WASHINGTON -- Federal Reserve Chairman Alan Greenspan said yesterday that the central bank will lower interest rates further to offset the credit crunch that has hobbled the economy if the money-supply slowdown continues.
Mr. Greenspan told the House Budget Committee that the recent drops in short-term rates engineered by the Fed "may be enough" to assure adequate expansion of the money supply.
"If it is not, further action will be required," he said, acknowledging that would mean additional lowering of short-term interest rates by the Fed.
In his first congressional testimony since the United States attacked Iraq Jan. 16, Mr. Greenspan came under some unusually sharp questioning by Democrats and Republicans about the unfolding recession, the ballooning budget deficit and the mounting costs of the Persian Gulf war.
On financing the gulf operation, Mr. Greenspan emphasized that no decision should be made until the cost is analyzed and Saudi Arabia and other countries make clear how much they will contribute.
The cost will be reduced by heavy use of existing arms inventories, he said.
Many members of Congress think the Fed acted too slowly to lower interest rates in the second half of last year to try to avoid or alleviate the economic slump.
Mr. Greenspan countered with a cautiously optimistic forecast and an assertion that avoiding the downturn was out of the control of the Bush administration, Congress and the Fed.
Sounding somewhat upbeat about the outlook, he told the panel that the rate of deterioration of the economy was "slowly" easing and that the downturn probably would not be "as intense as it was" in the final three months of 1990.
As a word of warning, however, he said it was difficult to gauge the full economic impact of the severe strain on banks, which stems from bad loans and a squeeze on capital and profits.
That, he conceded, had resulted in a credit crunch -- which, as he has explained in the past, means that not even worthy customers are qualifying for loans.
"It is quite novel; there is no historic precedent" for the current degree of tight credit, he said. "It is clearly negative; it is unclear how negative."
Normally, the auto and housing industries, now at their low point, would soon begin to recover, ushering in a recovery by midsummer, he said. But the bank difficulties prevent a sound forecast, he said.
Tracing the performance of the economy since the start of 1990, Mr. Greenspan said it was already "quite sluggish" before Iraq invaded Kuwait Aug. 2 but that whether there will be a recession is "a close call."
After the Iraqi invasion, the probability of a recession became "somewhat higher, 50-50," he said.
But in any case, he said, the government would have been unable to prevent the downturn -- which he attributed to "market forces" related to a glut of cars and other merchandise that consumers, after eight years of an expanding economy, no longer wanted to buy.
"It is very difficult to alter these market forces, which are determined by value choices of the population," he said.
In the last half of 1989, the Fed gradually lowered the key federal funds rate, charged on loans between banks, to 8.25 percent from 10 percent.
But during the first half of this fiscal year, when the economy was anemic, the Fed left the rate unchanged as its concern about inflation continued.
By keeping the rate unchanged, the Fed was effectively tightening its monetary policy.
Only in recent weeks, when the recession became evident and the banks restricted lending even more, did the Fed ease its monetary policy -- lowering the federal funds rate to 6.75 percent.
In explaining the recent drop in that rate, Mr. Greenspan told the House panel that the Fed was refocusing its attention on the money supply, which has shown no growth in three months, in large part because of the sharp slowdown in bank lending.
"The money supply is a reasonably good signal of how the economy is emerging, which was not the case in the mid-1980s because of the financial restructuring," he said.
He said the Fed's "most recent action [in lowering rates] was triggered in large part by further evidence of weak monetary growth."
On another point, Mr. Greenspan emphasized that it would be a "mistake" to abandon the spending limitations contained in the $492 billion, five-year deficit-reduction package adopted last fall.
Under the agreement, the limits can be suspended if a forecast by the Congressional Budget Office shows two consecutive quarters of declining economic activity. CBO Director Robert D. Reischauer is to report to the Senate Budget Committee today that the economy has declined in the last and current quarters.
Mr. Greenspan warned that "undercutting this agreement" would cause long-term interest rates to climb, hurting the economy.