Greenspan stays alert for deflation

UNDERLYING FORCES: There is little fear of any imminent harm, says the Fed chairman, but the potential for long-term damage is substantial


Fri, May 23, 2003 - Page 12

US Federal Reserve chairman Alan Greenspan said Wednesday he was on heightened alert for deflation, a minor but potentially devastating menace to the sluggish postwar economy.

"We at the Federal Reserve recognize that deflation is a possibility," Greenspan said to the US Congress' joint Economic Committee.

Deflation, or falling prices, delivers a double economic punch by pressuring people to postpone buying until prices fall further and by raising real interest rates.

Financial markets appeared to have little fear of imminent deflation, Greenspan said.

"Nevertheless, even though we perceive the risks as minor, the potential consequences are very substantial and could be quite negative," the powerful Federal Reserve boss told lawmakers.

"It does require very close scrutiny and maybe -- maybe -- action on the part of the central bank," he said.

Underlying US inflation plunged to a 37-year low last month, according to government figures.

Core US consumer prices, stripping away volatile food and energy prices, rose just 1.5 percent when compared to April of last year -- the smallest annual increase since March 1966.

The Federal Reserve, in a surprise shift of focus, acknowledged the threat of downward pressure on prices at a meeting May 6, although it carefully avoided using the word "deflation."

"We believe that, because in the current environment the cost of taking out insurance against deflation is so low, that we can aggressively attack some of the underlying forces, which are essentially weak demand," the 77-year-old central bank chief said.

"Indeed we have done that since we started a very aggressive easing of monetary policy in early 2001," he said.

Since early 2001, the Federal Reserve has slashed its target for the federal funds target rate, which commercial banks charge each other, from 6.50 percent to a four-decade low 1.25 percent.

The US economic outlook was murky, Greenspan said.

"We do not yet have sufficient information on economic activity following the end of hostilities to make a firm judgment about the current underlying strength of the real economy," he said.

A weak jobs market and sluggish industrial output outlasted the Iraq war largely because of decisions taken before the conflict, he said.

But productivity had improved and financial markets had rallied.

"Looking ahead, the consensus expectation for a pickup in economic activity is not unreasonable, though the timing and extent of that improvement continue to be uncertain," he said.

Along with low interest rates, energy prices were a "favorable influence" on the US economy as they dropped in line with a decline in crude oil prices after the Iraq war.

Those prospects had been dampened, however, by the slow recovery of Iraq's oil industry and by renewed "geopolitical risks," a veiled allusion to the recent Saudi Arabian and Moroccan suicide bomb attacks.

The spread of the potentially lethal SARS virus, meanwhile, had injected new uncertainty into the global economy, Greenspan said.

"To date, the effects of SARS on the US economy have been minimal," despite delivering another blow to airlines, he said.

The big question in the economy was when businesses would ramp up investment, the Fed chairman said.