Washington, Feb. 11 (Bloomberg) -- U.S. economic growth will probably pick up once investors, consumers and corporate executives know what will happen with Iraq, an ``uncertainty'' that's creating ``formidable barriers'' to new investment, Federal Reserve Chairman Alan Greenspan said. ``The intensification of geopolitical risks makes discerning the economic path ahead especially difficult,'' Greenspan said in the text of testimony to the Senate Banking Committee. Once the outcome in the Middle East is clear ``we should be able to tell far better whether we are dealing with a business sector and an economy poised to grow more rapidly -- our more probable expectation.'' If, ``contrary to our expectations,'' companies and consumers don't then pick up spending, additional cuts in interest rates and taxes ``will doubtless move higher on the policy agenda,'' he said.
Treasury securities fell and stock indexes rose after Greenspan's comments. The 4 percent note that matures in November 2012 fell about 1/8 point, pushing up its yield 3 basis points to 3.98 percent at 10:15 a.m. New York time. A basis point equals 0.01 percentage point. The Dow Jones Industrial Average rose 15 points, or 0.2 percent, and the Nasdaq Composite Index rose 8 points, or 0.7 percent. U.S. gross domestic product expanded at a 0.7 percent annual rate in the final three months of 2002, the slowest quarter since the July-September 2001.
Fed Rate Cut
On Nov. 6, Fed policy makers lowered the benchmark overnight bank lending rate by a half percentage point to a 41-year low of 1.25 percent, a move Greenspan today called ``insurance against the threat of persistent economic weakness.'' The FOMC had cut rates 11 times in 2001. The chairman's comments, the first of two annual appearances before congressional banking panels, are supposed to reflect views of the central bank's seven governors and 12 district bank presidents. Their feeling, he said, is that the economy has performed about as they expected, with final sales slowing and ``soft'' business spending as companies kept inventories lean and concern about accounting scandals restrained investors. On top of that came talk of war. ``In particular, worries about the situation in Iraq contributed to an appreciable rise in oil prices,'' the Fed chairman said. ``These uncertainties, coupled with ongoing concerns surrounding macroeconomic prospects, heightened investors' perception of risk, and perhaps their aversion to risk,'' he said.
Falling Stocks
That led to falling stock prices, high market volatility, and wider spreads between government and corporate bond yields. ``Liquidity in corporate debt markets declined,'' he said. As a result, companies limited hiring and capital spending, and slowed inventory building. The Fed's Nov. 6 rate cut helped markets improve, ``but only haltingly,'' Greenspan said. The Standard & Poor's 500 Index has declined about 10 percent the past two months, partly on concern that a U.S.-led war with Iraq would hurt the economy and cut into corporate profits. The dollar has declined against the euro for six straight months. Crude oil prices rose 16 percent in December and 7.4 percent in January. ``While household spending has been reasonably vigorous, we have yet to see convincing signs of a rebound in business outlays,'' Greenspan said. Capital spending has shown signs of reviving in recent months, he said. ``However, the emergence of a sustained and broad-based pickup in capital spending will almost surely require the resumption of substantial gains in corporate profits.''
Business Spending
That will depend ``not only on market conditions and the prospects for profits and cash flow but also on the resolution of the uncertainties surrounding the business outlook,'' Greenspan said. ``The heightening of geopolitical tensions has only added to the marked uncertainties that have piled up over the past three years, creating formidable barriers to new investment and thus to a resumption of vigorous expansion of overall economic activity.'' If those uncertainties clear, Fed officials are optimistic because there are signs the economy is beginning to pick up, Greenspan said. With inventories low, production will have to pick up if demand rises, he said. ``Indeed, after dropping back a bit in the Fall, manufacturing activity turned up in December, and reports from purchasing managers suggested that the improvement has continued into this year,'' he said. The Institute for Supply Management's factory index reading of 53.9 in January was the third straight month of a number exceeding 50, which signals growth.
Fed Expectations
The Fed expects the personal consumption price index, an inflation measure tied to gross domestic product, to rise between 1.25 percent and 1.5 percent and the unemployment rate to fall over the next year to 5.75 to 6 percent. The personal consumption index rose 1.9 percent last year. The unemployment in the U.S. rate dropped to 5.7 percent in January from an eight-year high of 6 percent a month earlier, which Greenspan called an ``encouraging'' development. Companies added 143,000 workers, the biggest monthly increase since November 2000. Greenspan also stressed the ongoing rise in worker productivity. Output per hour at nonfarm businesses rose 3.75 percent over the past year, ``an impressive gain for a period of generally lackluster economic performance,'' he said. While companies' efforts to produce more with less have slowed hiring, it's also kept household incomes strong, he said. That, along with ``very low interest rates and reduced taxes,'' helped keep home construction and retail sales strong.
Refinancing
The refinancing boom that flowed from the lowest mortgage rates in decades ``is bound to contract at some point,'' Greenspan said. Yet he noted mortgage rates remain low and refinancing applications haven't fallen by much. Money added to the economy from processing existing applications alone will be a ``significant'' boost to growth ``at least through the early part of this year,'' he said. While household debt has risen, the increase in home equity and the low cost of servicing debt means that isn't ``a significant cause for concern at this time,'' he said. A year ago, Greenspan told Congress the U.S. economy was ``close to a turning point'' following a recession that began in March 2001 and probably ended later that year. The Fed's forecast at that time, for annual growth of 2.5 percent to 3 percent in 2002, turned out to be more accurate than its July prediction of 3.5 percent to 3.75 percent growth. Greenspan declined to comment on President George W. Bush's proposed $690 billion package of tax cuts, saying he doesn't ``claim to be able to judge'' its relative merits.
Bush Budget
Bush has proposed a $2.23 trillion budget for the fiscal year beginning Oct. 1, and the administration projects a record budget deficit of $307 billion -- a figure that does not include the cost of any armed conflict with Iraq. In January 2001, Greenspan's endorsement of tax cuts helped Bush convince Congress to pass a $1.35 trillion plan four months later. While Greenspan didn't align his views specifically with the Bush plan two years ago, he told the Senate Budget Committee at the time that ``should current economic weakness spread beyond what now appears likely, having a tax cut in place may, in fact, do noticeable good.'' However, noting that he was speaking for himself and not the other members of the Fed, Greenspan offered a lengthy analysis of the faults in the federal budget process, and called on Congress to ``enhance discipline'' in spending.
Long-term Costs
He recommended lawmakers move to ``accrual'' accounting from the current ``cash'' accounting system, so the actual costs of existing programs and proposed changes would be clear. That would ``help shift the national dialogue and consensus toward a more realistic view of the limits of our national resources'' and focus attention on the ``difficult choices'' facing the country as it prepares to pay for the retirement and medical needs of the ``baby boom'' generation over the next few decades. The Fed chairman also called on the senators to ``without delay'' reinstitute statutory limits on discretionary spending and ``pay-as-you-go'' budget rules that require new spending to be offset by additional taxes or spending cuts elsewhere. Triggers on spending and ``sunsets'' on programs would be ``helpful,'' he suggested. Greenspan also said Congress should base cost-of-living increases in federal retirement programs on the new ``chain weighted'' consumer price index instead of the CPI itself, which overstates the cost of living. If that had been used in the most recent fiscal year, the 2002 deficit would have been $40 billion dollars lower than its actual $159 billion. ``There should be little disagreement about the need to reestablish budget discipline,'' Greenspan said. //www.quote.bloomberg.com