Federal Reserve Chairman Alan Greenspan said yesterday that sharp increases in oil prices are both weakening the U.S. economy and adding to inflation, and he indicated that the central bank will be extremely cautious about reducing interest rates.

"It's obvious that the short-term outlook ... is weaker," Greenspan told Congress's Joint Economic Committee. "I think ... we are still growing at this particular stage very slowly. I don't see as yet any hard evidence of an immediate day-by-day deterioration."

Greenspan's assessment of the economic outlook was his most pessimistic since before the October 1987 stock market crash. He said the chances of a recession have grown following the Iraqi invasion of Kuwait, which caused crude oil prices to jump from about $18 a barrel to about $34 since the beginning of August. He added, however, that he could not tell yet whether the chances of a recession were more than 50-50.

Many financial analysts took his remarks as a strong sign the Fed does not plan to lower short-term interest rates soon in an attempt to bolster economic growth, as many investors had expected. President Bush earlier this week urged the Fed to reduce rates to encourage faster growth.

Greenspan once again did suggest that one way to get interest rates down would be to reduce the federal budget deficit.

If the current budget negotiations between the administration and Congress succeed, "and the Congress does enact a credible, long-term, enforceable budget agreement, I would expect long-term interest rates to decline," he testified. "In that context, I would presume that the Federal Reserve would move toward {lowering short-term rates} to accommodate those changes in the capital markets."

In other words, if investors believe a budget deal will mean less federal borrowing in the future, they likely would bid down long-term interest rates and the Fed would act to cut short-term rates, too.

Separately, the Fed issued a report on current national economic conditions based on a survey by its 12 regional reserve banks that found that "economic activity is expanding more slowly or declining" in most parts of the country, although several Fed districts reported continued, modest growth.

"Weakness is most apparent in the northeastern and mid-Atlantic districts," the report said, with the best conditions found on the West Coast. In some parts of the country, consumer spending, manufacturing production and construction are declining, it added.

During his testimony, the Fed chairman also outlined a definition of recession that is different from the popular rule of thumb. He stressed that when he talks about a recession, he does not mean just an extended period of very slow economic growth or perhaps even a very small decline in the gross national product for a quarter or two. He means something considerably worse.

Rather than defining a recession as a period of two consecutive quarters in which GNP, adjusted for inflation, declines -- the often-used definition -- Greenspan said a recession is "a cumulative process of deterioration in which events feed on each other" and cause a large economic decline.

The distinction between the standard definition, which could involve only a very minor economic contraction, and the much more serious sort of decline is important, the Fed chairman said, because the latter would have to be met with much stronger action by the central bank than the former.

"A process in which the economy is deteriorating in a cumulative, interactive manner ... is a true recession. That is the process which we try to fend off," he said.

The two-quarter-decline-in-real-GNP was a shorthand definition coined by the late Arthur Okun, a chairman of the Council of Economic Advisers in the Johnson administration. The definition of recession as a process of economic decline is the one used by the National Bureau of Economic Research, a private nonprofit research group based in Cambridge, Mass., that historically has had the final say on when economic expansions and recessions begin and end.

While Greenspan did not spell it out, many financial analysts interpreted his comments as indicating that a period of zero growth or small declines would not be met by any substantial lowering of interest rates because of worries about inflation.

A typical reaction to the testimony came from David Jones, an economist with Aubrey G. Lanston & Co., a New York investment firm. "I think the Fed's frozen in place," Jones said. "A majority of Fed policy makers would like to keep policy unchanged while they let the dust settle on the Middle East explosion."