07/18 10:22 Greenspan Says Weakness May Require More Rate Cuts (Update1)
By Michael McKee
Washington, July 18 (Bloomberg) -- The Federal Reserve, which has ``moved a considerable distance'' to boost the U.S. economy, still is prepared to lower interest rates again if growth doesn't pick up soon, Fed Chairman Alan Greenspan said.
Any additional reductions would be limited because the central bank has already cut the nation's benchmark lending rate to its lowest in seven years, which probably will lead to faster growth by year end, he suggested.
``The period of sub-par economic performance, however, is not yet over, and we are not free of the risk that economic weakness will be greater than currently anticipated, and require further policy response,'' Greenspan said in the text of testimony to the House Financial Services Committee.
U.S. Treasury securities rose in response. The 10-year Treasury note increased 5/16 point, pushing its yield down 4 basis points to 5.16 percent.
Over the past six months, the Fed's policy-making Open Market Committee has cut the overnight bank lending rate by 2 3/4 percentage points to 3.75 percent. That's the lowest since April 1994. As a result, interest rates have fallen, the money supply is rising, and recent economic statistics ``have turned from persistently negative to more mixed,'' Greenspan said.
``By aggressively easing the stance of monetary policy, the Federal Reserve has moved to support demand and, we trust, help lay the groundwork for the economy to achieve maximum sustainable growth,'' he said.
Inventories
Economists expect that that U.S. economic growth cooled to a 0.5 percent annual rate in the second quarter, which ended in June, from a 1.2 percent pace in the first quarter and 5 percent for all of last year.
Inventories for most products other than telecommunications equipment are falling, and, coupled with falling energy prices and $300 rebate checks going out Friday to every taxpayer, that should provide the stimulus the economy needs, he said. Greenspan emphasized that consumer spending has risen this year, assisted by an increase in home equity.
``Our front-loaded policy actions this year coupled with the tax cuts under way should be increasingly affecting economic progress as the year progresses,'' Greenspan said.
If those monetary and fiscal policies don't do enough to stimulate growth, the FOMC has scope to move again because inflation is not a problem now, Greenspan said.
High energy prices, which cut business and consumer purchasing power earlier this year, are now falling, as are prices for many raw materials. Competition still prevents most businesses from raising prices, he said, and with unemployment rising, labor costs are falling.
Core Rate
As a result, ``overall prices seem likely to be contained in the period ahead,'' Greenspan said.
Although the consumer price index has ``picked up this year,'' that hasn't been matched by a rise in the core personal consumption expenditure index, a measure of inflation preferred by Fed officials. ``Moreover, survey readings on long term inflation expectations have remained quite stable,'' Greenspan said.
The flexibility that affords policy makers may be needed if the Fed's medicine doesn't take quickly, Greenspan suggested. The Fed still sees risks, he said.
Businesses, caught short by a rapid drop in demand late last year and earlier this year, have been cutting production to reduce stocks of unsold goods.
While automakers have largely completed the process, computer and semiconductor producers inventories are only ``belatedly being brought under control,'' he said.
Profit Margins
``Little gain is apparent'' by telecommunications companies, Greenspan said. ``A period of substantial liquidation of stocks still seemingly lies ahead for these products.''
One reason for that is ``growth of investment in equipment and software has turned decidedly negative'' even though the expected long-term return on investment in those products ``remains high,'' he said. That may be ``a continuing problem,'' he said.
``At some point, inventory liquidation will come to an end, and its termination will spur production and incomes,'' Greenspan said. That make take some time, he said.
Pressure on profit margins has been ``unrelenting,'' Greenspan said, as companies have been forced to deal with unexpectedly high energy costs at a time when low unemployment was pushing up labor costs. Both problems should ease in time, although it isn't clear how soon that will happen, he said.
Consumer Spending
It also isn't clear that consumer spending will hold up. Declining or flat stock prices have lowered household wealth, and ``we can expect the decline in stock market wealth that has occurred over the past year to restrain the growth of household spending,'' Greenspan said.
With unemployment rising -- it hit 4.5 percent last month -- ``softer job markets could induce a further deterioration in confidence and spending intentions,'' he said.
Anticipating congressional criticism, Greenspan offered a strong defense of the Fed's management of the economy over the past year. While the central bank can work to control inflation, it cannot eliminate boom-and-bust cycles. ``There is no tool to change human nature,'' Greenspan said. ``Too often people are prone to recurring bouts of optimism and pessimism that manifest themselves from time to time in the buildup or cessation of speculative excesses.''
The Fed expects the economy to grow at a 1.25 percent to 2 percent inflation-adjusted rate in 2001, and by 3 percent to 3.25 percent next year. In February, the Fed forecast the economy would grow at a 2 percent to 2.5 percent rate. The Fed's forecasts measure growth between the fourth quarter of 2000 and the fourth quarter of 2001 and reflect the ``central tendency'' of the central bank's five current governors and 12 district bank presidents.
Unemployment
The Fed expects the personal consumption expenditure price index -- an inflation measure tied to gross domestic product -- to rise by 2 percent to 2.5 percent this year and 1.75 percent to 2.5 percent in 2002. In their February forecast, the central tendency of Fed inflation forecasts was for inflation to rise 1.75 percent to 2.25 percent. Last year the PCE index rose 2.4 percent when measured from fourth quarter to fourth quarter. Last year's increase was largest since 1993.
Slower growth will push unemployment higher, the Fed said. The jobless rate will probably rise this year to about 4.75 percent to 5 percent in the fourth quarter, according to the forecast, and 4.75 percent to 5.25 percent next year. In February, the Fed's central tendency was for a unemployment rate of 4.5 percent, which the economy reached in June. In the fourth quarter of last year, the unemployment rate averaged 4 percent, close to a 30-year low.
Greenspan is required to present testimony to the Senate Banking Committee in February and the House Financial Services Committee in July. He can appear voluntarily at any time and will reprise his testimony from today to the Senate committee on July 24.
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