Greenspan: Fed on guard against deflation

Posted: Thursday, May 22, 2003

WASHINGTON With short-term interest rates near rock bottom, Federal Reserve Chair Alan Greenspan said he still has plenty of ''monetary ammunition'' to prevent a destabilizing drop in prices. The Fed's goal: pump up demand for cars, homes and other items and get the economy moving again.

At Greenspan's appearance Wednesday before the congressional Joint Economic Committee, he gave his first detailed comments about deflation since Fed policy-makers warned May 6 they would be on guard against the remote possibility of such a rare and dangerous episode of widespread price declines.

The Fed's main tool to influence the economy is the federal funds rate, the interest that banks charge on overnight loans. It is at a 41-year low of 1.25 percent, which limits the number of rate cuts the Fed can order to energize the economy.

Greenspan said the Fed has other ways to pump more money into the economy, such as buying longer-term Treasury securities to drive down longer-term interest rates.

''We see no credible possibility that we will at any point, irrespective of what is required of us, run out of monetary ammunition to address problems of deflation or anything similar to that which disrupts our economy,'' he said.

Greenspan stressed that the Fed does not see the chance of deflation as an ''imminent, dangerous threat to the United States, but a threat that, even though minor, is sufficiently large that it does require very close scrutiny and maybe, maybe, action on the part of the central bank.''

America's last serious case of deflation came during the Great Depression of the 1930s, and modern day central bankers in the United States generally have focused on fighting inflation.

''The notion that deflation would have emerged just never entered our minds until the Japanese demonstrated to us otherwise,'' Greenspan said. Since the early 1990s, Japan has been suffering with a stagnant economy and is now struggling to emerge from a period of deflation.

Deflation concerns raised by Greenspan and his colleagues have boosted the odds that Fed policy-makers will reduce the funds rate, perhaps by a quarter percentage point, at their next meeting on June 24-25, some economists said.

Such a move would mark the Fed's first rate reduction since Nov. 6 when the rate was lowered to its current 1.25 percent rate.

''It would take a lot of really strong economic data to prevent the Fed from lowering the funds rate, and I don't see that happening,'' said Stuart Hoffman, chief economist at PNC Financial Services Group.

Others believe the Fed will stay on the sidelines. ''Recent economic data is still blurred by the effects of the war and Greenspan will need another meeting to determine exactly which way the economy is heading,'' said Mark Zandi, chief economist at Economy.com.

Although Greenspan was mum on what the Fed's next interest-rate step would be, he predicted that economic growth in the current April-June quarter ''is going to be quite soft.''

Even though the ''profitability of many businesses is on the mend,'' businesses remain cautious and are wary of making big spending and hiring commitments, Greenspan said. That is a major factor preventing the economy from getting back to full economic speed.

On other matters, Greenspan said that the contagious severe acute respiratory syndrome, SARS, which has hit the economies of Hong Kong and China particularly hard, thus far has had minimal effects on the U.S. economy, though the illness has dealt battered airlines another blow.

While some energy prices have retreated something that might make consumers and businesses more inclined to spend natural gas prices have gone up sharply because of tight supplies, Green-span said.

Should Congress consider extending federal emergency jobless benefits to help people who exhaust their state benefits, Greenspan said: ''I would be careful to keep the extensions relatively short and renew them again if necessary. Because we're not quite clear at this stage what the path of short-term economic activity is.''



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