CHICAGO ( Reuters ) - Federal Reserve Chairman Alan Greenspan Saturday warned of dangers if the U.S. economy should enter a period of falling prices, reinforcing beliefs he is not inclined to raise interest rates.
In his most detailed talk yet on the potential for deflation, Greenspan said a debate on the issue was hampered by faulty price measures and lacked clarity."Some observers have begun to question whether deflation is now a possibility," the central bank chief told the annual meeting of the American Economic Association ( AEA ) .
"Even if deflation is not considered a significant near-term risk for the economy, the increasing discussion of it could be clearer in defining the circumstance," he added.
Deflation has not occurred in the United States on a broad scale since the Great Depression of the 1930s. Greenspan declined to say whether there was an imminent risk of a deflationary cycle, but said it could be at least as bad for the economy as inflation.
"Both rapid or variable inflation and deflation can lead to a state of fear and uncertainty that is associated with significant increases in risk premiums and corresponding shortfalls in economic activity," he said.
Economists listening to Greenspan's speech were struck by the attention on deflation after decades in which the Fed has made the fight against rising prices its overriding mission. "Today, he devoted a full 15 minutes to discussing the negative consequences of deflation," said Peter Kretzmer, an economist at NationsBank. "It indicates that Greenspan will take a lot of care before he decides to tighten monetary policy and there is even a possibility of an easing."
Inflation, running at 2.1 percent, is at its lowest level in a generation and Fed research suggests even that figure may be double the actual rate of price increases.
Asia's financial crisis has put a spotlight on deflation as producers in the battered region are expected to unload a glut of cheapened goods, bringing down global prices. Before the Asian troubles mounted, Fed policymakers were leaning in favor of higher interest rates because of worries that the nation's tight labor market would generate wage pressures that could feed inflation.
Allen Sinai, chief economist at Boston-based Primark Decision Inc., said Greenspan's remarks on Saturday clearly showed that deflation was at least on the Fed's radar screen.
"It's a tip-off they will not raise interest rates," he said. "The Fed will be on guard in either direction." Fed policymakers next meet on Feb 3-4 to consider interest rates. The key overnight federal funds rate currently stands at 5.5 percent and has remained unchanged since last March.
Discussing deflation, Greenspan drew a distinction between declines in the prices of assets, such as stocks and houses, and those of goods and services. He said a gradual fall in asset prices had contributed to the recent troubles in Asia but that in most cases this type of deflation could be absorbed by the economy.
"But historically, it has been very rapid asset price declines -- in equity and real estate, especially -- that have held the potential to be a virulently negative force in the economy," he added.
The Fed is charged with seeking an environment of stable prices, in which neither inflation nor deflation is a threat, while maintaining the maximum level of employment.
Greenspan said the "remarkable progress" that had been made in bringing down inflation had brought the issue of price measurement into especially sharp focus. He said there were "uncertainties surrounding the accuracy of our measured price indexes," adding his weight to criticism of the main U.S. inflation gauge, the consumer price index.
Inflation had declined to the point where even an upward bias of a few tenths of a point mattered, he said. "Inflation has become so low that policymakers need to consider at what point effective price stability has been reached," he noted |
