Greenspan Warns of Higher Rates to Check Inflation

WASHINGTON — Federal Reserve Chairman Alan Greenspan, fearing higher inflation, warned Wednesday that the central bank may continue to push up short-term interest rates in a bid to keep prices under control.

Greenspan confirmed to the Senate Banking, Housing and Urban Affairs Committee that the Fed, from late March to late June, took a series of small steps to tighten credit--but he said he is still worried that it has not gone far enough.

“Federal Reserve policy at this juncture might be well advised to err more on the side of restrictiveness rather than of stimulus,” Greenspan said in the Fed chairman’s twice-yearly report to Congress on monetary policy.

Although Greenspan suggested that the Fed does not plan any immediate or sharp moves that would boost interest rates, his testimony made it obvious that the Fed will not hesitate to raise the short-term rates it controls if the economy continues to advance as strongly as it has so far this year.

Analysts said that if economic growth is greater than the 2% to 2.5% rate that officials on the policy-making Federal Open Market Committee now expect for the rest of the year, the Fed will make the cost of borrowing modestly more expensive in an effort to contain inflationary pressures. In the first half of the year, growth appears to have exceeded 3%.

“I expect the Fed will be forced to keep tightening as the strength of the economy continues to exceed their relatively modest expectations,” said David Levine, chief economist at Sanford C. Bernstein & Co., a New York investment firm.

Short-Term Rates Up

The Fed’s tightening moves over the last two months have pushed up a variety of short-term interest rates by about a full percentage point, but longer-term rates have not risen as much because of confidence among investors that inflation still remains under control.

“The timely tightening of monetary policy this spring, along with perceptions of better prospects for the dollar . . . seemed to improve market confidence that inflationary excesses would be avoided,” Greenspan said.

The Fed, following the Oct. 19 stock market crash, moved immediately to ease credit conditions and allow interest rates to fall to prevent the panic among investors from causing a widespread economic downturn.

When Greenspan last appeared before Congress in February to discuss monetary policy, he said that the Fed had just recently relaxed its grip on credit another notch. At that time, he said, the dangers of either a recession or higher inflation were about equal.

But after more months of steady growth in the economy, which pushed the unemployment rate last month down to its lowest level in 14 years, there was no doubt that inflation is now the Fed chairman’s chief worry.

Steady Joblessness Called Key

“Considering the already limited slack in available labor and capital resources,” Greenspan said, “a leveling of the unemployment and (factory operating) rates is essential if more intense inflationary pressures are to be avoided in the period ahead.”

The characteristically opaque Greenspan, while declining to discuss the outlook for interest rates directly, was so unusually clear this time that even some of the less-informed members of the committee got the message that interest rates are likely to rise.

“From everything you say, it’s clear that interest rates are headed up,” Sen. Donald W. Riegle Jr. (D-Mich.) told the Fed chairman.

Greenspan, saying that he is “not in the business of forecasting rates,” replied that an interest rate hike is not “inevitable.” But he agreed that the only thing that would prevent rates from moving up is if “inflationary pressures . . . begin to ease for reasons that are not obvious at the moment.”

The Fed said it is leaving its targets for monetary growth unchanged for 1988 but planning to lower the growth ranges for its key measure of the money supply, known as M-2, from 4% to 8% for this year to 3% to 7% in 1989. M-2 includes all money in circulation as well as checking and savings accounts and certificates of deposit.

Few Surprises

For those who closely follow the central bank, there were few--if any--surprises in Greenspan’s comments. Investors already generally were aware of the Fed’s four successive interest rate hikes, and most analysts have been expecting another slight tightening of credit in coming weeks as evidence continues to pile up that the U.S. economy is growing at an unexpectedly robust pace.

Despite the stock market crash, the economy advanced at a 3.6% annual rate in the first quarter of the year and analysts expect that the report later this month will show that it continued to grow somewhere between 2.5% and 3.5% in the April-June quarter.

Analysts said that the Fed, in contrast to the severe credit crunch engineered by former Fed Chairman Paul A. Volcker in the early 1980s to bring down double-digit inflation, will move fairly cautiously in its efforts to keep inflation from accelerating above its current 4% to 4.5% rate.

“None of the indicators to date suggest any imminent acceleration of inflation,” said Alan Blinder, an economist at Princeton University, “so I think the Fed will be reluctant to simply hammer the economy into submission. I don’t think this Fed is particularly enamored of recessions.”