Economy Still Soft, Greenspan Warns

By: John M. Berry

Federal Reserve Chairman Alan Greenspan said last night that there are few signs that the U.S. economy has regained any vigor since hitting a "soft patch" in the summer.

In a speech to the New York Economic Club, Greenspan ticked off some of the gloomy developments that caused the central bank last month to reduce its target for overnight interest rates to its lowest level in more than 41 years.

"The limited evidence since the November easing has supported our view that the U.S. economy has been working its way through a soft patch. And the patch has certainly been soft", the Fed chairman said.

"The labor market has remained subdued, as businesses apparently have been reluctant to add to payrolls. The manufacturing sector remains especially damped, and nonresidential construction has trended lower. By all reports, state and local governments continue to struggle with deterioration in their fiscal conditions. Oil prices have recently risen and, not least, the economies of most of our major trading partners have shown little vigor", Greenspan said.

A copy of the text of Greenspan's speech was made available in Washington.

The Fed chairman said business spending on new equipment has continued to lag for several reasons, including corporations' aversion to risk-taking brought on by scandals involving accounting and other governance issues.

"In the end, capital investment will be most dependent on the outlook for profits and the resolution of the uncertainties surrounding the business outlook and the geopolitical situation", he said.

The latter was a reference to the possibility of war with Iraq, which many analysts regard as the most important of the forces restraining business investment.

All these considerations together "at present impose a rather formidable barrier to new investment", Greenspan said.

Despite his assessment that the "soft patch" is continuing, the Fed chairman gave no hint that he is considering further rate cuts.

For one thing, he did mention some brighter bits of economic news, such as continuing gains in consumer spending, particularly for motor vehicles, which have been spurred by low-interest, even free, financing.

"More broadly, strong growth of labor productivity, supplemented by reduced tax payments, has provided a boost both to incomes and to spending. Meanwhile, new home sales have been buoyed by low mortgage interest rates as well as favorable demographics", he said.

Moreover, since early October, "conditions have turned less adverse" as stock prices have gone up and some longer-term interest rates have come down.

"The overall cost of business capital has clearly declined", which has led to an increase in sales of corporate bonds and stabilized other forms of borrowing such as commercial paper - an unsecured corporate promissory note - and business bank loans, he said.

Greenspan devoted a significant portion of his speech to how central banks can deal with asset price "bubbles", such as the U.S. stock market bubble that burst in 2000. Numerous Fed critics have complained that the Fed helped cause the surge in stock prices by keeping interest rates too low and pumping too much money into the economy.

But the Fed chairman reiterated his view that it is extremely difficult to identify a bubble except in hindsight, and that the only way to deflate one is to raise interest rates so high that the economy is crunched.

"The notion that a well-timed incremental tightening could have been calibrated to prevent the late 1990's bubble is almost surely illusion", he said, repeating remarks he made at a Kansas City Federal Reserve Bank conference in late August.

Although Greenspan never mentions it in defending the Fed's policies, he and his policymaking colleagues began raising interest rates in June 1999 and continued to do so until early 2000. During that period stock prices, particularly of high tech firms, soared.

Once the bubble burst and it became clear the economy was headed for a slump, the Fed cut rates 11 times during 2001, an unusually aggressive set of policy moves.

"It is too soon to judge the final outcome of the strategy that we adopted", Greenspan said. "If the postmortem of recent monetary policy shows that the results of addressing the bubble only after it bursts are unsatisfactory, we would be left with less-appealing choices for the future."

Such a less-appealing choice would be crunching the economy, presumably.