Federal Reserve Board Chairman Alan Greenspan said Wednesday that the recent drop in stock prices will end up as a boon to the economy.
He said it should slow economic growth to a more sustainable level, in turn reducing the risk that a labor shortage will ignite inflation.
"The market's net retrenchment of recent days ... should help to prolong our six-and-a-half-year business expansion," Mr. Greenspan said in testimony to the congressional Joint Economic Committee.
The Fed chief was particularly careful not to make explicit mention of interest rate changes. While he vowed continued vigilance against rising prices, he also described the performance of the economy as "impressive" and noted that inflation is falling.
"The Federal Reserve is dedicated to contributing as best it can to prolonging this performance," he said. "We will be watching economic and financial market developments closely and evaluating their implications."
Rep. Jim Saxton, the New Jersey Republican who is chairman of the economic committee, said the market downturn would not hurt the economy if the Fed continues to fight inflation. "There is no need for a Fed policy change," he told Mr. Greenspan.
Market watchers praised Mr. Greenspan's performance.
"He did what he set out to do," said Bert Ely, president of the Alexandria, Va., consulting firm Ely & Co. "He calmed the waters."
"His job was to say this was not an apocalyptic event and these things happen," said Joel L. Naroff, chief economist at First Union Corp. "Even if he has some concerns right now, he needed to downplay them. He had to be as noncommunicative as he could be."
Ramachandra Bhagavatula, chief financial economist at Citicorp Securities Inc., said he was disappointed that Mr. Greenspan refused to discuss rate hikes.
"He was cagey," Mr. Bhagavatula said. "He clearly didn't want to upset the markets any more than they already were."
Mr. Greenspan's remarks played well on Wall Street. The Dow Jones industrial average rose to 7,614.22 by the time he finished speaking at 10:30 a.m., 84 points higher than at the opening. The Dow closed at 7,506.67, up slightly from Tuesday's close.
Although Mr. Greenspan appeared reassuring, some economists were predicting another significant stock market correction.
"There are going to be more ups and downs," said Sung Won Sohn, chief economist of Norwest Corp. "We cannot entirely rule out the possibility of another correction in the stock market coming from another currency crisis in Asia or even a hike in interest rates by the Fed next year."
Frederick Breimyer, chief economist of State Street Bank and Trust Co., said the market drop and subsequent partial recovery worked out perfectly for Mr. Greenspan.
"This was helpful to him," Mr. Breimyer said. "If the stock market trades more soberly and at lower prices, then that reduces his concern about excessive future growth and the need to tighten monetary policy."
Mr. Greenspan said Monday's market break was unavoidable. Starting in 1995, investors began increasing their long-term corporate earnings estimates. As a result, they bid share prices up to unrealistic, artificially high levels.
"Earnings expectations and equity prices in the United States were primed to adjust," he said. "If it was not developments in Southeast Asia, something else would have been the proximate cause for a reevaluation."
Yet he said Southeast Asia's troubles were avoidable. Investors from the United States and Europe poured far more capital into these economies than could be put to productive use. As a result, developers built far more projects than needed, resulting in a real estate slump.
He blamed the banking systems in these developing countries, saying they were "beset with problems of lax lending standards, weak supervisory regimes, and inadequate capital."
These economies will recover if the respective governments permit the market to work, Mr. Greenspan said. "Companies should be allowed to default, private investors should take their losses, and government policies should be directed toward laying the macroeconomic and structural foundations for renewed expansion," he said.
Mr. Greenspan also called for increasing U.S. intervention in the world markets, either through the International Monetary Fund or another agency.
"It is in the interest of the United Sates and other nations around the world to encourage appropriate policy adjustments, and where required provide temporary financial assistance," he said.
