The booming stock market was on the mind of Federal Reserve Chairman Alan Greenspan last night as he signaled in a New York speech that the central bank will raise interest rates again soon to keep inflation at bay and allow what is about to become the longest economic expansion in U.S. history to continue.
"Our goal, in responding to the complexity of current economic forces, is to extend the expansion by containing its imbalances and avoiding the very recession that would complete a business cycle," Greenspan told the New York Economic Club, in a much-anticipated address less than three weeks before Fed policymakers next meet.
The Fed chairman credited, as he has before, the burst of technological innovation and massive capital investment by American businesses with significantly increasing the ability of the economy to produce goods and services. Those same developments, however, have raised long-term profit expectations and "engendered a huge gain in equity prices," he said.
"Through the so-called 'wealth effect,' these gains have tended to foster increases in aggregate demand beyond the increases in supply. It is this imbalance between growth of supply and growth of demand that contains the potential seeds of rising inflationary and financial pressures that could undermine the current expansion," Greenspan cautioned.
A key concern, he reiterated, is the shrinking pool of potential workers who would like a job but don't have one. Sooner or later, if the unemployment rate--which has been 4.1 percent for the past three months--keeps falling, pressures from accelerating wage increases will push inflation higher, he argued.
"If our objective of maximum sustainable economic growth is to be achieved, the pool of available workers cannot shrink indefinitely," Greenspan said.
The Fed chairman's remarks indicated that, as most financial analysts have been expecting, the Fed will raise its target for overnight interest rates at the end of its two-day policymaking session on Feb. 2, with additional increases possible if the very rapid increases in spending by American consumers and businesses don't begin to taper off.
Several of Greenspan's Fed colleagues, who will participate in the upcoming meeting, said in speeches this week that they, too, are concerned that inflation will rise if economic growth remains at 4 percent or more. And they, too, signaled that a rate increase is on the way since three quarter-percentage-point increases beginning last summer haven't slowed spending as much as the officials believe is needed.
J. Alfred Broaddus, president of the Richmond Federal Reserve Bank, said in a speech in Richmond, "Personally, I still believe that the principal risk in the near-term outlook is that continued exceptionally strong domestic demand for goods and services may eventually cause the economy to overheat, and I think this risk is rising."
That troubles Broaddus because he doesn't want to lose any of the ground the Fed has gained against inflation in recent years. "I'm happy to tell you that I think we have at long last achieved price stability, not only in terms of recent inflation statistics--certainly that--but also in terms of the currently high public confidence that inflation will remain under firm control indefinitely," Broaddus said.
And in what was a clear vote for higher rates, he added, "I have a new obsession--maintaining the progress we've made: in other words, validating public confidence that inflation will stay contained."
Meanwhile, Cathy Minehan, Broaddus's counterpart at the Boston Fed, told a Connecticut audience that even if all of the gains in labor productivity the country has experienced since 1996 are long-lasting, "there is a case to be made that the economy has been growing beyond what is sustainable.
"Growth has been 4-plus percent, not 3-plus," Minehan said, "the unemployment rate has fallen over the past year, and labor markets continued to tighten. What we haven't yet seen is the pick up in inflation that would usually accompany such an extended period of high growth and resource utilization."
"In this environment continuing to operate beyond [the economy's sustainable level of production] potential carries increasing inflation risk, and risk that this long, benevolent period of U.S. economic growth will come to an end," she warned.
In Greenspan's speech, a text of which was made available in Washington, he said: "However one views the causes of our low inflation and strong growth, there can be little argument that the American economy as it stands at the beginning of a new century has never exhibited so remarkable a prosperity for at least the majority of Americans.
He also noted that long-term interest rates have gone up substantially, though it seemed clear that they haven't risen enough in his view to cause consumers and businesses to trim their spending plans.
"An excess of demand over supply ultimately comes down to planned investment exceeding saving that would be available at the economy's full potential," he said. "In the end, balance is achieved through higher borrowing rates."
In the current situation, long-term rates have gone up in part because of increased demand for credit by businesses eager to make productivity-enhancing investments. But the Fed chairman also stressed that the increases have been "supported by a central bank intent on defusing the imbalances that would undermine the expansion."
Greenspan also had a pointed cautionary note for politicians who want to use a large share of prospective federal budget surpluses to finance either substantial spending increases or large tax cuts.
The growing budget surpluses "have absorbed a good part of the excess of potential private demand over potential supply" and thus helped keep the economy relatively balanced, he said. "A continued expansion of the surplus would surely aid in sustaining the productive investment that has been key to [utilizing] the opportunities provided by new technology, while holding down a further reliance on imports and absorption of the pool of available workers.
"I trust that the recent flurry of increased federal government outlays, seemingly made easier by the emerging surpluses, is an aberration. In today's environment of rapid innovation, growing unified budget surpluses can obviate at least part of the rebalancing pressures evident in marked increases in real long-term interest rates," Greenspan said.
In other words, he was warning that reducing the prospective surpluses would mean higher interest rates.
CAPTION: Fed chief Alan Greenspan expressed concern about the impact of a falling unemployment rate on the U.S. inflation rate.