Originally created 07/22/98

Fed inflation-wary despite slowdown in economy



WASHINGTON -- Asia's turmoil has sharply slowed both U.S. economic growth and inflation, but the Federal Reserve remains ready to raise interest rates if prices begin to rise faster, Fed Chairman Alan Greenspan told Congress.

Delivering the central bank's midyear report on Tuesday, Greenspan signaled that Fed policy-makers' interest-rate stance remains where it has been since late March -- on hold but open to higher rates if labor shortages and rising wages awaken now-dormant inflation.

And despite the hopes of some Wall Street investors and the AFL-CIO, he offered no hint that policy-makers would consider lowering rates to counter the factors slowing American growth, which include plunging export sales to Asia, the General Motors strike and a buildup of unsold goods in inventory.

Policy-makers believe "that given the current tightness in labor markets, the potential for accelerating inflation is probably greater than the risk of protracted, excessive weakness in the economy," he told the Senate Banking Committee.

The Fed's monetary committee "will need to remain particularly alert to the possibility that more fundamental imbalances are increasing inflationary pressures ... (and) would need to resist vigorously any tendency for an upward trend," he said.

However, Greenspan didn't suggest he was in a hurry to raise rates, and economists said the increase, if needed, might not occur until next year.

"It was standard Greenspan in that he gave lip service to all the possibilities but, in the end, he made it pretty clear that he's not about to do anything soon," said economist Robert Dederick of Northern Trust Co. in Chicago. "If he were, he would have given us a signal and there's no signal there."

For now, concern about the potential interaction between higher U.S. rates and Asia is keeping the Fed from acting, he indicated.

"We need to be aware that monetary policy tightening actions in the United States could have outsized effects on very sensitive financial markets in Asia, a development that could have substantial adverse repercussions on U.S. financial markets and, over time, on our economy," he said.

Wall Street appeared to take Greenspan's comments in stride. Bond prices rose after his comments, and stocks slipped slightly. A late burst of profit-taking, though, sped the drop in the Dow Jones industrial average, which closed down 105.56 points at 9,190.91.

Greenspan said the fact that Asian markets remain unsettled portends "further difficult adjustments" there. And, in the United States, "we have yet to see the full effects of the crisis in East Asia on U.S. employment and income," he said.

David A. Smith, AFL-CIO public policy director, cited Asia's precarious condition in arguing that the Fed should cut interest rates.

"It would be far better to lower U.S. interest rates now than to wait for the East Asian economic crisis and the weakness in the U.S. economy to worsen," he said in a statement to the committee.

But Greenspan said central bankers "see a slowing of ... demand as a necessary element" to keeping the economy on an even keel.

In a new forecast Tuesday, the Fed policy-makers said they expect economic growth next year to lapse to between 2 percent and 2.5 percent, from 3-3.25 percent this year.

They predicted the unemployment rate, which hit a 28-year low of 4.3 percent in May, will rise slightly to between 4.5 percent and 4.75 percent at the end of next year.

Inflation should creep from a 1.75-2 percent range this year to between 2 percent and 2.5 percent next year, they said.

Separately Tuesday, the Commerce Department said a burst of apartment construction helped push housing starts up by 5.6 percent to a seasonally adjusted annual rate of 1.62 million in June.