Posted on: Thursday, May 22, 2003
Fed chief vows to fight off deflation
By Ken Moritsugu
Knight Ridder News Service
WASHINGTON — Federal Reserve Chairman Alan Greenspan indicated yesterday the Fed would cut low interest rates even further if needed to stave off deflation.
While he stressed that the threat of deflation — a period of declining prices that can prolong an economic slowdown — is "minor," Greenspan added that it "is sufficiently large that it does require very close scrutiny and maybe — maybe — action on the part of the central bank."
The Fed, which is the nation's central bank, first expressed worries about deflation at its May 6 meeting.
That public statement of concern prompted speculation by analysts that the Fed would cut interest rates at its next meeting on June 24-25. Greenspan's comments, made at a congressional hearing yesterday, left that possibility open.
Whether the U.S. economy falls into deflation depends largely on whether or not economic growth picks up. Most analysts believe the economy will bounce back by the end of this year, erasing deflation fears.
Greenspan called expectations of a pickup "not unreasonable" but added that the strength of the pickup and when it will occur remain unclear.
Analysts believe a Fed rate cut in June depends on what the May unemployment report and other upcoming economic data show.
Stocks were largely unchanged, as Greenspan's testimony shed little new light on the economic outlook.
Most analysts agree that the probability of deflation in the United States remains low, but concern is edging up. Richard Berner, the chief U.S. economist at the Morgan Stanley investment bank in New York, thinks the odds of deflation have risen from 15 percent to 25 percent.
Deflation is worrisome because widespread price declines could make it more difficult for the Fed to spark an economic recovery. Companies may lay off workers or reduce wages if lower prices cut into their profits. Both firms and individuals may find it harder to pay off debts if their profits and incomes follow prices downward.
"Even though we perceive the risks as minor, the potential consequences are very substantial and could be quite negative," Greenspan told the congressional Joint Economic Committee.
The Fed may be forced to try some unusual strategies to fight deflation. Since interest rates can't go below zero, the Fed has little downward movement left in rates. The overnight federal funds rate is now 1.25 percent, a 41-year low.
The Fed has been exploring alternative ways to boost the economy, such as buying Treasury bonds, which would pull down longer-term interest rates.
Greenspan expressed confidence that the Fed can handle deflation.
Even if the federal funds rate were to reach zero, "that does not mean that the Federal Reserve is out of business," he said. "We see no credible possibility that we will at any point, irrespective what is required of us, run out of monetary ammunition to address problems of deflation or anything similar to that which disrupts our economy."
