Greenspan Says Fed Interest-Rate Reductions May Not Be Over
*** Note the common usage of "overshooting" by Meyer and Greenspan
Michael McKee
New York, May 24 (Bloomberg) -- The U.S. still faces a period of slow economic growth and the Federal Reserve may decide to push interest rates lower, Fed Chairman Alan Greenspan said.
Offering his first assessment of the economy's prospects since February, Greenspan said that while the U.S. is experiencing only a ``pause'' in the record economic expansion, weakness will persist for several more quarters.
``The period of sub-par economic growth is not yet over, and we are not free of the risk that economic weakness will be greater than currently anticipated, requiring further policy response,'' Greenspan said in the text of remarks to the Economic Club of New York.
The central bank has latitude to reduce rates further because inflation isn't a danger, he suggested. ``With energy prices probably peaking and the easing of tightness in labor markets expected to damp wage increases, prices seem likely to be contained,'' Greenspan said.
The Fed's policy making Open Market Committee has reduced the benchmark overnight bank lending rate five times since the first of the year, the most aggressive period of rate-cutting ever by the Greenspan Fed. At 4 percent, the overnight rate is at its lowest in seven years.
In that stretch of rate reductions, totaling 2 1/2 percentage points, ``we have been responding to our judgment that a good part of the weakening of demand was likely to persist for a while,'' he said.
Changes Take Time
Because it takes time for interest-rate changes to work their way into investment decisions by businesses and consumers, ``the effect of our recent policy initiatives will take time to strengthen financial portfolios and spillover into demand for goods and services,'' he said.
Expanding on remarks he's made previously, the Fed chairman blamed a rise in inventories and a drop in demand for computers and telecommunications equipment for the deeper-than-expected slowdown in growth.
Those same technologies, however, lead to a more rapid adjustment in production levels than in the past. Computer orders fell 1.2 percent in March, following a 4.7 percent decline in February, while orders for electronic components dropped 7.9 percent and communication equipment orders fell 4.1 percent, the Commerce Department reported. Orders for high-tech goods are 11.7 percent below year-ago levels.
``More advanced supply-chain management and flexible manufacturing technologies have enabled our firms in recent years to adjust production levels more rapidly to changes in sales,'' Greenspan said. ``But apparently these improvements have not yet solved the thornier problem of anticipating demand.''
Computer Inventories
While automakers seem to have succeeded in lowering their inventories to acceptable levels, stocks of computers, semiconductors, and communications products ``are only belatedly being brought under control,'' Greenspan said. ``A substantial liquidation still appears ahead for these products.''
With demand for investment goods still weak, companies are facing an ``unrelenting'' profit squeeze, he said. Unit labor costs are rising because the long period of expansion and high demand for labor pushed up workers' compensation. At the same time, companies were hit by a ``sharp'' rise in energy costs that is ``likely to weigh on the economy in the short run.''
The primary inflation threat has been a surge in energy prices. Energy costs, which account for about a 10th of the CPI, rose 1.8 percent in April, compared with a 2.1 decline in March. The price of gasoline surged 5 percent, the largest increase since a 6.1 percent increase in September of last year. Fuel oil prices decreased 2.1 percent and the cost of natural gas declined 1.6 percent.
Energy Costs
The cost of electricity rose 0.2 percent last month compared to a 0.5 percent increase in March. Electricity costs may keep rising.
Analysts expect earnings for the companies in the Standard & Poor's 500 Index to decline 3.3 percent this year, according to First Call/Thomson Financial. Still, they forecast that profits will grow 8.4 percent in the fourth quarter after dropping in the first three quarters of 2001, and next year analysts forecast a surge of 18 percent, the firm said.
While consumer spending has held up better than expected, there are risks, he said. The decline in stocks over the past year will likely impact spending, he said.
The Nasdaq Composite Index plunged 68 percent from it's all- time high in March 2000 to its recent low on March 4. The Standard & Poor's Index of 500 stocks plunged 28 percent from its record high of last year to its low on March 4, and the Dow Jones Industrial Average fell 20 percent from its January 2000 peak to its March 2001 low.
Consumer Spending
``We can expect the decline in wealth that has occurred over the past year to restrain household spending relative to the growth of income,'' Greenspan said. ``Furthermore, most survey measures suggest consumer sentiment, while having stabilized recently, remains fragile.''
Greenspan that while it appears gasoline prices will not jump in the coming months, higher gas prices would act as an additional ``tax'' on consumers, ``hardly welcome in today's context.''
Inflation has remained low even though energy prices and labor costs have risen, because competitive pressures have kept companies from being able to raise prices, Greenspan said. With demand slowing, inflation is likely to remain subdued for now, he said.
``Despite some apparent deterioration in actual and expected CPI inflation, there has been little acceleration in the broader index of core personal consumption expenditure prices,'' Greenspan said. ``The lack of pricing power reported overwhelmingly by business people underscores and absence of inflationary zest.''
The GDP deflator rose 3.2 percent in the first quarter of the year, up from a 2 percent increase in the fourth quarter of 2000. The personal consumption expenditures price index, a measure of inflation tied to consumer spending and closely watched by Fed policy makers rose at a 3.3 percent annual rate, after a 1.9 percent gain in the fourth quarter.
Price Index Expectation
The Fed expects the personal consumption price index -- an inflation measure tied to gross domestic product -- to rise by 1.75 percent to 2.25 percent this year, following a 2.4 percent increase in 2000, when measured from fourth quarter to fourth quarter. Last year's increase was largest since 1993.
Consumer spending ``has been soft, but for the moment at least, not unduly so,'' Greenspan said. Once inventories have been worked off, production will likely rise as demand increases. ``In the past, such episodes, with their associated increases in employment, household incomes, and profits, would engender a cycle of expansion, including a pickup in investment,'' Greenspan said.
``While such a scenario is likely to develop at some point in the period ahead, there are, nonetheless, considerable uncertainties about its timing and magnitude,'' he said.
There are signs the Fed's actions are beginning to have an effect, he said. Interest rates have fallen on an inflation- adjusted basis, particularly for corporations which finance activities with commercial paper and high-yield bonds.
Money Supply
The money supply has also picked up, and the Treasury yield curve, which plots interest rates for different maturities of fixed income securities, has steepened, reflecting investors concerns that a pickup in growth would raise the danger of inflation over the longer term. That is a ``not insignificant change,'' Greenspan said.
``With all our concerns about the next several quarters, there is still, in my judgment, ample evidence that we are experiencing only a pause in the investment in a broad set of innovations that has elevated the underlying growth rate in productivity,'' he said.
The forces constraining business investment are ``fizzling out,'' and once they do, demand for computers and other high- technology goods ``should again strengthen demand for capital equipment and restore solid economic growth,'' Greenspan said.
That means that even if the Fed does lower rates again, it must do so carefully, in order not to set the stage for higher inflation in the future.
``Monetary policy, as we currently practice it, endeavors to lean against economic overshooting, from whatever source, by changing interest rates,'' he said. ``But we are unlikely ever to be successful.''
In the 14 months from the start of the last recession in July 1990 until August 1991, the Fed lowered the overnight rate 2 3/4 points, to 5.5 percent from 8.25 percent. In the next 14 months, until September 1992, central bankers chopped 2 1/2 more points off the rate, taking it to 3 percent.
Earlier today, Fed Governor Laurence Meyer said the Fed's effort to lower interest rates will help the U.S. economy ``gradually'' return to growth of around 3.5 percent to 4 percent a year.
While the biggest risk to the economy remains a ``sharper- than-expected slowdown,'' Meyer warned that the central bank must be careful not to cut rates too far, sparking faster inflation when the economy does recover.
``Given that labor markets remain tight, that inflation remains above the rate that I would find acceptable over the longer run, and that core inflation has been edging higher, attention must also be given to calibrating the easing to avoid overshooting in the other direction,'' Meyer said in a speech at a finance and investment seminar in Edinburgh, Scotland. |
