WASHINGTON -- Federal Reserve officials have given up, at least for now, hopes of achieving further gains against inflation even though the economy remains soft, Board Chairman Alan Greenspan said yesterday.
Testifying before a House Banking subcommittee, Greenspan revealed that Fed officials have scaled back their forecasts for economic growth in 1993 and now believe inflation will rise by 3% or slightly more both this year and next.
The price forecasts, if realized, would be up a tad from the 2.9% rise in the consumer price index recorded in 1992, and up even more from the estimated gain of between 2 1/2% and 2 3/4% for 1993 that Greenspan presented to Congress in February.
"Certainly the May and June price figures have helped assuage concerns that new inflationary pressures had taken hold," Greenspan said. "Nonetheless, on balance, the news on inflation this year must be characterized as disappointing. Despite disinflationary forces and continued slack, the rate of inflation has at best stabilized."
Greenspan's comments before the Subcommittee on Economic Growth and Credit Formation, chaired by Rep. Paul Kanjorski, D-Pa., were part of his semiannual report to Congress on the economy and monetary policy.
Greenspan was characteristically vague on current policy, and he gave no sign of where the central bank is headed on rates.
He emphasized that he believes the Fed remains accommodative by targeting a 3% federal funds rate, and he pointed out that the move to an asymmetric policy directive in May leaning toward higher short-term rates "does not prejudge that action will be taken.
On the other hand, he stressed that Fed officials still want to achieve price stability. But the public, he acknowledged, "clearly remains to be convinced."
Greenspan said that prices may have jumped early this year in reaction to the spurt of growth that took place late last year, when sales and factory operating rates "were moving up markedly and there was a surge of optimism about future economic activity."
Other signs of price pressures are worrying the Fed, Greenspan told the panel. He cited surveys from the University of Michigan that consumers expect inflation to rise 4 1/2% over the next year, and he said Fed officials are taking seriously the jump in the price of gold to nearly $400 an ounce in recent months.
In assessing the economy, Greenspan said member of the Federal Open Market Committee and other Fed district bank presidents now project growth in the range of to 2 3/4% in 1993. The revision marks a reduction from the 3% rise projected in February.
Greenspan attributed much of the lower estimate to a deceleration of growth in the first quarter, when gross domestic product rose only 0.7%.
But, he went on, high debt burdens of corporations and individuals that are still discouraging spending and investment. He also noted that the credit crunch is continuing at commercial banks, although he said there are faint signs that banks are stepping up loans to small business.
Greenspan said that while the economy appears to be expanding "in fits and starts," the outlook does not appear to be any worse than it was several months ago. He estimated growth picked up to "in excess of 2 1/2%" in the second quarter, and he noted that the Fed's official forecast calls for the unemployment rate to ease to 6 3/4% by the end of the year from the current 7%.
For 1994, Fed officials forecast that the economy will expand by 21/2% to 31/4% while prices rise between 3% and 31/2%, "The evidence remains consistent with our diagnosis that the the underlying forces at work are keeping the economy generally on a moderate upward track," Greenspan said.
One surprise in the hearing was Greenspan's disclosure that Fed officials have slashed their targets for money supply growth in 1993 and 1994. The revised range for M2 is between 1% and 5%, down from the 2% to 6% that was presented to Congress in February. M2 is a broad measure of money that includes currency, checking accounts, money market mutual funds, and small certificates of deposit.
For the last several years, yield-hungry investors have been shifting money out of bank deposits into stock and bond funds, which are not counted as part of M2. Fed officials have been monitoring the shift and de-emphasizing the value of M2 as an economic forecasting tool.
Greenspan effectively buried M2, at least for now, as a measure of interest to Fed policymakers.
"The historical relationship between money and income, and between money and the price levels have largely broken down, depriving the aggregates of much of their usefulness as guides to policy," he said. "At least for the time being, M2 has been downgraded as a reliable indicator of financial conditions in the economy, and no single variable has yet been identified to take its place."
Fed officials clipped the 1993 and 1994 target range for M3, a broader money measure, to between 0 and 4% from the 1/2% to 4 1/2% set in February. For non-financial debt, they set a range of 4% to 8%, down from 4 1/2% to 8%.
Greenspan added little by way of commentary to the budget debate in Congress, saying he did want to get into arguments over how to cut the deficit. But he said the bond market would react negatively if Congress backs off from the $500-billion deficit reduction target set by President Clinton.
He also said Congress will have to revisit the budget issue a second or even a third time to bring the long-term deficit under control. "It's also clear that we are going to need to take another shot at the deficit," he told the panel.
Greenspan said that while President Clinton's budget by itself will act as a drag on growth, there is an important offsetting stimulus -- the drop in long-term interest rates on bond market expectations that the program will become law. Dean Patterson contributed to this