Federal Reserve Chairman Alan Green-span delivered a stern warning to Congress Tuesday that the central bank stands ready to raise interest rates if necessary to squelch any signs of accelerating inflation.
Greenspan acknowledged in testimony before the House Banking subcommittee on economic growth that price pressures moderated in May and June.But, he said, worrisome price increases earlier in the year meant "on balance, the news on inflation must be characterized as disappointing."
"Despite disinflationary forces and continued slack, the rate of inflation has at best stabilized rather than easing further," he said.
Greenspan's economic assessment was delivered to lawmakers who are counting on the Federal Reserve to keep interest rates low to offset the dampening effects of the tax increases they're about to approve as part of President Clinton's plan to cut the federal deficit.
However, Greenspan said the restraint on growth coming from deficit reduction is uncertain and warned that an "ill-timed easing" in short-term interest rates could cause "a flare-up of inflation expectations" - even when the economy appears relatively slack.
That's why the Fed in May shifted the bias of its monetary policy in favor of raising rates, although it has not yet acted on that bias.
"Even expectations not validated by economic fundamentals can themselves add appreciably to wage and price pressures for a considerable period, potentially derailing the economy from its growth track," he said in his statement.
Greenspan acknowledged that economic growth early this year was less than expected and reported that the central bank had cut its growth forecast for this year. In February, it projected growth in the gross domestic product, the sum of all goods and services produced within U.S. borders, at between 3 percent and 3.25 percent. Now it says GDP will grow between 2.25 percent and 2.75 percent.
Nevertheless, he said, "the economy appears to have accelerated gradually over the past two years, to maintain a pace of growth that should yield further reductions in the unemployment rate."
That reduction, though, will be very small. The Fed predicted that the unemployment rate, now at 7 percent, would fall to 6.75 percent by the fourth quarter of this year and only to between 6.5 percent and 6.75 percent by the fourth quarter of 1994.