Greenspan says economy strong, defends rate increases by Fed

WASHINGTON — WASHINGTON -- Federal Reserve Chairman Alan Greenspan refused yesterday to rule out further increases in short-term interest rates, but he declared the economy in fine shape -- provided inflation can be kept at bay.

In a hearing before members of the Senate Banking Committee, Mr. Greenspan defended the Federal Reserve's four rate increases this year against attacks by Democratic lawmakers, including Sen. Paul Sarbanes of Maryland.


The so-called federal funds rate on loans among banks is up to 4.25 percent from 3 percent in early February. On May 17, the Fed raised the discount rate on loans to members of the Federal Reserve System to 3.5 percent from 3 percent.

Those rate increases have prompted a national debate on whether the Federal Reserve Board's inflation-fighting efforts will stop the slowly recovering economy in its tracks, or even send it back into recession. Yesterday's hearing was a chance for the Democratic senators to try to pin the blame on the Fed.


But the Fed chairman deflected charges that the rate hikes are unnecessarily dampening economic growth. "This is looking to me as good as I've seen an economy evolving in a balanced form in a very long period of time," Mr. Greenspan said.

He argued that the only way to sustain long-term productivity and economic growth is to ensure that inflation is headed off even before it occurs. Once the economy heats up beyond a certain point, economists agree that higher employment levels will put upward pressure on wages and other prices, which will lead to inflation.

"Because of the lags in the effects of monetary policy, inflation once initiated would likely continue to rise for a time even after monetary policy began to tighten," Mr. Greenspan said. "Inflationary expectations would begin to increase, influencing patterns of wage bargaining and interest rates."

Despite persistent requests by committee Chairman Donald Riegle, a Michigan Democrat, Mr. Greenspan would not commit to a waiting period for the nation to adjust to the latest interest rate increases. And he refused to be pinned down to a target level of either economic growth or price levels that would signal the end of inflation fears.

"Clearly, uncertainties regarding the economic outlook remain, and the Federal Reserve will need to monitor economic and financial developments to judge the appropriate stance of monetary policy," he said.

But the Democratic lawmakers insisted that the Fed's restrictive policy is unnecessary, given the low current inflation rate. The consumer price index rose only 2.4 percent in the last year, and it gained a scant 0.1 percent in April. And the producer price index, for finished goods, fell 0.4 percent in the last 12 months, according to Mr. Sarbanes.

He and the other senators maintained that the nation is already suffering from the slowdown caused by the higher interest rates.

It would be "foolhardy to needlessly bring this expansion to a premature shutdown," Mr. Riegle said. "Already consumers are feeling . . . price inflation in higher interest rates on their adjustable-rate mortgages and home equity loans."


Mr. Sarbanes noted that the AFL-CIO and the U.S. Chamber of Commerce are in rare agreement that further rate hikes may threaten the recovery.

"Every time the economy picks up out of the water to catch its breath, you push it down again," Mr. Sarbanes said. Armed with charts, newspaper and magazine articles and editorial cartoons, Sarbanes accused the Fed chairman of fearing a phantom of inflation.

In fact, Maryland will suffer a drop of 1,600 housing starts in the coming year if the recent run-up in mortgage rates is sustained, according to a letter sent to Mr. Greenspan this week by Maryland Comptroller Louis L. Goldstein.

Mr. Sarbanes and the other legislators accused the Fed chairman of protecting the interests of Wall Street more than those of Main Street.

But Mr. Greenspan refused to back down. "The fact that long-term nominal interest rates are well above historical levels is an indication that there is still concern about inflation" in the financial markets, he said.

"These are not unsophisticated people who scare easily, who see the ghosts of inflation in every closet," Mr. Greenspan added. "I don't acknowledge that there is a difference between the goals of Wall Street and Main Street."