Greenspan Issues Warning on Inflation
That is Echoed by Atlanta Fed's Guynn
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WASHINGTON -- Federal Reserve Chairman Alan Greenspan said Wall Street may be too optimistic in its expectations that U.S. productivity gains will continue to insure rapid economic growth without stoking inflation.
See the full text of Mr. Greenspan's testimony on technology.
In a speech Monday to Congress's Joint Economic Committee, Mr. Greenspan said history suggests investors should be cautious. "The rate of growth of productivity cannot increase indefinitely," he said.
"While there appears to be considerable expectation in the business community, and possibly Wall Street, that the productivity acceleration has not yet peaked, experience advises caution," he said.
Modest Projections
Greenspan cautions that U.S. productivity gains may be near a peak and doubts they will be able to restrain inflation amid ongoing economic growth.
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Productivity Gap
Greenspan examines the remaining productivity gap between the U.S. and other countries.
Mr. Greenspan, who in 1996 worried that investors' "irrational exuberance" may have pushed stock prices too high, reminded the committee that he has warned a number of times about the dangers in believing that the world has entered some new economic era because of breakthroughs in technology.
Atlanta Federal Reserve Bank President Jack Guynn also warned that the Fed's adoption of a bias toward higher interest rates is "a blinking caution light" that the central bank is ready to act on any sign of inflation.
Last month, Fed policy makers announced that they were leaning toward raising interest rates to forestall inflation. Many analysts assume that central-bank policy makers will raise rates when they meet June 30, and some in the financial markets have grown worried that inflationary economic data could signal that a series of rate increases are in the offing.
Raising the Readiness Alert
"The asymmetric policy directive we adopted last month represents a blinking caution light," Mr. Guynn told a conference here, referring to the Fed's tightening bias. "It indicates that we're paying especially close attention to developments as they emerge, and that we're prepared to adjust policy if and when that seems appropriate.
"That, ultimately, signals our dedication to keeping the economy and this near-record expansion thriving well into the third millennium," he added. "Stay tuned."
The Fed's policy-setting Federal Open Market Committee meets June 29 and 30 to discuss monetary policy. Many economists expect the central bank to raise its target for the benchmark for interest rates, the federal-funds rate, by a quarter of a percentage point from 4.75%.
Although Mr. Guynn isn't a voting member of policy-making committee, his language suggests that he and his Fed colleagues are closely monitoring the economy for signs that inflation is getting a foothold.
"Most often, inflation enters the economy by mistake, when monetary policy makers let down their guard," said Mr. Guynn. "The FOMC's asymmetric directive should be taken as an indication of our resolve not to let that happen."
While a bias toward tighter policy doesn't guarantee that the Fed will raise rates, Mr. Guynn said that he feels that risks are currently weighted toward the possibility of growing inflationary pressures.
That's a departure from the language Fed officials have typically used in recent months, when they've often said risks to the economy were "balanced."
Part of the risk toward rising inflation, Mr. Guynn said, stems from a rebound in global energy prices. Another factor upsetting the balance is that "the residual stimulus from last fall's rate cuts," could be feeding too much fuel to the U.S. economy. The Fed cut the federal-funds rate three times last fall in an effort to head off a global financial crisis.
His inflation-hawkish remarks, however, were somewhat offset by data by Federal Reserve Bank of Atlanta, also released Monday, showed that manufacturing activity in the Atlanta region expanded at a somewhat softer pace in May. The current production index decreased to 17.1 from the prior month's reading of 22.6. However, new orders did increase -- to 21.9 in May from April's 17.9.
"This [new orders] index has been on a clear upward trend since September 1998 and is at its highest level since March 1998," the Atlanta Fed said.
Backlogs were also higher in May, indicating solid activity in the months ahead.
Endurance Question for Productivity
Economists have attributed the U.S. climate of fast growth and low inflation to rapid gains in the productivity of workers, which have allowed companies to hold down prices. U.S. productivity grew at a 3.5% annual rate in the first three months of 1999.
But Mr. Greenspan on Monday said economists can't be sure those gains will endure.
"History is strewn with projections of technology that have fallen wide off the mark," he said. "There is little reason to believe that we are going to be any better at this in the future than in the past."
Mr. Greenspan noted that productivity, the amount of output per hour of work, has been growing at an annual rate of around 2% since 1995, double the annual gains of the previous two decades. He credited these gains in part to a surge in business investment in a variety of high-technology products from computers to fiber-optic cable.
Productivity is considered the crucial element in raising living standards because it allows employers to pay their workers more without triggering inflationary pressures by having to raise the cost of products.
"Despite the remarkable progress to date, we have to be quite modest about our ability to project the future of technology and its implications for productivity growth and for the broader economy," he said.
Mr. Greenspan's testimony was one of two appearances he will make this week before the Joint Economic Committee. Monday's subject was technology. Mr. Greenspan is scheduled to testify Thursday on monetary policy.
Mr. Greenspan's comments extended a series of warnings he has issued recently about the ability of the U.S. economy to continue growing without an outbreak of inflation. They are likely to fuel speculation, already widespread in the U.S. and international markets, that the Fed is poised to raise interest rates this month for the first time since March 1997.
Mr. Greenspan said improvements in technology have made capital investment "distinctly more profitable." That, in turn, has led to a surge in investment that has increased industrial capacity faster than factory output. The result has been "greater competitive pressure on businesses to hold down prices."
Falling international trade barriers -- another outcome of technological improvement -- have also helped to restrain inflation, he said. "All else equal, the enhanced competition in tradable goods enables excess capacity previously bottled up in one country to augment world-wide supply and exert restraint on prices in all countries' markets."
But Mr. Greenspan said the gains in U.S. productivity that have helped restrain inflation can't be attributed solely to technological innovation. For example, productivity in Europe and Japan hasn't yet caught up to U.S. levels, although those regions have had the same technologies that are available to the U.S.
One possible reason for the discrepancy, Mr. Greenspan said, is that regulations in Japan and Europe don't permit companies to fire workers easily.
"One hypothesis is that unnecessary conditions for information technology to increase output per hour is a willingness to discharge or retrain workers that the new technologies have rendered redundant," Mr. Greenspan said. "Countries with less flexible labor markets than the United States enjoys may have been inhibited in this regard."
Mr. Greenspan said the actual causes of productivity gains may need to be studied further. "But at this stage, one lesson seems reasonably clear," he said. "As we contemplate the appropriate public policies for an economy experiencing rapid technological advancement, we should strive to maintain flexibility in capital markets."
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