WASHINGTON, July 15 - Federal Reserve Chairman Alan Greenspan vowed on Tuesday to keep U.S. interest rates low for a long time even as he predicted a hearty economic recovery. He told Congress the Fed officials might cut official borrowing costs below their current 45-year low of 1 percent if they need to prevent deflation. Greenspan eschewed for now more dramatic actions such as buying long-term U.S. bonds. Indeed, he said the economy "could very well be embarking on a period of extended growth," meaning such aggressive measures probably will not be needed.
An upbeat economic view in the Fed chief's semiannual monetary policy testimony sent U.S. Treasuries prices tumbling. The 10-year bond's yield, which moves in the opposite direction to the price, posted the biggest one-day rise since October 1998. The pullback in bonds put a damper on the recent stocks rally. The Dow Jones industrial average fell 48 points to 9,129. The tech-laced Nasdaq Composite lost 2 points 1,753. Speaking to the House of Representatives Financial Services Committee, Greenspan said the central bank "stands prepared to maintain a highly accommodative stance of policy for as long as needed to promote satisfactory economic performance." "We would seek significant improvement in the performance from what we currently see before (a rate increase) is even on the table," he said.
TURNING POINT? It is highly unusual for Greenspan to offer an outlook for interest rates over an extended period of time. He tends to prefer to keep his options open. Many analysts were also struck by the Fed's forecasts for the U.S. economy. Policy-makers predicted gross domestic product growth of 2.5 percent to 2.75 percent in 2003. Given the slim GDP gains so far this year, the figures imply a sharp rebound in coming months.
"The Fed's forecast for the second half has to be close to 4 percent," said Roger Kubarych, economic adviser to Hypo-Vereins Bank. Many private economists have issued more cautious forecasts. GDP rose at an annual rate of 1.4 percent in the first three months of this year. The government has not yet tallied second-quarter GDP but experts think the growth rate could mirror the first quarter. The Fed pegged GDP growth in 2004 at 3.75 percent to 4.75 percent. Greenspan did warn of some hazards the U.S. economy faces, including spillover from economic woes in Japan and Europe. He also noted the mood in corporate boardrooms is one of wariness, so much so that low rates are failing to entice managers to commit to new investments. For the overall economy, however, he said rising stock prices, a spree of home refinancings and steps by corporations to bolster their balance sheets portend better times ahead. "We believe that we're at a turning point, and our best judgment is that things will be improving," Greenspan said. The Fed chief weighed in on the politically charged issue of President George W. Bush's $350 billion tax-cut package. He cited the cuts as one factor that would help the recovery. But he warned once again that lawmakers and the administration must tackle large and growing budget deficits. The White House on Tuesday predicted the federal budget deficit would balloon to a record $455 billion this year.
"PERNICIOUS" DEFLATION
On the subject of monetary policy, Greenspan did not specify how long he would be prepared to keep borrowing costs at their current cheap levels, but economists speculated it could be well into 2004 or even early 2005. He pointed to the small but worrisome risk of deflation. "Indeed, there is an especially pernicious, albeit remote, scenario in which inflation turns negative against a backdrop of weak aggregate demand, engendering a corrosive deflationary spiral," Greenspan said. The issue of deflation was a key topic at the Fed's most recent meeting on June 24-25, at which it reduced short-term borrowing costs for the thirteenth time since early 2001. Policy-makers at that gathering talked over a variety of steps they might take to guard against price declines. Greenspan said they came to conclusion the economy is not in enough peril now to warrant a test of unconventional measures like intervention in long-term bond markets. Moreover, Greenspan said officials see "substantial" room for further cuts to its traditional target of overnight interest rates. While some economists on Wall Street worry about the feasibility of some of the newer tools the Fed might use, the idea of further cuts in short-term rates is also controversial.
Even an official interest rate of 0.75 percent could disrupt the market for overnight money by removing the leeway that financial firms have to make a profit.//