Greenspan’s Warning Rattles Financial Markets Fed Chief Says Inflationary Pressures Could Halt Economic Growth
Federal Reserve Chairman Alan Greenspan said Wednesday the economy has been on an “unsustainable track,” sending shivers through Wall Street. Stock prices slumped after his comments, though they regained some ground later.
In closely watched testimony before Congress, Greenspan said it would be “unrealistic” to expect stock market gains anywhere near those of the past two years.
And hinting of possibly higher interest rates, Greenspan said growing demand for scarce labor could drive up wages, and eventually consumer prices, and that risks short-circuiting the economy’s 6-1/2-year-old expansion.
He told the House Budget Committee that “A re-emergence of inflation is, without question, the greatest threat to sustaining what has been a balanced economic expansion virtually without parallel in recent decades.”
The stock market’s most-watched barometer slumped in response, even though, as usual, the central bank chairman left vague the timing of any interest-rate increase aimed at cooling speculation on Wall Street and inflation pressures on Main Street.
The Dow Jones average shed 115 points immediately after Greenspan spoke. It closed down 83.25 points at 8,095.06.
Though delivered in plainer language, Greenspan’s latest warning provoked a somewhat milder response than his now-famous musing in December over “irrational exuberance” in the markets. His latest comment raises the specter of significantly smaller increases rather than a steep plunge in prices.
“It clearly would be unrealistic to look for a continuation of stock market gains of anything like the magnitude of those recorded in the past couple of years,” he said.
The Dow average had soared 26 percent in 1996 and, before Wednesday’s pullback, it had risen 27 percent this year, just 1 percent short of the record high established Aug. 6.
“I’m sure he believes the market is overvalued, that there are speculative excesses developing,” said economist Mark Zandi of Regional Financial Associates in West Chester, Pa. “He said that point-blank almost a year ago and got so much grief that now he’s being a little more circumspect.”
In his remarks, Greenspan analyzed what he sees as the most likely source of inflationary pressures: the labor market.
“To be sure, job growth slowed significantly in August and September, but it did not slow enough,” he said. “The performance of labor markets this year suggests the economy has been on an unsustainable track.”
The unemployment rate, at 4.9 percent in September, is near a 24-year low. And, though some early retirees, homemakers and students presumably could be lured into the labor market, that might require pay increases, he said.
He conceded there’s little evidence of wage acceleration so far, but warned, “to believe, however, that wage pressures will not intensify … strains credibility.”
“The law of supply and demand has not been repealed,” he said. “The question is surely when, not whether, labor costs will escalate more rapidly.”
The central bank hasn’t changed interest rates since March 25, when it raised its benchmark rate for overnight loans between banks a quarter point to 5.5 percent. It again voted to hold rates steady last week, but Greenspan left the clear impression the Fed was prepared to act if necessary.
“The markets, which had just shrugged off the possibility of any further Fed tightening, now has to look to the great probability of a tightening either at the next meeting on Nov. 12 or in December,” said economist David Jones of Aubrey G. Lanston & Co. in New York.
Greenspan delivered his cautions about the possibility for economic and financial upset to lawmakers already debating plans for spending expected budget surpluses predicated on the economy and stock market continuing its stellar performance.
He urged them to run surpluses in the years immediately ahead, whittling the $5.3 trillion nation debt, in preparation for the retirement of the Baby Boom generation starting in 2010.