Greenspan said.
If inflation remains under control, the Fed can hold to its current view that it can raise interest rates gradually. But if inflation should show signs of worsening, then the Fed would need to accelerate its rate increases, Greenspan said.
The Fed boosted interest rates June 30, the first time in four years, acting to keep inflation at bay. It raised a key rate to 1.25 percent from a 46-year low of 1 percent.
Private economists continue to believe the Fed will boost interest rates by another one-quarter percentage point at its next meeting on Aug. 10.
“Bottom line: Greenspan made it clear that superlow interest rates are no longer necessary,” said Sherry Cooper, chief economist at BMO Nesbitt Burns. “In a nutshell, he said that the economic rebound is self-sustaining – pooh-poohing the June slowdown in economic activity – and inflation is now a meaningful threat.”
The Fed had cut interest rates 13 times starting in January 2001 and ending in June 2003. The credit-easing campaign was aimed at helping the economy rebound from the collapse in tech stock prices in 2000, a recession, the 2001 terror attacks and a series of corporate accounting scandals.
Greenspan also provided the Fed’s updated economic forecast for 2004. The Fed has slightly raised its expectations for inflation while trimming its forecast for growth.
The Fed predicted the economy would grow between 4.5 percent and 4.75 percent this year as measured from the fourth quarter of last year, with the rate of inflation, as measured by one price gauge that factors out volatile energy and food costs, rising from 1.75 percent to 2 percent.
The Fed left its outlook for unemployment unchanged at 5.25 percent to 5.5 percent by the end of this year. The jobless rate currently is 5.6 percent.
For 2005, the Fed expected economic growth to slow a bit to around 3.50 percent to 4 percent. It said inflation would hover in about the same range as projected for 2004, while unemployment could dip to a low of 5 percent.
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