Wall Street anticipates wisdom of Greenspan

WASHINGTON -- The question for Federal Reserve Chairman Alan Greenspan today is: Has the danger of accelerating inflation become so remote that he's raised the U.S. economy's speed limit?

Investors don't expect Greenspan to spend a lot of time talking about the immediate danger of inflation when he gives his semi- annual Humphrey-Hawkins testimony on Capitol Hill today.

The consumer price index rose at an annual rate of just 1.4 percent for the year through June. It's even lower, perhaps zero, if you believe, as Greenspan does, that the CPI overstates inflation by as much as 1.5 percent annually. "Greenspan's testimony will be of interest not because of his inflation forecast, because there isn't any," said Ray Worseck, chief economist at A.G. Edwards & Sons in St. Louis. "But we may smoke out whether he sees the current condition as a temporarily permanent one, or whether he's still looking under rocks for snakes." At the same time, growth is averaging just under 4 percent for the first half of 1997 -- almost twice the pace classic economic theory says should be inflationary. Yet Greenspan has convinced his Fed colleagues to leave interest rates almost unchanged. They raised the overnight bank lending rate just once in the last 18 months -- in March -- and then by just a quarter of a percentage point. "A lot of people are thinking the Fed chairman is shifting in favor of this new economy idea -- that he may be more tolerant of growth because he doesn't see the past relationship between growth and inflation holding up anymore," said Dan Laufenberg, chief U.S. economist at American Express Financial Advisors in Minneapolis. Many of those people are betting that's correct. The rate on the August fed funds futures contract, the first to expire after the Fed's Aug. 19 interest rate policy meeting, is 5.52 percent. That's just over the current target rate of 5.50 percent, a sign investors don't believe rates are going up. Longer-term rates have fallen, meanwhile. The yield on the benchmark 30-year Treasury bond has fallen 18 basis points since the Fed last met on July 2 and 44 basis points since the Fed raised rates March 25. The bond's yield was 6.53 percent in morning New York trading today. Stocks continue to fly. The Dow Jones Industrial Average has risen more than 1,600 points -- 26 percent -- since its closing low of 6268.35 on Dec. 16, soon after Greenspan questioned rhetorically whether markets were being driven by "irrational exuberance." Last week the Dow crossed 8000 for the first time. Some point to Greenspan's remarks in March that U.S. stocks aren't necessarily overvalued -- as long as projections of corporate earnings growth hold up -- as a sign that the Fed chairman may limit warnings about stock prices in this week's congressional testimony. "Earnings reports for the first half of the year have been quite strong," said Lincoln Anderson, economist at Fidelity Management & Research in Boston. "I'd take his earlier comments at face value." Productivity increases, perhaps not captured in government statistics, are behind the non-inflationary growth, the Fed chairman has said. U.S. companies, said Greenspan, may be experiencing "an undetected delayed bonus" from years of cost-cutting and restructuring, and that "has kept costs in check through increased productivity." In a speech last May, however, Greenspan also suggested that bonus might have already been spent. "There appears to be little slack in our capacity to produce," he said. Demand would have to weaken, he warned, or the Fed's policymaking Open Market Committee would be forced to nudge interest rates higher to prevent inflation from accelerating. After growing at 5.9 percent in the first three months of the year, the economy did slow to about 2.0 percent in the second quarter, and the FOMC stood pat at its May 20 and July 2 meetings. What's uncertain is how much longer they can do so. "I think the economy's going to rebound in the second half, and I imagine many Federal Reserve officials would share that view," said Lyle Gramley, a former Fed governor who's now consulting economist at the Mortgage Bankers Association and Washington Research Group. If so, the FOMC will again have to weigh what a pickup in growth means for the economy and inflation. U.S. central bankers meet next on Aug. 19 and then on Sept. 30. Given the uncertainty, Greenspan probably will remind his audience this week that the Fed must remain vigilant. "He will continue to emphasize the fact that the principal risks against which the Federal Reserve has to guard are the risks of higher inflation," Gramley said. Many members of Congress, however, say Greenspan worries too much. Firmly in the new economy camp, they argue raising rates runs the risk of slowing the economy too much and pushing unemployment higher. While the Fed has left the overnight rate unchanged in recent months, the memory of the March move remains. Members of the House Banking Committee may remind Greenspan of that, said Scott Brown, an economist at Raymond James & Associates in St. Petersburg, Florida. "The occasion will give Congress the opportunity to scold him for raising rates," Brown said. There is a small, but growing group of economists who think Greenspan should address the apparent disinflation, or the possibility of deflation. "We have to recognize that inflation is heading down, not up," said Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson, Inc. in Chicago. With consumer price inflation measured at 1.4 percent thus far this year, the real overnight rate is 4.1 percent, the highest since 1990. That's too high, said Wesbury, who argued the Fed should cut rates. "Monetary policy is becoming more restrictive. The Fed is holding interest rates above levels suggested by the fundamentals," he said. Investors will be watching Greenspan's reaction closely. Some see him agreeing there is a new paradigm at work in the economy. "If it seems like he's willing to tolerate growth, then people will begin to say yes, the economy can grow faster without inflation increasing," said Laufenberg of American Express. On the other side, Chrysler Corp. chief economist Van Bussman said Greenspan may use the occasion of his testimony to clear up any misconceptions about how tolerant he's willing to be. While the Fed chairman may be willing to experiment with higher growth, "paradigms can shift pretty quickly," Bussman said. Finally, there's a group who said Greenspan will be Greenspan, reverting to the cautious, delphic acknowledge-all-possibilities style of testimony he's made famous. "He's going to try to walk a tightrope and say nothing," said William Michaelcheck, chairman of Mariner Partners in New York.

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