Greenspan sees no urgency
Moderating stock market the key to soft landing
By Rex Nutting, CBS MarketWatch
Last Update: 11:44 AM ET Feb 17, 2000 Bond Report
WASHINGTON (CBS.MW) -- The Federal Reserve sees no urgent need to slam the brakes on the economy, Alan Greenspan told Congress on Thursday, but he warned it might take a moderation in stock markets to provide the economy with a necessary soft landing.
While warning again of "imbalances" that could derail "this remarkable economic performance," the Fed chief said the Fed sees no imminent danger that inflation will get out of hand.
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Greenspan spoke to the House Banking Committee, delivering the semiannual Humphrey-Hawkins report on the economy. His testimony points to a continuation of the Fed's gradual tightening of monetary policy to contain inflation. See Greenspan's testimony and the full report.
Stock and bond markets headed south as Greenspan headlines hit the tape, although financial markets more recently turned mixed. The 30-year Treasury bond was up 7/32 to yield to 6.255 percent. The 10-year was down 7/32 to yield 6.517 percent. See Bond Report.
The Dow Jones Industrial Average lost 33 to 10528. The Nasdaq rose 56 to 4484. See Market Snapshot and international indices.
Analysts said Greenspan's testimony signaled more rate hikes. "He's Humphrey-Hawkish," quipped Irwin Kellner, chief economist at CBS.MarketWatch.com and the Weller professor of economics at Hofstra University.
"There should be no doubt after this testimony that rates are going higher, and Mr. Greenspan wants to signal that he will do whatever is necessary," said Ian Shepherdson, chief U.S. economist at High Frequency Economics.
In a balanced presentation on the state of the economy, the Federal Reserve chairman said a continuing acceleration in productivity has created an "unprecedented" expansion that has boosted living standards and given millions of people their first job.
However, he said, "these profoundly beneficial forces driving the American economy to competitive excellence are also engendering a set of imbalances that, unless contained, threaten our continuing prosperity."
"The problem is that the pickup in productivity tends to create even greater increases in aggregate demand than in potential aggregate supply," Greenspan said.
Chief among the imbalances he mentioned is an "excess of demand in financial markets" that is spurring demand above potential supply and thereby tightening labor markets, a process that could lead to higher wages and ultimately higher consumer prices.
For every dollar of new wealth created by the stock market, he said, investors typically spend 3 or 4 cents.
Constraining the "wealth effect" from the stock market's bull run is the key, he said.
"How the current wealth effect is finally contained will determine whether the extraordinary expansion that it has helped foster can slow to a sustainable pace, without destabilizing the economy in the process," Greenspan said.
"The higher stocks go, the more the Fed will raise rates," said Tony Crescenzi, fixed income analyst at Miller Tabak. "Greenspan sounded more hawkish here today than he has in some time."
With help from the "vigilant" Fed, "real long-term rates will at some point be high enough to finally balance demand with supply at the economy's potential in both the financial and product markets," he said.
The process has already begun, he said. Corporations are now paying a full percentage point more for long-term debt.
The Fed has raised overnight interest rates four times since June by a total of one full percentage point in an effort to brake the economy to a more manageable speed.
"There is little evidence that the American economy ... is slowing appreciably," he said. The four rates haven't taken yet, perhaps because "rising business expectations and declining compensation for risk have more than offset the effects of this increase, propelling equity prices and the wealth effect higher," he said.
The safety valves of weak foreign demand, low oil prices and capital inflows from abroad are dissipating. he warned. The excess demand must now be met more by domestic producers. "There is an effective limit to new hiring," he said.
"At some point ... wages increases must rise above even impressive gains in productivity," he said. "This would intensify inflationary pressures or squeeze profit margins, with either outcome capable of bringing our growing prosperity to an end."
Greenspan also repeated his admonition to Congress to use the growing budget surpluses wisely. Once again, he expressed a strong preference for paying down the federal debt. But if the political heat gets too much, he advised Congress to lower taxes rather than increase spending.
Greenspan said the Treasury buy-back program has not undermined the Fed's monetary policy, even though long-term Treasurys have risen in price and fallen in yield. The important market, Greenspan said, is corporate and other private sector lending rates, which haven't been affected by the short supply in Treasurys.
Going forward, the Fed is forecasting growth of 3.5 to 3.75 percent in 2000, with the unemployment rate at 4 to 4.5 percent and inflation (as measured by the personal consumption deflator) at 1.75 to 2 percent, "or bit below the rate in 1999, which was elevated by rising energy prices."
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