Alan Greenspan told Congress on Wednesday that the U.S. economy is expanding at a "reasonably good pace," with inflation and inflation expectations in check.
chairman cited the falling dollar and rising energy prices as possible near-term inflation catalysts, and said the mitigating impact of improving worker productivity remains difficult to predict.
In prepared remarks, Greenspan said nothing to suggest the Fed plans to alter its measured approach to interest rate tightening, which has resulted in six consecutive half-point increases in the fed funds rate. The benchmark now stands at 2.5%.
"All told, the economy seems to have entered 2005 expanding at a reasonably good pace, with inflation and inflation expectations well-anchored," he said. "The evidence broadly supports the view that economic fundamentals have steadied. Consumer spending has been well maintained over recent months, buoyed by continued growth in disposable personal income, gains in net worth, and accommodative conditions in credit markets."
Still, the Fed chairman listed a catalog of concerns about the future, including the possibility of a decelerating wealth effect in real estate markets and a continuing weak business investment. He said the outlook for costs and prices will depend in large part on worker productivity.
"The growth of output per hour slowed over the past half year, giving a boost to unit labor costs after two years of declines," Greenspan said. "Going forward, the implications for inflation will be influenced by the extent and persistence of any slowdown in productivity. A lower rate of productivity growth in the context of relatively stable increases in average hourly compensation has led to slightly more rapid growth in unit labor costs."
"Whether inflation actually rises in the wake of slowing productivity growth, however, will depend on the rate of growth of labor compensation and the ability and willingness of firms to pass on higher costs to their customers," he said.
Regarding the falling dollar, Greenspan reiterated that exporters to the U.S. have tended to hold their prices down in an effort to gain market share, sparing the U.S. from imported inflation.
"However, the recent somewhat quickened pace of increases in U.S. import prices suggests that profit margins of exporters to the United States have contracted to the point where the foreign shippers may exhibit only limited tolerance for additional reductions in margins should the dollar decline further," Greenspan said.
Greenspan largely downplayed the threat of higher energy prices, saying the share of total business expense attributable to energy costs has declined over the past 30 years.
"Still, although the aggregate effect may be modest, we must recognize that some sectors of the economy and regions of the country have been hit hard by the increase in energy costs, especially over the past year," he said.
Greenspan said consumer spending continues to be fueled by rising asset prices and liquidity in real estate markets.
"Of course, household net worth may not continue to rise relative to income, and some reversal in that ratio is not out of the question. If that were to occur, households would probably perceive the need to save more out of current income; the personal saving rate would accordingly rise, and consumer spending would slow."
Greenspan noted the so-called flattening yield curve, in which longer-term bond rates have fallen even as the Federal Open Market Committee has tightened the short end. To a greater or lesser degree, the Fed chairman rejected conventional explanations for the phenomenon, including subdued expectations for long-term growth and foreign demand for U.S. bonds.
The muted growth thesis "does not mesh seamlessly with the rise in stock prices and the narrowing of credit spreads observed over the same interval." Meanwhile, demand for U.S. securities from foreign investors fails to explain why "yields and risk spreads have narrowed globally."
"For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum. Bond price movements may be a short-term aberration, but it will be some time before we are able to better judge the forces underlying recent experience."