WASHINGTON -- Federal Reserve Chairman Alan Greenspan said today that Fed policy-makers understood the need to act quickly to contain a widening global currency crisis, raising the prospects of an immediate cut in U.S. rates. His words sparked a 257-point rally on Wall Street.
Greenspan, testifying before the Senate Budget Committee, said that there was a need to "bring the existing instabilities to a level of stability reasonably shortly to prevent the contagion from really spilling over and creating some very significant further difficulties for all of us."
Economists said Greenspan's comments were a strong signal that the central bank will cut interest rates when policy-makers meet next Tuesday.
"He is telling us he is going to ease at the next meeting," said David Jones, economist at Aubrey G. Lanston & Co.
In response to a question, Greenspan said he could not comment directly on whether the Fed was ready to lower interest rates because policy makers have not yet met. But he stressed that his colleagues at the Fed were aware of the seriousness of the global financial crisis, which began 14 months ago in Asia, has now spread to Russia and is threatening to strike Latin America next.
"I think we know where we have to go," Greenspan said. "We don't underestimate the problem."
One analyst took Greenspan's comments as a signal to expect an interest rate drop.
"Greenspan told us in unambiguous terms that he will be cutting interest rates next Tuesday," said Sung Won Sohn, chief economist at Norwest Corp. in Minneapolis. "He really emphasized global economic turbulence and its impact on the U.S. economy."
Greenspan's comments sparked a huge surge on Wall Street with the Dow Jones industrial average climbing 257.21 points, or 3.26 percent, to close at 8154.41.
Greenspan said that because of the global turmoil, policy-makers around the world have to be "especially sensitive to the deepening signs of global distress" which he said had entered a "more virulent phase" with the collapse last month of the Russian economy.
Hopes for a cut in interest rates had been heightened before Greenspan's appearance by remarks Tuesday from William McDonough, president of the New York regional Fed bank. "The balance of risk has shifted from one of concern about inflation to one of concern about inadequate growth," McDonough said.
Lower U.S. interest rates would help a number of countries struggling to defend their currencies by lowering the value of the U.S. dollar on global markets. The lower U.S. rates also would bolster global confidence by assuring foreign businesses that the Fed stood ready to ensure that U.S. growth would continue to serve as an economic engine for the rest of the world.
Greenspan noted that labor markets in the U.S. economy remain tight and hourly compensation is continuing to grow more rapidly. But he said there is no evidence that inflation is getting out of hand.
He also cautioned that "looking forward, the restraining effects of recent developments on the U.S. economy are likely to intensify."
Greenspan, repeating remarks he made in September, said the increasing risks to the U.S. economy had prompted the Fed in August to change its policy directive from one leaning toward increasing interest rates to fight inflation to a neutral stance.
Since then, Greenspan said today, "Deteriorating foreign economies and their spillover to domestic markets have increased the possibility that the slowdown in growth of the American economy will be more than sufficient to hold inflation in check."
In his Sept. 4 speech at the University of California at Berkeley, Greenspan said: "It is not credible that the United States can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress."
But last week, Greenspan sent markets in the opposite direction when in an appearance before the House Banking Committee, he deflated expectations of coordinated interest rate cuts among the world's seven largest economies.