Fed Signals Low Rates to Persist

WASHINGTON — Federal Reserve Chairman Alan Greenspan signaled Wednesday the central bank will leave short-term interest rates at a four-decade low despite the economy showing signs of a recovery that would ordinarily prompt inflation-dampening rate hikes.

Greenspan’s willingness to permit low rates to continue performing their growth-spurring work stems from a virtual absence of inflation and deep doubts about whether the economy’s recent revival is durable.

Although the country has done considerably better in recent months than most people had predicted, many economists wonder what will keep it growing. Consumers, who confounded forecasters by continuing to buy cars, clothes and houses during the recession, may be tapped out. Many executives are still hung over from the business investment binge of the late 1990s, and so are reluctant to expand hiring and production.

The result, according to Greenspan: “The strength of the economic expansion that is underway remains to be clarified.

“Either we are going to get a significant increase in production, in profits, in capital investment” or “we’ll slip back,” he told Congress.

Analysts said Greenspan’s remarks all but ensure that Fed policymakers will leave their signal-sending federal funds rate at a 40-year low of 1.75% when they meet May 7 and again June 25 and 26, and they may not begin nudging the rate up until late summer.

Interest rates across the economy are keyed to the federal funds rate, which is what banks charge each other for short-term loans. Keeping the funds rate low would help encourage new investment, spending and growth by holding down borrowing costs generally. But doing so in an economy that’s already reviving risks setting off an inflationary spiral.

However, Greenspan suggested Wednesday there are so few signs of inflation in the current situation and evidence of revival is so tentative that the risk is worth taking.

“The Federal Reserve should have ample opportunity to adjust policy to keep inflation pressures contained once sustained, solid economic expansion is in view,” he told the Joint Economic Committee.

As if to demonstrate the economy’s continued weakness, computer giant IBM Corp. announced late Wednesday that profit during the first three months of the year fell 32% and sales slipped 12%. Seattle-based Boeing Corp. also reported a quarterly loss, its first in four years.

The stock market reacted to Greenspan’s remarks and poor corporate profit reports by sinking. The Dow Jones industrial average fell 80.54 points, or 0.8%, to 10,220.78. The broader S&P; 500 index slid 2.3 points, or 0.2%, to 1,126.07, while the technology-heavy Nasdaq composite index lost 6.12 points, or 0.3%, to 1,810.67.

It is widely agreed that one of the chief causes of the recession, which began in March of last year, was the bursting of a stock market bubble that erased trillions of dollars in paper profits and caused especially affluent households to trim their spending. In his testimony Wednesday, Greenspan went out of his way to argue that no comparable bubble has developed in housing despite the ongoing strength in the housing market.

The Fed chairman argued that the size and cost of real estate transactions are larger than those in stocks, making the housing market less prone to wild price run-ups. In addition, he said that the market for housing is more localized than that for stocks, so if a problem occurs, it is likely to remain contained.

Nevertheless, Greenspan conceded, local bubbles and busts do occur, and real estate experts say that several appear to be under way. They include San Francisco, where median house prices have climbed 83% since 1995, or twice the national average, and Boston, where they have rocketed 96%, according to the National Assn. of Realtors.

“The housing market is localized” and thus less prone to busts that produce economy-wide damage, said Wellesley College economist Karl Case. But he said Greenspan “may be protesting a little too much” in dismissing the threat of a housing bubble.

The Fed’s policymaking Open Market Committee slashed the federal funds rate 11 times last year in an effort to offset the effects of the stock crash and then the Sept. 11 terrorist attacks. By late January, the committee appeared confident that it had reversed the economic tide and stopped its rate cutting.

An early glimpse at whether the low rates are sustainable will come next week when the government issues its preliminary estimate of how much the economy grew in the first three months of the year. Forecasters said the annualized growth rate for the gross domestic product could be as high as 5%.

If so, pressure could grow for the central bank to begin reversing its interest cuts and begin raising rates.

“These low rates are fine when the economy is in recession, but they are absolutely inappropriate when it is in recovery,” said Mickey D. Levy, chief economist at Bank of America in New York.