Greenspan holds off interest rate forecast

WASHINGTON -- Federal Reserve Chairman Alan Greenspan said Wednesday it's too soon to tell whether a Fed interest-rate increase is necessary to ensure the U.S. economy slows to a sustainable non- inflationary pace.

"We are seeing increases in wages, but we are not seeing increases in prices," Greenspan told members of a House Banking subcommittee. The question Fed officials must answer is "are we looking at productivity increases or are we looking at contractions in profit margins?"

Greenspan's comments echoed his upbeat testimony before a Senate committee last week about the likelihood of a gradual slowdown from the second quarter's sizzling growth rate of as much as 5 percent. And like last Thursday, his outlook helped send U.S.bonds higher.

"He didn't want to frighten the markets the other day. He didn't want to frighten the markets today," said Robert Dederick, a consultant at the Northern Trust Co. in Chicago.

"I didn't think any new ground was broken," Dederick said. "There had been some belief that the market misinterpreted his comments the other day and he would use this opportunity to set them straight. But they got the basic message."

This time, though, a Greenspan-inspired bond surge didn't carry stocks higher as well. The Dow Jones Industrial Average slumped 44.39 points Wednesday to close at 5346.55, and the Nasdaq Composite Index plunged almost 3 percent.

Greenspan said recent instability in the stock market is "not unusual," particularly among high-technology stocks. Volatility is part of a normally functioning market, he said, and what was unusual was the prolonged runup in U.S. stocks.

The drop which followed release of disappointing earnings reports, by high technology stocks in particular, is "the more expected state of affairs," Greenspan said.

Greenspan told the House subcommittee there are "significant areas of tightness in the labor market," that could lead to inflationary pressures, Greenspan said, although he said that's not true of the labor market as a whole.

The Fed chairman declined comment on the future direction of interest rates. "Our basic goal is to keep an economy which is over the long run moving at a maximum sustainable growth rate," he said.

Greenspan said the Fed could raise rates before its next policy meeting on Aug. 20 if economic conditions warranted, though he made it clear such a move isn't likely.

"There's nothing sacrosanct about moving only at meetings" of the FOMC, he said. "We have moved quite often between meetings."

The Fed has the capability to push interest rates up "with virtually no lead time," Greenspan said, depending on "the nature of the type of monetary environment."

Separately, he deflected questions about the economic impact of tax cuts being considered by Republican presidential candidate Bob Dole.

While tax cuts should be matched by spending cuts, he said, "you can't argue that if you increase the deficit therefore you (automatically) increase interest rates. There are so many other elements in the system that I wouldn't even begin to address that question."

Greenspan denied the Fed's interest-rate setting Open Market Committee has adopted a policy of "opportunistic disinflation," tolerating low levels of inflation in order to increase growth, while using inevitable cyclical recessions to tamp down overall inflation growth.

"It's never been discussed by the FOMC," he said, though a recent staff study of the theory "got more press than we thought it would."

Greenspan's written text for his House panel appearance was identical to the testimony he presented last week at a Senate committee hearing. It states that higher bond yields, a strengthening dollar and waning consumer and business demand should temper growth in the second half of the year.

The Fed chairman cautioned, however, that higher interest rates still may be required.

"The timing and extent of that downshift are uncertain," he said in the text. If inflationary pressures intensify in the second half because of continued strong economic growth, he said, Fed policymakers will "move to tighten" rates, according to the text.

Greenspan laid out a rather precise timetable in responding to questions last week. The slowdown "has to become evident in the period immediately ahead," he said.

The chairman said Fed policymakers will pay close attention to a series of reports that will come out next week: the first government estimate of second quarter gross domestic product, the quarterly employment cost index, the National Association of Purchasing Management report on manufacturing activity and the Labor Department report on July's jobs market.

"He sort of told us everything we really need to know," said Dave Gottlieb, senior vice president at Donaldson, Lufkin & Jenrette Securities in New York. "We just need to wait for the numbers over the next few weeks."

Many analysts doubt Greenspan will find the slowdown he's looking for in those numbers. "I think he will have to ultimately tighten," said Fed-watcher David Jones, an economist at Aubrey G.Lanston & Co. in New York. "What he's done is he's prepared the markets for that possible outcome."

The day after Greenspan's testimony last week, the University of Michigan reported its preliminary index of consumer sentiment for July rose to 93.0 from 92.4 in June, the third consecutive monthly increase.

It's a sign that consumers, whose spending fuels about two-thirds of overall economic activity, remain upbeat about their personal finances and the prospects for the economy.

The same day, the Labor Department said first-time claims for state unemployment insurance fell last week by 6,000, suggesting continued strength in the employment market.

Greenspan said the Fed projects the economy will expand at a 2.5 percent to 2.75 percent rate this year, falling to 1.75 percent to 2.25 percent next year. That compares with 1.3 percent in 1995. The White House is forecasting 2.6 percent growth this year.

The Fed projects the consumer price index will rise by 3 percent to 3.25 percent this year, up from last year's 2.5 percent, and drop to 2.75-to-3 percent next year. The nation's unemployment rate, 5.3 percent in June, will edge up to 5.5 percent at year's end and remain close to that in 1997, according to the Fed.

Greenspan's semi-annual review of the economy, mandated by the Humphrey-Hawkins Balanced Growth and Full Employment Act, is followed by investors worldwide for what it may reveal about the central bank's future interest rate policies.

The Fed last raised the federal funds rate on overnight bank loans, by a half point, on Feb. 1, 1995. Since then, all of its move have been to lower rates, ending with a quarter-point cut on Jan. 31 when many analysts were predicting the U.S. economy was heading into a recession.

The Fed decided against changing rates at policy meetings on March 26, May 21 and July 2-3.

Back in February, the central bank forecast a 2 to 2.25 percent growth rate for this year. Greenspan said that range was as fast as the economy can expand without igniting inflation.

The Clinton administration, however, has argued that the Fed's desired growth range is too low, given the fact that there's little inflation despite the economy's strong performance recently.

Officials also note that President Bill Clinton's latest budget projects a deficit shrinking to $117 billion this fiscal year, or just 1.6 percent of the gross domestic product. That's the smallest share of the economy since 1974 -- a significant disinflation factor.

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