The Federal Reserve had to raise interest rates this year to avoid an outbreak of inflation that could have endangered the expanding economy, Chairman Alan Greenspan said Friday.
Greenspan, appearing before the Senate Banking Committee, vigorously defended the central bank's decision to increase short-term interest rates four times since February.He said that the Fed had held rates at unusually low levels through the end of 1993 to ensure a good start to the economic recovery.
However, he said, "maintenance of that degree of accommodation, history shows, would have posed a risk of mounting inflationary pressures that we perceived as wholly unacceptable."
Greenspan, who is under fire from Democrats who fear the higher rates will choke off the expansion, conceded that the central bank had nudged rates higher before inflation actually worsened. He said, though, that his approach should avoid more precipitous rate increases later.
If the Fed had waited until inflation worsened, "monetary policy would need eventually to tighten more sharply . . . possibly even placing the continuation of the economic expansion at risk."
He said the rate increases ordered by the Fed "would not impede satisfactory economic growth, but rather would help such growth to be sustained."
However, committee members were skeptical of that.
Sen. Paul Sarbanes, D-Md., brandished a blowup of a political cartoon depicting Greenspan holding a sign reading, "The economy is picking up. We are doomed."
"We are becoming increasingly concerned . . . that monetary policy not choke off the economy that only recently has begun to generate income and growth. It seems very likely that the Federal Reserve has already moved excessively," Sarbanes said.
The Federal Reserve also has been criticized for spooking financial markets and sending long-term rates, such as those charged on mortgages, higher. But Greenspan said that although the Fed's action had a role in triggering the rise in long-term rates, the more important factor was market fears that economic growth would lead to future inflation.
"Longer-term rates eventually would have increased significantly even if the Federal Reserve had done nothing this year," he said. In fact, he said the Fed's first three interest-rate increases this year were small quarter-point moves intended to forestall as much turbulence as possible in financial markets.
"Many of us were concerned that a large, immediate move in rates would create too big a dose of uncertainty, which could destabilize the financial system," he said.
Judging by the turmoil that roiled markets, "our worries seem to have been justified," Greenspan said. But by the time of the Fed's fourth move on May 17, policymakers judged the market could withstand a larger half-point increase, he said.