- The Washington Times - Wednesday, May 21, 2003

Federal Reserve Chairman Alan Greenspan told Congress yesterday the United States is not in “imminent danger” of slipping into a deflationary quagmire like the one that has gripped Japan for a decade.

After raising a storm two weeks ago with a statement that for the first time alluded to the threat of deflation, or a sustained fall in prices that sinks the economy into recession, the Fed chairman appeared to make light of the possibility in testimony before the Joint Economic Committee, suggesting that the chances are remote, even theoretical.

“The notion that deflation would have emerged just never entered our minds until the Japanese demonstrated to us otherwise,” he said. Japan’s economy has been stagnant or in recession for more than a decade, and prices there have fallen for the last three years.

The United States has not seen such an episode of deflation since the Great Depression, but “the threat, even though minor, is sufficiently large that it does require very close scrutiny and maybe, maybe action on the part of the central bank,” Mr. Greenspan said.

The Fed’s aggressive moves to cut interest rates in the last two years were designed to pre-empt the causes of deflation, he said, which happens when consumer and business demand falls substantially short of supply of goods and services, forcing businesses to slash prices and jobs and creating a dangerous downward spiral.

Signs of such deflation have been evident for months in the airline industry, manufacturing, textiles and a few other areas of the U.S. and world economies. But in other sectors such as health care, education and housing, demand is brisk and prices have been rising, sometimes at double-digit rates.

Some economists worry that because the Fed already has slashed short-term interest rates to the lowest levels in decades, it may arrive at the point where the Bank of Japan is today — with interest rates effectively at zero and no further way to stimulate the economy. The Fed’s key bank-lending rate is hovering at 1.25 percent.

But Mr. Greenspan insisted the Fed will avoid that dilemma and is prepared to take extraordinary pre-emptive action — by buying long-term Treasury bonds to inject additional money into the financial system and draw down long-term interest rates.

“We see no credible possibility that we will at any point, irrespective of what is required of us, run out of monetary ammunition to address problems of deflation or anything similar to that which disrupts our economy,” he said.

“We have now been putting very significant resources in trying to understand, without actually seeing it happen, what this phenomenon is all about,” he said. “I think we’ve made very substantial progress in that intellectual endeavor.”

Mr. Greenspan is not alone is seeing only a slight chance of deflation. The International Monetary Fund also said this week that it sees little chance of that happening in the United States, though some other countries including Germany are in danger.

Still, a debate on deflation has been raging from Main Street to Wall Street since the Fed raised the issue May 6.

Richard Berner, economist at Morgan Stanley, said a spate of reports showing a big drop in prices last week, with the “core” measure of consumer inflation excluding energy and food prices falling below 1 percent, “legitimately stirred deflation fears.”

He said the odds of the U.S. economy falling into a deflationary spiral have grown from about 15 percent to 25 percent.

Mr. Greenspan remained hopeful that the economy will rebound in the second half of the year after being depressed by the Iraq war.

But he cautioned that “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 … many more weeks of data will be needed to confidently discern the underlying trends.”

Among recent more-favorable developments are a sustained rally in stock prices and drop in oil prices, a bounce-back in consumer confidence and an increasing backlog of orders for capital goods.

Also, “recent earnings reports suggest that the profitability of many businesses is on the mend,” he said, which may make companies more inclined to hire and spend in the future, in a key ingredient for any recovery.

Productivity gains also have been impressive, he said, although “the ability of business managers to reduce costs, especially labor costs, through investment or restructuring is, of course, one reason that labor markets have been so weak.”

Mr. Greenspan urged Congress once again to be mindful of the budget deficit in crafting a tax-cut plan designed to stimulate the economy.

“What is missing here and was never missing in previous discussions is restraint on spending,” he said. “I would like to see this issue addressed far more than it is, and I must say the silence is deafening.”

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