Greenspan: Not Enough Inflation

Federal Reserve Chairman Alan Greenspan told a congressional panel Wednesday that the Fed is ready and able to do whatever is necessary to guard against the remote possibility that a weak economy will trigger a debilitating bout of falling prices.

The Fed chairman also told the joint house-senate committee many companies are still hesitant to start hiring.

"Lingering business caution could be an impediment to improved economic performance," he said.

Greenspan assured the congressional Joint Economic Committee that even with the Fed's key economic policy lever, the federal funds rate, at a 41-year low of 1.25 percent, the central bank has other resources to influence interest rates to jump-start economic growth.

He said that in addition to pushing the funds rate, the interest that banks charge each other on overnight loans, closer to zero, the Fed can simply begin buying longer-term Treasury securities to drive longer-term interest rates lower.

"Should it turn out that, for reasons which we don't expect, but we certainly are concerned may happen, the pressures on short-term markets drive the federal funds rate down close to zero, that does not mean that the Federal Reserve is out of business," Greenspan said.

"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 — a widespread, prolonged drop in prices — 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 Federal Reserve."

Greenspan said the reason the Fed is being so careful to guard against potential deflation has been the experience of Japan. Since the early 1990s, Japan has been trapped in a prolonged period of economic weakness and is now struggling to emerge from a period of deflation.

Greenspan said most economists in recent decades dismissed the threat of deflation because governments have the ability to print more money to pump up prices if necessary since the world removed currencies from the gold standard in the 1930s.

"We never dealt with this before," Greenspan said. "The notion of deflation just never entered our minds until the Japanese demonstrated to us otherwise.

In his prepared testimony, Greenspan noted that at the present time, "the probability of an unwelcome substantial fall in inflation over the next few quarters, though minor, exceeds that of a pickup in inflation."

"Even though we perceive the risks as minor, the potential consequences are very substantial and could be quite negative," he added at the hearing.

That language tracked what Fed policy-makers said after their May 6 meeting when the central bank, in an historic shift, signaled that for the first time in more than a half century, they were more worried about the possibility of deflation than in inflation. The country's last bout of deflation occurred during the Great Depression of the 1930s.

Many economists believe that the Fed's new worries about the possibility of deflation have increased the odds that the central bank will cut interest rates when policy-makers next meet June 24-25. Analysts believe the debate at that meeting may not be over whether to cut rates but how large of a rate cut to provide, either the normal quarter-point move or a larger half-point cut.

The last Fed rate cut occurred Nov. 6, when the Fed, worried about a developing "soft spot" in the economic recovery, cut rates by a half point. That reduced the target for the federal funds rate, the interest that banks charge on overnight loans, to a 41-year low of 1.25 percent.

Greenspan said that at the present time economic data is sending mixed signals about the strength of the recovery with no strong pattern established in the weeks following the end of the Iraq war.

"The economy continues to be buffeted by strong cross currents," Greenspan said.

He added that he believed overall economic growth in the current April-June quarter "is going to be quite soft."

He said that corporate profits will not go down, however, during this period because strong productivity growth is helping companies shore up their profit margins during this period of weak economic growth.

Greenspan said that while declines in energy prices immediately after the war were encouraging, with West Texas intermediate crude falling to below $26 per barrel, some of that decline was recently reversed with the price of crude oil rising to near $30 a barrel. That's because of indications of delays in restoring Iraqi crude production and various other geopolitical risks creeping back into market expectations.

He called this a "worrisome trend if continued" but noted that even at $30 per barrel, oil prices are still about $10 below the peak hit in February.