Greenspan calls rise in prices ‘welcome’

Federal Reserve Chairman Alan Greenspan caused an anxiety attack on Wall Street yesterday by declaring that the threat of deflation has disappeared as a result of a gradual rise in prices.

Worried that the Fed will raise interest rates soon to nip inflationary pressures in the bud, investors drove the Dow Jones industrial average down 123 points to 10,314, and the Nasdaq Composite Index fell 2 percent to 1,979.

“It is fairly apparent that pricing power is gradually being restored” among businesses that for years have been reluctant to raise prices out of fear of losing customers, Mr. Greenspan said at a hearing of the Senate Banking, Housing and Urban Affairs Committee.

But rather than portray the modest uptick in prices this year as a threat to the economy, Mr. Greenspan said it was a “welcome” development. He said it has been accompanied by signs of accelerating growth and suggests that the expansion is no longer threatened by a potentially debilitating cycle of falling prices and incomes like the one that gripped Japan during the past decade.

“Threats of deflation that were a significant concern last year by all indications are no longer an issue before us,” he said. “Clearly it is a change that has occurred in the last number of weeks, and it is a change, as best I can see, that has been long overdue and most welcome.”

The Fed, in an unprecedented move, announced a year ago that deflation was its top concern. Mr. Greenspan’s comments yesterday suggest that the central bank will return to its traditional role of guarding against inflation and thwarting any harmful rise in prices.

The interest rates on bonds and other securities rose sharply as Mr. Greenspan hinted that the central bank has drawn a step closer to raising short-term rates for the first time in five years.

The Fed chairman created that impression not only by heralding the revival of prices, but also by saying that he thinks the nation’s banks can weather any jolt from higher interest rates that may be coming.

Banks and other interest-sensitive sectors such as housing and auto sales could suffer if rates rise too steeply or quickly. Banks and financial institutions such as Fannie Mae, in particular, have to guard against losses in their vast portfolios of mortgages and bonds, which are cheapened by rising rates.

“The industry is adequately managing its interest rate exposure,” Mr. Greenspan said. Although “some banks would undoubtedly be hurt by rising rates, many banks indicate that they now either are interest-rate neutral or are positioned to benefit from rising rates.”

While noting that prices are on the rise, Mr. Greenspan dismissed fears that a sharp uptick in prices for commodities such as oil, gold and copper in the past year poses an inflation threat.

He said those prices represent a fraction of the costs that businesses must bear.

Wages and benefit costs, which make up most of the costs passed on to customers, continue to decline, thanks to the “still impressive” growth of worker productivity, he said. Inflation should be “reasonably contained” as long as labor costs remain low, he said.

The Fed’s Dallas Reserve Bank president, Robert McTeer, indicated yesterday that he was more alarmed than Mr. Greenspan about a recent, sharp rise in consumer prices led by record-high gasoline prices and spiraling health care and tuition costs.

He told CNN/FN that a report showing an unexpectedly large inflation increase of 0.5 percent last month was “disturbing” for the Fed. “We have seen the whites of one eye of inflation. We’re waiting for two.”