WASHINGTON -- Federal Reserve officials remain committed to heading off an upturn in inflation and may have to tighten credit further, but they are leaving policy alone for now, Fed chairman Alan Greenspan said yesterday.
Appearing before the Senate Banking Committee where he heard repeated pleas from Democrats to keep rates steady, Greenspan said officials must act based on what they think will happen in the future, not on past inflation statistics.
"It is an open question whether our actions to date have been sufficient to head off inflationary pressures and thus maintain favorable trends in the economy," Greenspan said.
He also issued a surprisingly blunt warning about the recent weakness in the dollar, calling it "bad for the economy."
Greenspan's testimony, which included the Fed's semiannual monetary policy report to Congress, sent stock and bond prices reeling as investors concluded that the central bank is inclined to lift short-term interest rates again.
"The market saw Greenspan's comments as a bit hawkish and feels the possibility of a Fed tightening has increased," said Sung Won Sohn, chief economist for Norwest Corp. in Minneapolis. "He reiterated his concerns about a possible resurgence in inflation."
The bond market was also shaken by Greenspan's expression of concern over the dollar because many analysts had been assuming that the plight of the U.S. currency has not had a major effect on the thinking of Fed policymakers.
Greenspan, however, called the dollar's decline over the past six months "substantial."
"Foreign exchange rates are key prices in the American economy, with significant implications for the volumes of exports and imports as well as for the prices of domestically produced items that compete with imports," he said.
In discussing the economy, Greenspan said that Fed officials have been getting mixed signals. "Labor demand has been quite strong, pointing to robust growth in production and incomes," he said. Greenspan also noted that the economies of Europe and Japan are recovering, which should boost demand for U.S. exports.
On the other hand, Greenspan noted that U.S. businesses have recently built up large inventories while consumer demand slackened. That could portend a slowdown in production in coming months, but it is too early to tell, he told the panel.
Still, he went on, "the amount of slack in the economy, while difficult to judge, appears to have become relatively small." An increase in inflation, he said, "would come at considerable cost" and is an outcome that Fed officials "are determined to prevent."
For the near-term outlook, the economy appears to be headed toward gradual deceleration while inflation stays about the same or goes up slightly, according to the forecast of members of the Federal Open Market Committee and other Fed bank district presidents.
They projected that real gross domestic product this year will rise in a range of 3% to 3.25%, which is unchanged from their February estimate, and then slow to a range of 2.5% to 2.75% in 1995.
The Fed officials forecast that inflation, measured by the consumer price index, will rise between 2.75% and 3% this year and between 2.75% and 3.5% next year. "In 1995, inflation may be about the same as in 1994 or slightly higher. The recent depreciation of the dollar is likely to put pressure on inflation over the next year if it is not reversed," Greenspan said.
The civilian jobless rate is not likely to stay stuck in a range of 6% to 6.25%, according to the Fed's forecast.
Similar economic projections have been issued by the Clinton Administration, the Congressional Budget Ofrice, and many private forecasters.
However, Greenspan said that Fed officials do not regard forecasts of an upturn in inflation "as a desirable outcome" and cited several instances in which price pressures seem to be on the rise.
"There are reports of shortages of some types of labor," for example, and indexes of vendor performance, which measure the responsiveness of businesses to rill orders, "have deteriorated considerably," Greenspan said. He also said manufacturers are paying higher prices for materials.
Greenspan's testimony did not sit well with Democrats on the committee, who took turns in opening statements urging him to wait and see what happens as a result of the Fed's four moves this year to boost rates.