Fed chairman says recent economic weakness temporary, super-low rates no longer necessary.
July 20, 2004: 3:24 PM EDT
By Mark Gongloff, CNN/Money senior writer
NEW YORK (CNN/Money) - The economy will likely shake off its recent spell of weakness, Federal Reserve Chairman Alan Greenspan told Congress Tuesday, meaning the super-low interest rates of recent years are no longer necessary.
The central bank chairman, in prepared remarks delivered to the Senate Banking Committee, said the economic recovery appeared to be self-sustaining, that inflation had picked up, and that the economy seemed prepared to handle higher rates.
"Financial markets, along with households and businesses, seem to be reasonably well prepared to cope with a transition to a more neutral stance of monetary policy," Greenspan said in his remarks.
Though inflation has risen this year, Greenspan said, some of that has been due to "transitory factors," including higher oil and gas prices.
He suggested those higher prices may have contributed to a slowdown in consumer spending in June, implying that lower prices would ease inflationary pressures while also encouraging more consumer spending, which makes up more than two-thirds of the total economy.
Though he repeated the Fed's earlier pledge to be "measured" in raising rates, he again warned that the central bank could move more quickly if necessary.
"Mr. Greenspan is set to continue the unloosening, the risks of which are 'outweighed' by the benefits, and he'll go faster if he has to," said Ian Shepherdson, chief U.S. economist at High Frequency Economics.
Still, Greenspan acknowledged that a faster pace of tightening could be more troublesome than the slow and easy approach he now expects.
"Considerably more uncertainty and hence risk surrounds the behavior of the economy with a more rapid tightening of monetary policy than is the case when tightening is more measured," he said. "In either scenario, individual instances of financial strain cannot be ruled out."
Bond markets appeared to take Greenspan's remarks as a sign that rate hikes would come somewhat more quickly than they expected. Bond prices fell, driving rates higher, as he spoke. Stock prices gave up some of their earlier gains, though they continued to trade higher.
In its semi-annual monetary report to Congress, the Fed said it expected U.S. gross domestic product (GDP) to grow between 4.5 and 4.75 percent in 2004. It expects its favored measure of core consumer prices, the Commerce Department's personal consumption expenditure deflator, to rise between 1.75 percent and 2 percent.
At the end of June, Fed policy-makers raised their target for the fed funds rate, an overnight lending rate that influences other rates throughout the economy, to 1.25 percent from 1 percent, which had been the lowest level in more than 40 years. It was the Fed's first rate increase since May 2000.
Most analysts expect the Fed to continue to raise that target this year, to perhaps as high as 2.25 percent, a leisurely rate of increase. Many economists believe a more "neutral" level of fed funds is about 4 percent, a rate that may not be reached until 2005 or 2006.
So far, the economic data would seem to justify such a slow pace, as Greenspan noted in his testimony. An improving labor market has not yet pushed labor costs -- the biggest component of consumer price inflation -- particularly high, Greenspan said, and businesses continue to be cautious about spending money and hiring workers.
At the same time, Greenspan said the period of low interest rates -- which began with the first of 13 rate cuts in January 2001 -- had allowed businesses and consumers to clean up their balance sheets. Meanwhile, financial markets have already priced in higher rates, meaning further rate increases won't come as much of a shock to anybody.
Some analysts disagree, warning that higher rates will damage debt-laden consumers and cause pain in the housing market, which flourished amid the lowest mortgage rates in a generation.
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