Greenspan Won't Reject Aggressive Rate Hikes

Both Greenspan and Kohn prominently noted the recent rise in inflation and sounded more concerned about its likely path than in other recent comments.

Consumer prices, excluding those in the volatile food and energy categories, rose 1.4 percent in the 12 months ended in May, according to a Commerce Department gauge favored by the Fed. That is a low "core" inflation rate and well within the comfort range of many Fed officials. But it has risen steadily since December, when it was 0.8 percent.

This rise surprised Fed officials who had predicted early this year that inflation would stay very low and possibly even decline further because of slack in the economy -- relatively high unemployment and unused production capacity.

Kohn outlined several one-time or temporary factors that help explain the jump in inflation, including higher prices for raw materials, the weakness of the dollar and the rebound of inflation from an abnormally low level a year ago.

Kohn said he still believes "the rise in inflation will be limited," but made plain his heightened wariness by adding, "Experience counsels caution. There is much about the inflation process that we do not understand, and I have been surprised at the extent of the pickup in core inflation."

Greenspan noted recent developments that have removed some of the restraints on inflation that had caused it to fall last year. For example, businesses' labor costs per unit of output have started to rise this year, after falling last year.

And, he said, "the persistence of the rise in energy prices is a worrisome element in the cost picture."

The stakes are high for the Fed in managing this policy transition.

Fed officials want to avoid a repeat of the financial turmoil that occurred in 1994 and 1995, when the central bank surprised many investors by lifting its overnight rate to 6 percent from 3 percent in just 12 months. The Fed's actions contributed to the Mexican peso crisis, the failure of investment bank Kidder Peabody & Co. and the Orange County, Calif., bankruptcy, according to many analysts.

So this time around, Greenspan and others have painstakingly warned that rates are headed upward and indicated that they will move slowly if they can. Already many long-term interest rates set by financial markets -- such as mortgage rates -- have been rising in anticipation.

But the Fed's plans can change, Greenspan cautioned yesterday. "Economic developments going forward will determine the level and term structure of interest rates."