ANALYSIS: GREENSPAN DETAILS THREE ITEMS TO KEEP AN EYE ON
10:39 EST 02/17 --Stocks, Lower Quality Corporate Bonds, Federal Budget Very Much on the Fed Chairman's Mind
By Joseph Plocek
WASHINGTON (MktNews) - Alan Greenspan's semiannual Congressional monetary policy testimony was notable for its diversion into the unexpected as the Federal Reserve Chairman detailed some of the things he is looking at to help guide decision-making. Stocks, lower quality corporate bond rates, and the Federal budget surplus were mentioned prominently.
To be sure, Greenspan said there is "little evidence that the American economy... is slowing appreciably" and talked about remarkable productivity growth. He also worried about the wealth effect and passing on higher interest costs to businesses as the main factors that transmit monetary policy.
Greenspan noted market interest rates have moved up and this will contain demand eventually -- but "a monetary policy vigilant against emerging macroeconomic imbalances" still is needed, he said. The Chairman specifically mentioned BBB corporate bond rates adjusted for inflation expectations. He said they "have risen by more than one percentage point during the past two years."
Normally, higher borrowing costs would hurt business valuations, Greenspan implied. But rising earnings expectations and declining risk premia have offset the increase recently, pushing stock prices up.
Greenspan remains worried about the stellar level of the stock market. He said "outsized increases in wealth cannot persist indefinitely." He noted "For so long as the levels of consumption and investment are sensitive to asset values, equity values increasing at a pace faster than income... will induce a rise in overall demand in excess of potential supply."
"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," the Chairman concluded.
Greenspan also included a large section on the federal budget. He favors maintaining surpluses, naturally, and chided Congress for the "modest erosion in fiscal discipline" of last year. Greenspan called recent Congressional Budget Office surplus projections "reasonable" and said there are still downside risks to the fiscal outlook pending analysis of recent "tax surprises."
Paying down the public debt with budget surpluses is the favored outcome, Greenspan said. "The growth potential of our economy under current circumstances is best served, in my judgment, by allowing the unified budget surpluses presently in train to materialize and thereby reduce Treasury debt held by the public," he said.
FOMC: DEFENDS ECONOMIC PREDICTIONS MORE OPTIMISTIC THAN WHITE HOUSE
11:10 EST 02/17 --Increases In Health Care Costs 'Appear to Be Coming' --'Substantial Plant Capacity' Still Available in 'Some' Industries --Employment Cost Index Likely Understating Wage Pressures
By Denny Gulino
WASHINGTON (MktNews) - The Federal Open Market Committee, in its formal report to Congress Thursday morning, defended its economic predictions that this time around are more optimistic than those of the White House.
The FOMC sees growth at 3.5% to 3.75% in 2000, fourth quarter over fourth quarter, and an unemployment rate staying in the range of 4.0% to 4.25%, while inflation as measured by the Fed's preferred personal consumption expenditures rather than the Consumer Price Index, ranges from 1.75% to 2%, on the "low side" of results for last year.
As did Fed Chairman Alan Greenspan in his prepared testimony, the FOMC saw risks that "lagged effects of the past year's oil price rise" and stronger wage pressures could escalate prices this year.
Like Greenspan, the FOMC could not find evidence that imbalances are present now, but warned of the potential of wage pressures, lagged oil price hike effects and pressures on U.S. production capacity from increasing exports.
"The FOMC forecasts are more optimistic than the economic predictions that the administration recently released," the report said, "but the administration has noted that it is being conservative in regard to its assumptions about productivity growth and potential expansion of the economy."
While the inflation forecasts are "fairly similar," the FOMC sees "a somewhat larger rise in real GDP in 2000 and a slightly lower unemployment rate," the FOMC said.
The FOMC echoed Greenspan's testimony in saying that the rapid rise of the dollar through mid-1998 "has since given way to greater stability, on average, and the tendency of the early appreciation to limit export growth and boost import growth is now diminishing."
The FOMC went on, "From one perspective, these external adjustments are welcome because they will help slow the recent rapid rates of decline in net exports and the current account."
But the adjustments are also "likely to add to the risk of an upturn in the inflation trend, because a strengthening of exports will add to the pressures on U.S. resources and a firming of the prices of non-oil imports will raise costs directly and also reduce to some degree the competitive restraints on the prices of U.S. producers."
The FOMC said "substantial plant capacity is still available in some manufacturing industries and could continue to exert restraint on firms' pricing decisions, even with a diminution of competitive pressures from abroad." The FOMC report went on, "However, an already tight domestic labor market has tightened still further in recent months, and bidding for workers, together with further increases in health insurance costs that appear to be coming, seems likely to keep nominal hourly compensation costs moving up at a relatively brisk pace."
Yet, so far, the FOMC said, wage pressures have "been offset by the advances in labor productivity."
The FOMC repeated that the "pool of available workers cannot continue to shrink without at some point touching off cost pressures that even a favorable productivity trend might not be able to counter."
The FOMC's report was primarily an economic history lesson and shied away, more so than many other recent reports, from forward looking analyses.
The FOMC's implicit criticism of the CPI methodology, which it ignored and replaced with the Bureau of Economic Analysis personal consumption expenditures, was contrasted with an explicit critique of another Labor Department report, the employment cost index.
"Because the employment cost index does not capture some forms of compensation that employers have been using more extensively -- for example, stock options, signing bonuses and employee price discounts on in-store purchases -- it has likely been understating the true size of workers' gains."
The fact that the Labor Department's productivity measure "captures at least some of the labor costs that the employment cost index omits" may explain "why the productivity and cost measure has been rising faster," the FOMC said.
Yet even the productivity measure "is affected by problems of measurement, some of which would lead to overstatement of the rate of rise in hourly compensation," the FOMC said. |
