Federal Reserve Chairman Alan Greenspan warned Wednesday that economic growth this year “almost surely” will slow and hinted that central bank policymakers are starting to think about cutting interest rates at some point down the road.
Greenspan told the Senate Banking Committee evidence of the slowdown already is emerging, citing an increase in the unemployment rate from 5.4 percent in December to 5.7 percent in January, a slackening in retail sales and a drop in housing construction.
“The data … have offered some indications that the expansion may finally be slowing from its torrid and unsustainable pace of late 1994,” he said.
Economists said Greenspan’s testimony indicated the central bank probably would leave short-term interest rates unchanged for some time, almost certainly through its March 28 meeting and perhaps until after its May 23 gathering.
In Wednesday’s closely-watched semiannual report to Congress on monetary policy, the Federal Reserve forecast growth will subside to somewhere between 2 percent and 3 percent. That’s somewhat less than most private forecasters expect.
As measured by the gross domestic product, the economy grew at a 4 percent annual rate last year, the fastest in a decade.
“The likely performance of the economy in 1995 almost surely will pale in comparison with that of the previous two years,” Greenspan said.
He also said inflation “is unlikely to moderate further and may even tick up temporarily.” The Fed is predicting an increase in consumer prices between 3 percent and 3.5 percent this year, up from 2.7 percent for the past two years.
However, the Fed chairman held out hope that the central bank can nudge rates lower if it becomes convinced the inflation uptick is masking a fundamental improvement in price pressures.
“There may come a time when we hold our policy stance unchanged, or even ease, despite adverse price data, should we see signs that underlying forces are acting ultimately to reduce inflation pressures,” he said.
Economist Robert G. Dederick of the Northern Trust Co. in Chicago said Greenspan was signaling that “the Fed is clearly going to be in a wait-and-watch-the-data posture.”
“Easing is something held out for the future but not something viewed as an issue for today,” he said.
Rising interest rates over the past year have made many lawmakers unhappy and the senior Democrat on the committee, Sen. Paul Sarbanes of Maryland, told Greenspan the Fed already has gone too far.
“The Fed is now out on the limb risking the jobs of working Americans,” he said.
Greenspan’s testimony made it clear he believes the underlying conditions needed to contain inflation are not yet firmly in place. He cited a still-low unemployment rate, despite the January increase, high rates of factory capacity use and a sharp rise in the prices of raw materials over the past year.
“There are increasing reports that firms are considering marking up prices of final goods to offset those increased costs,” he said, noting that inflation in January - minus the volatile food and energy components - rose at its steepest rate in more than two years.
But Greenspan also suggested the economy is losing steam, a development that would ease inflation pressures. He said strong consumer spending of the past three years “may have exhausted most of the pent-up demand that had accumulated when the economy was sluggish in the early 1990s.”
Also, it’s unlikely businesses will build up their inventory stockpiles as fast as they did last year, he said.
The Fed last raised rates by half a percentage point on Feb. 1, the seventh increase in a year.
Over the period, the federal funds rate charged among banks on overnight loans doubled from 3 percent to 6 percent. The discount rate charged on the Fed’s own loans rose from 3 percent to 5.25 percent. And the prime rate charged by banks to their best business customers rose from 6 percent to 9 percent.