The US economy has entered a self-sustaining expansion that is creating some inflationary pressures, and the US central bank is prepared to raise interest rates more quickly if prices rise more steeply, Federal Reserve chairman Mr Alan Greenspan told Congress yesterday.
In a generally upbeat mid-year economic forecast, Mr Greenspan said that economic conditions "have generally been quite favourable in 2004", with stronger growth finally producing significant gains in employment.
His remarks sparked a small rally on Wall Street and firmed up gains in the dollar against the euro and other world currencies.
Mr Greenspan's forecast of lower unemployment and continued growth is good news for the Bush re-election campaign, particularly as he said it was helped by reductions in income tax, which lie at the heart of President George Bush's economic policy.
"The improvement in labour market conditions will doubtless have important follow-on effects for household spending," Mr Greenspan said. "Expanding employment should provide a lift to personal disposable income, adding to the support stemming from cuts in personal income taxes over the past year."
Summing up the state of the economy, he said that not only had economic activity quickened "but the expansion has become more broad-based and has produced notable gains in employment".
As long as price pressures eased in coming months and didn't threaten to become embedded in wages, the Fed felt it could continue to raise interest rates "at a pace that is likely to be measured".
Asked by members of the Senate Banking Committee if his forecast meant that the central bank would raise interest rates at its August 10th meeting, the Fed chairman replied that it was prepared, if the economy showed signs of significant inflationary pressure, to "do what is required" to achieve price stability.
The Fed raised its benchmark federal funds rates for the first time in four years on June 30th, from a 46-year low of 1 per cent to 1.25 per cent. Economists expect this will be followed by further quarter-point hikes in August and later this year and next.
Apparently preparing financial markets for the possibility that the Fed would raise rates more rapidly if inflation worsens, Mr Greenspan said: "We cannot be certain that this benign environment will persist and that there are not more deep-seated forces emerging as a consequence of prolonged monetary accommodation."
Inflation had been boosted, he said, by transitory factors such as the surge in energy prices.
"Those higher prices, by eroding households' disposable income, have accounted for at least some of the observed softness in consumer spending of late, a softness which should prove short-lived."
Answering questions from senators, he forecast that, if oil prices stayed high, the US would turn to vehicles that consumed less petrol. He also said that, while the US current account deficit was the highest in history and could not be sustained, there was "very little problem" financing the deficits.
The Fed predicted that the economy would grow 4.5-4.75 per cent this year, down from the February estimate of 4.5-5 per cent, and that inflation would be 1.75-2 per cent, up from its February forecast of 1-1.25 per cent. The figures do not include food and energy.
The outlook for unemployment, currently at 5.6 per cent, remained unchanged at 5.25-5.5 percent by the end of this year.
