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Tuesday, February 23, 1999 Published at 21:57 GMT

Business: The Economy

Greenspan's balancing act

What Alan Greenspan says can move markets

Financial markets in the US were not sure how to interpret the latest remarks on the economy by the Federal Reserve Chairman Alan Greenspan.

"We are attempting to balance the domestic and the international (concerns)", said Mr Greenspan in his his semi-annual testimony to Congress.

[ image: Worries about foreign markets could stop the Fed raising rates]
Worries about foreign markets could stop the Fed raising rates
Mr Greenspan, chairman of the Federal Reserve says the bank stands ready to move either way to preserve the US economy's expansion - the one remaining area of the world which is still enjoying robust growth.

His remarks suggest that for the moment, US interest rates will stay on hold.

His difficult task in the longer term is to manage to slow the booming US economy while not plunging the rest of the world deeper into recession.

Mr Greenspan was upbeat about US economic prospects, but warned that the longest peacetime economic expansion in history had taken its toll.

"In many respects, the fundamental underpinnings of the recent U.S. economic performance are strong," he said. "But after eight years of expansion, the economy appears stretched in a number of dimensions, implying considerable upside and downside risks to the economic outlook."

Inflation dangers

[ image: Mr Greenspan is famous for his enigmatic remarks]
Mr Greenspan is famous for his enigmatic remarks
Mr Greenspan mainly emphasised the danger of inflation, due to the tightening of US labour markets. The central bank expects the growth of the US economy to slow to a more sustainable 2.5%-3.0% per year, while it expects inflation to move up slightly to 2% to 2.5%.

"Should labour market conditions continue to tighten, there has to be some point at which the rise in nominal wages will start increasingly outpacing gains in labor productivity, and prices inevitably will begin to accelerate," Mr. Greenspan said.

Among the other risks he cited were the high levels of debt by households and companies, the growing US trade deficit, the over-valued stock market, and economic weakness in many overseas markets.

He said the Fed was reviewing whether its policy easing in the autumn was still justified as the global economic crisis had moderated, despite the continuing worries about Brazil.

Inflation was kept down in 1998 by some one-off factors, such as low commodity prices and the currency devaluations in Asia, which are unlikely to recur.

Market jitters

Mr Greenspan's testimony is, as always, closely watched by the world's financial markets, who have recently been backing the dollar amid signs that economic growth in the United States shows no signs of slowing down.

The Dow Jones Industrial Average fell sharply after the first details of his testimony were released, losing over 70 points in the first few minutes before recovering later to a more modest 15 point gain when he finished at 1700GMT (1200 Washington time).

The Dow Jones industrial average ended down 8.26 points, or almost 0.1%, at 9,544.42.

Warning sounds

Mr Greenspan repeated his warnings that stocks might be too high, and could fall this year as profits would be weaker.

"Equity prices are high enough to raise questions about whether shares are overvalued," he said.

"It remains to be seen whether corporate earnings will disappoint investors, even if the slowing of economic growth is only moderate."

Several times in the past Mr Greenspan has warned that the stock market has been over-valued, using words like "irrational exuberance" and "a lottery" to characterise the situation, but the markets have repeatedly ignored his warnings and reached yet more record highs.

Mr Greenspan has acknowledged that a considerable part of the consumer boom has been based on the "wealth effect" based on the ownership of stock.

The risk is that a stock market correction could be hard to stop, and lead to a sharp drop in consumer demand and investment.

Booming US economy

Mr Greenspan's concerns are reflected in the extraordinarily buoyant condition of the US economy.

Consumer confidence in February reached a record high, at 132.1, up from 128.9 in January.

The US economy had a growth rate in the last quarter of 1998 of 5.6%, while unemployment and inflation have both been low. Some economists believe that if economic growth continues at the same pace into 1999, the Fed will have no choice but to cool the economy by raising interest rates.

"Here at home, economic growth is very strong. At the same time global conditions are dicey," commented Sung Won Sohn of Wells Fargo Bank.

He believes that the Fed could take action at its May meeting to raise rates.

Global crisis easing

But others believe that the Fed will have to keep rates on hold, in order to protect the US economy from further spillover from the global economic crisis.

In the autumn the Federal Reserve lowered rates three times, in order to ease pressures on global markets.

Since then, Brazil, one of the US's largest export markets, has been forced to devalue its currency, and there are fears that the contagion could spread to other Latin American countries.

The Fed chairman admitted that the US economy would suffer more severely this year from the slowdown in global growth which has now spread to most of the world's industrial countries.

"(The Asian economic crisis) will hit world growth much harder this year than any year since World War II .. For that reason, the Fed will keep policy on hold," said David Jones of Aubrey G. Lanston and Company.

He argues that the next US interest rate move will be down, as the economy slows in the second half of the year.

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