The U.S. economy has "firmed" and inflation is low, even with interest rates that remain "accommodative," Federal Reserve Chairman Alan Greenspan said yesterday.
The U.S. economy has “firmed” and inflation is low, even with interest rates that remain “accommodative,” Federal Reserve Chairman Alan Greenspan said yesterday. Treasury bond prices fell as investors perceived the Fed isn’t ready to slow the pace of rate increases.
“The economy seems to have entered 2005 expanding at a reasonably good pace, with inflation and inflation expectations well-anchored,” the Fed chairman said in testimony to the Senate Banking Committee. “The evidence broadly supports the view that economic fundamentals have steadied.”
Greenspan’s text did not mention the Fed’s policy pledge to continue raising interest rates at a “measured” pace, and he responded to a question from Sen. Richard Shelby, R-Ala., by saying, “We’re not going to have the same phrase in perpetuity.” Adjusted for inflation, the 2.5 percent federal-funds rate “by most measures” remains “fairly low,” he said.
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The 78-year-old central banker, whose term at the Fed expires next year, said the economy may grow as fast as 4 percent this year while a key inflation measure rises less than predicted in July. He said it is “imperative” that the government restore fiscal restraint to prepare for an aging work force and the rising burden of retirees on Social Security and Medicare.
The Federal Open Market Committee (FOMC) forecast Greenspan presented said gross domestic product (GDP) may expand 3.75 to 4 percent from the fourth quarter of 2004 to the end of this year. The low end of the range is higher than the 3.5 percent the FOMC predicted in its July forecast.
“In the seven months since I last testified before this committee, the U.S. economic expansion has firmed, overall inflation has subsided and core inflation has remained low,” Greenspan said in his text.
Economist Joel Naroff said that for “this Fed chairman, those words almost reach the level of exuberance.” Naroff is president of Naroff Economic Advisors in Holland, Pa.
The benchmark 10-year Treasury security fell 15/32 point, pushing the yield up 6 basis points to 4.15 percent. The dollar rose the most in three weeks against the yen. The dollar rose in New York to 105.36 yen from 104.42 late Tuesday and was at $1.3034 against the euro from $1.3017 Tuesday.
The Fed is trying to raise its benchmark overnight lending rate toward a so-called neutral level that neither stimulates nor restrains the economy, in an effort to head off faster inflation.
“Greenspan needs some wiggle room,” said John Herrmann, chief U.S. economist at Cantor Fitzgerald. “The Fed will be more or less honing in on a neutral rate by the time we get to the middle of the second half of the year.”
Fed officials don’t understand the decline in the yield on longer-term Treasury securities given a 1.5 percentage point increase in the central bank’s benchmark overnight bank lending rate since June, Greenspan said. The yield on the benchmark U.S. 10-year note has fallen nearly a half-point from June 30 when the Fed began raising rates in six straight meetings.
“Bond price movements may be a short-term aberration, but it will be some time before we are able to better judge the forces underlying recent experience,” Greenspan said. “For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum.”
The Fed chairman said bond yields might be low because of a larger share of world savings being deployed across borders, low inflation, or weak credit demand. In addition, “history cautions that people experiencing long periods of relative stability are prone to excess,” he said. “We must thus remain vigilant against complacency.”
Greenspan, who is serving his fifth and final term, presented a picture of stable, low inflationary growth possibly threatened by long-term domestic and international challenges, ranging from lingering business caution, low national savings rates in the face of an aging work force, a need to improve skills of U.S. workers, and budget and trade deficits.
Low interest rates have helped keep consumer spending strong, Greenspan said, households have seen rising net worth, particularly through the appreciation of home prices.
As interest rates rise and equity extraction slows, consumer spending may slip, he said.
“The rapid rise in home prices over the past several years has provided households with considerable capital gains,” Greenspan said. “Such capital gains, largely realized through an increase in mortgage debt on the home, do not increase the pool of national savings available to finance new capital investment.”
U.S. housing starts unexpectedly rose to a 21-year high in January, paced by record construction of single-family homes, the Commerce Department said yesterday. The 4.7 percent increase in new construction to 2.159 million housing units at an annual rate followed a revised gain of 14.3 percent the month before. The median forecast of 66 economists was for a decline.
Along with low interest rates, rising stock prices and small risk premiums on bonds and stocks suggest “participants in financial markets seem very confident about the future,” Greenspan said, and “quite willing to bear risk.”
Companies have become “somewhat more optimistic” in recent months, with capital spending firming “noticeably,” Greenspan said. Also, mergers and acquisitions “have clearly perked up.”
“We just put forward our forecast for investment for the year and our investment,” Intel Chief Executive Officer Craig Barrett said after Greenspan’s testimony. “Capital investment is going up 25 percent to 30 percent over last year so I guess we’re not in that group that’s cautious.”
While financial market conditions have set the stage for stronger growth with low costs for borrowers, and looser lending standards at banks, some businesses “have appeared reluctant to take on new workers and have remained focused on cost containment,” Greenspan said.
Greenspan again attributed the hesitancy of businesses to concerns about “potential legal liabilities.”
Productivity trends, which are difficult to predict, the Fed chairman said, will play a role in inflation trends. Productivity, a measure of how much an employee produces per hour of work, rose just 0.8 percent in the fourth quarter, the slowest pace in nearly four years.
Unit labor costs rose at a 2.3 percent annual rate last quarter, the most since 2002’s second quarter. Productivity rose 4.1 percent for all of 2004 versus gains of 4.4 percent for 2003 and 2002, the highest back-to-back gains since record keeping began in 1947.
Production at U.S. factories, mines and utilities was unchanged last month, held back by a decline in energy demand, according to a Fed report yesterday. The share of industrial capacity in use fell to 79 percent from 79.1 percent.
The dollar’s decline in world markets may also raise import prices, he said.
While high oil prices continue to hurt some sectors of the economy, he said, the “aggregate effect” has been modest. Oil prices are up 34.3 percent over the past 12 months, and off 14.3 percent from the recent peak of $55.17 a barrel reached on Oct. 26.