The surge in food and energy prices this year has dealt only a temporary setback to consumers because they increasingly are benefiting from growing jobs and incomes, Federal Reserve Chairman Alan Greenspan testified yesterday.
Downplaying the threat of inflation, the Fed chief told the Senate Banking, Housing and Urban Affairs Committee that the central bank is likely to keep raising interest rates at a slow or “measured” pace, providing a “smooth adjustment” for debt-laden consumers to a world of higher rates.
“Expanding employment should provide a lift to personal disposable income, adding to the support stemming from cuts in personal income taxes over the past year,” he said, noting that developments this year overall have been “favorable” for consumers and the broadening economic recovery.
The sharp rise in inflation since the beginning of the year is due in large part to soaring energy prices fed by the risk of terrorism in the Middle East, he said.
A significant part of the price increases also went toward raising business profits to robust levels in the last year, he said, but that will not continue.
Having taken advantage of the lowest interest rates in a generation in the past three years to shore up their balance sheets, Mr. Greenspan said consumers and businesses are now in good shape to deal with rising rates while continuing to propel the economy forward with increased spending.
Mr. Greenspan’s upbeat assessment of the U.S. economy yesterday helped send stocks higher. The Dow Jones industrial average rose 55.01 to 10,149.07 while the Standard & Poor’s 500 index was up 7.77 at 1,108.67.
The Fed engineered the extraordinarily low rates with the goal of nurturing shell-shocked Americans back to economic health in the wake of recession, a stock market bust, the September 11 terrorist attacks and corporate scandals, he said.
An important benefit that continues to this day is that consumers, through an historic mortgage refinancing boom during 2002 and 2003, were able to consolidate and lock in nearly half their mortgage debts at very low, fixed rates, shielding many households from today’s rising interest costs, he said.
Nevertheless, the era of extraordinarily low rates may have produced some excesses, he said, including a possible bubble in financial market. Investors, like consumers, have taken advantage of the low rates to go on a buying spree, bidding up the prices of holdings from oil and gold to bonds and mortgage-backed securities.
Some financial casualties are likely to result from those excesses, although many investors and banks appear to have gone a long way toward deleveraging their portfolios to avoid steep losses as rates go higher, he said.
Mr. Greenspan acknowledged that other risks may have emerged, including the possibility that the pickup in inflation is more than temporary and higher prices were induced by excess money creation by the Fed.
“We cannot be certain that this benign environment will persist and that there are not more deep-seated forces emerging as a consequence of prolonged monetary accommodation,” in which case the Fed would have to raise rates more vigorously, he said.
Another risk is that wage growth may continue to lag behind inflation, as it has so far this year, as businesses are forced to cover rising costs for energy, health care and raw materials.
Wages also could be held back by the trend toward substituting temporary employees for full-time staff, he said.
“The proportion of temporary hires relative to total employment continues to rise, underscoring that business caution remains a feature of the economic landscape,” he said.
Mr. Greenspan did not take note of a report yesterday that showed a sharp deceleration of home-building activity in the wake of higher rates. The Commerce Department reported that housing starts fell to the lowest rate in a year.
In fact, Mr. Greenspan said he expects the housing market to continue to prosper because mortgage rates remain far below the levels that prevailed in previous decades.
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