Economy Still Strong, but Risks Are There, Greenspan Says
By RICHARD W. STEVENSON -- February 24, 1999
WASHINGTON -- Alan Greenspan, the Federal Reserve
chairman, described the risks to the nation's long
run of prosperity Tuesday as balanced between the
possibility of too much growth causing inflation and
the threat of a stock market drop or further global
shocks derailing the expansion.
His remarks to Congress, which were just what investors
and economists had expected, suggested that the Federal
Reserve would wait for a clearer sense of where the
economy was heading before raising or lowering interest
rates.
After eight years of steady growth, Greenspan said,
"the economy appears stretched in a number of
dimensions, implying considerable upside and downside
risks to the economic outlook."
As a result, he said, interest rate policy "must be
ready to move quickly in either direction should we
perceive imbalances and distortions developing that
could undermine economic expansion."
Despite another expression of concern from Greenspan
about the level of stock prices, investors largely
shrugged off his comments, with the Dow Jones
industrial average bouncing around during Tuesday
before closing down 8.26 points at 9,544.42. Bond
prices fell and the dollar weakened.
Greenspan's testimony to the Senate Banking Committee
suggested that while the central bank wants to keep its
options open, it is somewhat more inclined to raise
rates than to lower them, given that the economy grew
at a 5.6 percent annual rate in the fourth quarter of
last year and has shown signs of considerable momentum
in the first two months of this year.
He told senators that after cutting rates three times
last fall, leaving the federal funds target rate on
overnight loans between banks at 4.75 percent, the
Federal Reserve now needed to reassess whether current
economic conditions justify keeping rates where they
are.
During the time the Fed was cutting rates, the global
crisis was threatening to create a credit squeeze in
the United States, a threat that has since lessened.
Some economists have criticized the Fed's third rate
cut last fall as unnecessary given the resilience of
the economy and the financial markets, and have
speculated that Greenspan would like to undo it, a
surmise that Greenspan gave some credence Tuesday.
"The Federal Reserve must continue to evaluate, among
other issues, whether the full extent of the policy
easings undertaken last fall to address the seizing-up
of financial markets remains appropriate as those
disturbances abate," Greenspan said.
The Fed next meets to review monetary policy on March
30, but analysts said that unless the economy veered
markedly in one direction or the other there was little
chance of any policy change before late spring or early
summer.
Greenspan said that after three consecutive years of 4
percent annual growth, the Federal Reserve expects the
economy to slow to a more modest growth rate this year,
and that as the economy slows any incipient
inflationary pressures will remain contained. But the
Fed has been forecasting a slowdown for two years, and
it has not materialized. On the other hand, as
Greenspan pointed out, neither has inflation.
Still, Greenspan did Tuesday what central bankers are
paid to do: worry about what could go wrong, and
provide some assurance that if the economy does go awry
he has a plan.
Greenspan said he remained concerned about the level of
stock prices, which he said were "high enough to raise
questions about whether shares are overvalued,"
especially if companies fail to post the robust
earnings investors have come to expect.
But he passed up an opportunity to say investors were
suffering from "irrational exuberance," answering a
question on the topic by saying it is all but
impossible to identify a stock market bubble before it
has burst.
"Nobody has questioned at all that the dramatic
acceleration that we have seen in some technologies,
and the marked increase in productivity and
profitability of American businesses, has undoubtedly
had a significant impact on underlying prices of all
capital assets, including equities," Greenspan said.
"Whether or not it's gripped by irrational exuberance
is an issue that you won't really know for sure except
after the fact," he said, adding, though, that stock
prices were high enough to give him "concerns."
Greenspan identified the rapidly growing trade deficit,
and its contribution to a large and rising current
account deficit, as one of the most notable long-term
threats to the nation's economic health.
"Should the sustainability of the buildup in our
foreign indebtedness come into question, the exchange
value of the dollar may well decline, imparting
pressures on prices in the United States," Greenspan
said.
He quickly added that the trade deficit so far has been
a symptom of forces that have proved beneficial, with
weak demand from abroad helping to offset the strains
on the economy from extremely strong domestic demand
even as the strong dollar holds down import prices.
The Fed chairman said the United States remained
"vulnerable to rapidly changing conditions overseas,
which, as we saw last summer, can be transmitted to
U.S. markets quickly and traumatically."
The outlook in Russia remains "troubling," he said,
while Brazil's outlook is uncertain. Contradicting
Japanese officials who say their country's beleaguered
economy has hit bottom and is ready to rebound,
Greenspan said Japan was still weakening.
Greenspan used much of his prepared testimony to
explain the temporary factors that have contributed to
the remarkable confluence of strong growth, low
unemployment and dormant inflation, and the more
fundamental forces reshaping the economy.
Among the temporary factors, he said, are the steep
decline in oil prices and commodity prices generally.
But even if those prices begin rising, the economy may
prove less susceptible to inflation than it has been in
the past, largely because companies are investing
heavily in technology and cost-saving equipment, he
said.
Unable to raise prices, and unwilling to pay higher
wages, companies have had to cope by improving their
productivity, or output per worker, he said.
Several factions within the Fed have been debating for
the last several years whether the United States is
seeing a resurgence in productivity growth after nearly
three decades of stagnation, and in his comments
Tuesday Greenspan again weighed in on the side of those
who think the improvement in productivity is part of a
basic improvement in the country's economic outlook.
"According to rough estimates, labor and capital
productivity has risen significantly in the past five
years," Greenspan said. "It seems likely that the
synergies of advances in laser, fiber optic, satellite
and computer technologies with older technologies have
enlarged the pool of opportunities to achieve a rate of
return above the cost of capital."
Technology, he said, allows companies to be more
nimble, ordering parts or raw materials only as needed,
restraining costs and increasing production capacity
faster than actual output has risen. The process of
holding down costs and prices has become
self-reinforcing, he said, with workers no longer
expecting big wage increases to make up for inflation.
But lest he be seen as taking his eye off the potential
for inflation, Greenspan added that improved
productivity would not keep the country from running
short of workers if the economy continued to race
along.
"This worker depletion constitutes a critical upside
risk to the inflation outlook because it presumably
cannot continue for very much longer without putting
increasing pressure on labor markets and on costs,"
Greenspan said.
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Copyright 1999 The New York Times Company
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