Greenspan - More interest rate cuts may be necessary

WASHINGTON -- The Federal Reserve will leave short-term interest rates at the lowest level in more than four decades "for as long as it takes" and might cut them even further to revive the sluggish economy, Fed chairman Alan Greenspan told Congress Tuesday.

Greenspan, in his twice-yearly economic report, made clear that policy-makers are prepared to do whatever they can to help the economy shift into a higher gear and stay there.

The economy, weighed down early in the year by falling consumer and business confidence that reflected worries about the Iraq war, has shown disappointing growth so far in 2003. The sluggish growth pushed the jobless rate to a nine-year high of 6.4 percent in June.

Greenspan expressed hope Tuesday, as many private economists do, that the economy will pick up momentum in the second half of this year as low interest rates and President Bush's latest round of tax cuts take hold.

He indicated that the Fed probably would use its primary tool, a reduction in the short-term federal funds rate, in any further revival effort rather than resort to such alternatives as buying longer-term securities. That disappointed the bond market, some economists said.

To nudge along the economic recovery, Greenspan and his Federal Open Market Committee colleagues reduced the funds rate on June 25 by one-quarter percentage point to 1 percent, a 45-year low. The funds rate is the interest that banks charge each other on overnight loans, the Fed's main lever for influencing economic activity.

The Fed "stands ready to maintain a highly accommodative stance of policy for as long as it takes to achieve a satisfactory economic performance," Greenspan said in testimony to the House Financial Services Committee.

Some economists had believed that the Fed would not move the funds rate lower than 0.75 percent, saying interest rates lower than that would make if difficult for money market mutual funds to meet expenses and still pay returns to investors.

Greenspan disagreed with that notion, saying: "I think that is mistaken." Financial firms have demonstrated considerable flexibility in the past in finding ways to make a profit even at low interest rates, he said.

"With the target funds rate at 1 percent, substantial further conventional easings could be implemented if the FOMC judged such policy actions warranted," Greenspan said.

At the Fed's last meeting in June, Greenspan said Fed policy-makers discussed at some length the possibility of using alternatives for influencing interest rates beyond the Fed's conventional lever of adjusting the funds rate. But Fed policy-makers had concluded that "economic fundamentals are such that situations requiring special policy actions are most unlikely to arise," Greenspan said.

When asked whether such alternatives if used would have side effects to the economy, Greenspan responded: "The types of problems which would be created by those types of actions are all generally inflationary in nature, and that is not an issue which we perceive to be something which should be of concern to us at this stage."

That's because the Fed these days is more concerned about the prospects of inflation moving lower, not higher. "A very low inflation rate increases the risk that an adverse shock to the economy would be more difficult to counter effectively," Greenspan said.

Economists believe Fed policy-makers are likely to hold the funds rate at its current level of 1 percent at their next meeting on Aug. 12. But the Fed wouldn't hesitate to cut rates then or later this year should the economy take an unexpected turn for the worse, analysts said.

The Fed predicted the economy would grow this year at an annual rate in the range of 2.5 percent to 2.75 percent. That represented a significant cut from the Fed's February forecast, when it had predicted this year's growth at a faster rate of between 3.25 percent to 3.5 percent.

For 2004, the Fed predicted a significant rebound in economic growth to 3.75 percent to 4.75 percent, which the Fed said could bring unemployment as low as 5.5 percent by the end of the year.

Various Democrats on the committee sought to use Greenspan's appearance to highlight soaring budget deficits, which they argued showed the Bush administration's mishandling of the economy. Democrats blame the deficits on Bush's tax cuts, while Republicans say the huge deficits have been caused by the sluggish economy and the cost of combating terrorism.

Greenspan said he was in favor of tax cuts to boost a sluggish economy, but he said it was important for Congress as soon as possible to re-institute so-called pay-go rules that require any tax cuts to be paid for by reductions in spending or increases in other taxes to get deficits under control.

"I would prefer to find the situation in which spending was constrained, the economy was growing, and that tax cuts were capable of being initiated without creating fiscal problems," Greenspan said.

Rep. Brad Sherman, D-Calif, quipped: "I would prefer to find a world in which Julia Roberts was calling me, but ... that is unlikely to occur."