WASHINGTON (AFX) - Federal Reserve board chairman Alan Greenspan said the current economic slowdown could be limited, but warned that downside risks still predominate.
Greenspan said the economy is suffering from an inventory correction, or retrenchment. He said it has been a sharper correction because businesses have much better control over their inventories. But he said that higher long-term productivity trends could quickly counter the weakness.
"If the forces contributing to long-term productivity growth remain intact, the degree of retrenchment will presumably be limited," Greenspan said in testimony prepared for his semi-annual report to Congress on monetary policy. "Prospects for high productivity growth should, with time, bolster both consumption and investment demand. Before long in this scenario, excess inventories would be run off to desired levels," he said.
Still, the Fed chairman cautioned that the economy is vulnerable to negative surprises, such as a break in consumer confidence, weakness in foreign economies and continued nervousness on the part of lenders. He admitted the Fed doesn't know "how far the adjustment of the stocks of consumer durables and business capital has come."
Although consumer confidence has fallen, "at least for not it remains at a level that in the past was consistent with economic growth," Greenspan said. The Fed chairman said that economic growth began in the middle of 2000 and intensified "perhaps even to the point of growth stalling out around the turn of the year."
Against this background, Greenspan said the FOMC undertook "a series of aggressive" rate cuts, reducing its targeted federal funds rate to 5.5 pct from 6.5 pct.
"An essential precondition for this type of response was that underlying cost and price pressures remained subdued, so that our front-loaded actions were unlikely to jeopardize the stable, low inflation environment necessary to foster investment and advances in productivity," Greenspan said. January does not appear as weak as December, he said. "The exceptional weakness so evident in a number of economic indicators toward the end of last year (perhaps in part the consequence of adverse weather) apparently did not continue in January," Greenspan said.
"But with signs of softness still patently in evidence at the time of its January meeting, the FOMC retained its sense that the risks are weighted toward conditions that may generate economic weakness in the foreseeable future," he added.
One of the important factors contributing to the slowdown has been higher energy costs, Greenspan said.
The most prominent effects of higher energy costs has been to depress aggregate demand, and does not appear to have had broad inflationary effects," he said.
Greenspan said the rapid nature of the current slowdown has caused financial market participants to become more risk adverse, similar to the fall of 1998, when financial markets seized up after Russia defaulted on their debt.
"Such a process presumably is now under way and arguably may take some time to run its course," Greenspan said.
The Fed chairman noted that the unpredictable nature of consumer confidence makes recessions difficult to forecast. But he noted that stock market analysts continue to expect elevated earnings growth over the long-run. He said that the advances in technology has enhanced that Fed's ability for real-time surveillance of economic activity. The stock market has become a more important determinant of shifts in consumer spending, he noted.