Stock market's dive may help economy, Fed chairman says Continuing expansion likely, Congress told

October 30, 1997|By Jay Hancock | Jay Hancock,SUN STAFF

WASHINGTON -- Never eager to pull the levers of monetary power, Federal Reserve Chairman Alan Greenspan likes to rely on a vigilante bond market and his own roundabout rhetoric to do the dirty work of slowing the economy and guarding against inflation.

This week he got a new ally: stocks.

The Dow Jones industrial average's 554-point dive on Monday "will tend to damp" the economy, Greenspan told Congress yesterday, "a development that should help to prolong our 6 1/2 -year business expansion."

Wall Street cheered, interpreting the comments to mean that Greenspan won't reach into his quiver and take aim at inflation by raising short-term interest rates.

"It didn't sound like any action was imminent," said C. Frazier Evans, senior economist with Colonial Investment Services in Boston.

If stocks don't decline further, people may look back on Monday's plummet "as a salutary event in terms of its implications for the macro-economy," Greenspan said in regular testimony before the Joint Economic Committee. Greenspan heads the Federal Reserve, the country's central bank.

The comments were a U-turn from what he said only three weeks ago, when he described the economy as being on an "unsustainable track." The Dow Jones industrial average fell 83.25 points that day, and analysts blamed it on fear that the Federal Reserve would tighten the money supply and raise short-term rates.

"Greenspan now seems to suggest that, between events in Asia and U.S. market volatility, the economy will slow on its own, without any help from the Fed," said Bruce Steinberg, chief economist for Merrill Lynch & Co.

Not only will the Fed hold tight at its Nov. 12 policy-committee meeting, Steinberg said, "we believe it will be on hold long after that as well."

Greenspan doesn't expect Asian problems to seriously wound America, however.

Despite Wall Street's turmoil, he said, "the foundation for good business performance remains solid" in the United States. Economic data, he added, "are beginning to support the notion that productivity growth, the basis for increases in earnings, is beginning to pick up."

As always, Greenspan emphasized the Fed's role as watchdog against inflation. He criticized the view "that we need no longer be concerned about the risk that inflation can rise again."

Greenspan spent much of the morning talking about recent economic turbulence in Asia. Steep U.S. stock market drops last week and Monday followed similar damage in Hong Kong and other Asian countries.

Greenspan called it the "contagion effect" and blamed it on the unprecedented extent to which financial systems are linked by computers.

But he downplayed the threat Asian problems pose to the U.S. economy.

In serpentine Greenspanian syntax, he said the impact of Asian stock declines "can be expected not to be negligible." But the effects are "not enough to explain the recent behavior of our financial markets," he added.

Some analysts say Greenspan isn't paying enough attention to the Asian threat. If they're right, the prospect in the United States isn't for flat interest rates, but falling ones.

"I was surprised the way he downplayed the problems in Asia," said Lacy H. Hunt, an economist with Hoisington Investment Management in Austin, Texas. "I see the whole region as economically troubled. The problem is very deep-seated. There are real, I think, deflationary risks."

Deflation, unseen in the United States since the early 1950s, is characteristic of extreme economic weakness and is when prices actually fall. Currency values actually grow, and interest rates shrink toward zero.

By watching too closely for inflation, Hunt said, Greenspan may miss the perhaps bigger risk of deflation -- and recession -- in America, as Asian problems cascade here.

"The United States has 27 percent of the world's gross domestic product," he said. "Asia has 25 percent of the world's gross domestic product. We sell 30 percent of our exports to Asia, including Japan.

"I personally would have liked to have seen a more balanced understanding that there is a deflationary risk present. You don't want the Federal Reserve to be so late to the game that when they take action to fight deflation, it's of no value."

Lynn Reaser, an economist with Barnett Bank in Jacksonville, Fla., agrees that recent stock declines will exert a braking force on the U.S. economy, especially on retail sales. "The market can have big swings in retail activity," said Reaser, who has studied the connection. "The consumer was the key" to the economy, she said, and consumers now are less likely to spend.

Pub Date: 10/30/97

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