U.S.: The Gospel According To Greenspan
It must have been a very pleased Alan Greenspan who appeared before the Senate Banking Committee on Feb. 26 to talk about monetary policy. After all, the Federal Reserve chairman projected that the economy's 1996 mix of solid growth and low inflation would continue in 1997. But the Fed chief also took the opportunity to air his concerns about the stock market and whether the era of job insecurity is ending.
In his semiannual Humphrey-Hawkins testimony before the Senate, Greenspan laid out the Fed's forecast for 1997 (table). Real gross domestic product is expected to grow between 2% and 2.25% over the four quarters of 1997, down from the 3.4% gain in 1996. And the consumer price index would rise between 2.75% and 3%, after increased food and energy prices pushed inflation up to 3.3% in 1996.
Greenspan admitted that "economic prospects in general are quite favorable," a suggestion that the Fed would not raise interest rates at its upcoming Mar. 25 meeting. But that doesn't mean monetary policy will remain on hold. In fact, Greenspan seemed to back away from past hints that the Fed would not raise interest rates until the price indexes started to rise. Instead he said, "We cannot rule out a situation in which a preemptive policy tightening may become appropriate before any sign of actual higher inflation becomes evident."
As befits the Fed's forecast, the slow-growth, low-inflation combination seems to have carried through into the first quarter. Real GDP growth has slowed from its blistering 4.7% gain in the fourth quarter. However, strong household fundamentals suggest that any surprises in the outlooks for consumer spending or housing will be on the upside in 1997. And those surprises could unhinge the falling-inflation scenario.
THE CHAIRMAN ACKNOWLEDGED inflation concerns of his own. Greenspan reiterated the idea that the restraint on wages was mainly the consequence of worker insecurity. That is, workers were more interested in keeping their jobs than in getting a pay raise. But, he said: "At some point, the trade-off of subdued wage growth for job security has to come to an end." And he pointed to some evidence that the end was near, including the low unemployment rate and the increase in workers who quit a job to find a new one.
His other big worry was the possible overvaluation of the stock market. Greenspan repeated his question of last December which asked, "How do we know when irrational exuberance has unduly escalated asset values?" He went on to warn that earnings disappointments could bring down stock prices. Just as in 1996, the markets did not appreciate Greenspan's jawboning. Both the stock and bond markets plunged during the testimony, and closed down for the day.
THE CENTRAL BANK'S outlook expects smaller gains in consumer demand roughly in line with moderate growth in disposable income. But even Greenspan admitted that the behavior of consumers was always uncertain. After all, why should shoppers scale back now when the latest data show that consumers are extremely upbeat about the current state of the economy as well as on job prospects and their financial futures?
The Conference Board's index of consumer confidence stood at 118.4 in February, barely down from the revised 118.7 reading of January, a 7 1/2-year high. The present-situation component of the index jumped from 141.2 in January to 143.4 in February, a 27-year high (chart). Consumers' expectations for the next six months fell only slightly, to 101.7 from 103.8.
So far in the first quarter, consumers continue to spend. The weekly surveys of retailers show that store sales in the first three weeks of February were up at least 2% above their average of January, when according to government data, total retail sales rose 0.6%.
In addition, the rise in the present-situation index indicates a healthy increase in February payrolls, to be reported on Mar. 7. And as Greenspan noted, consumers are feeling much more confident about their ability to find work. More than 32% think jobs are "easy to get," says the Conference Board. That's the highest percentage in eight years.
Besides the obvious fear that renewed job security generates higher wages, which boost labor costs, Greenspan also said that pay gains are a danger to the inflation outlook because faster income growth may touch off a round of demand-pull pressure on prices. That's a worry now that the economy seems to be using all its available capital and labor. As 1997 progresses, increased spending could exceed the output capacity of producers, causing shortages and production bottlenecks. Greenspan warned that such escalating pressure on resources "could destabilize the economy."
One safety valve for this demand-output imbalance is overseas production. Greenspan noted that the dollar's rise has made imports even cheaper. In fact, import prices fell 0.3% in January, 0.4% when oil is excluded. Over the past year, the prices of nonpetroleum imports have fallen 1.9%. That drop has offset the increases in prices of domestically made goods. But Greenspan doubted that the dollar would provide such a big inflation offset in 1997.
ANOTHER AREA where the Fed expects slower growth is homebuilding. And housing starts began 1997 poorly: They edged up 2% in January, to an annual rate of just 1.35 million. That followed an 11% plunge in December when bad weather shut down building sites in the West and Midwest. Western starts in January recovered, but Midwest construction remained weak.
However, the fundamentals that supported housing in 1996 show few signs of teetering in 1997. Relatively low mortgage rates, steady gains in incomes and jobs, and consumers' sense of economic well-being suggest that housing could hold its own in 1997, or at worst subtract only a bit from GDP growth.
Perhaps that's why builders are optimistic about the outlook. The National Association of Home Builders' housing activity index bumped up to 54% in February, the best reading since October. The biggest gain was in sales expectations for single-family homes. That index jumped from 63% in January to 68% in February, the highest level since June (chart).
One reason for the optimism is that home buying remains affordable. Fixed 30-year mortgage rates are firmly below 8%. And as long as the bond market holds steady, mortgage rates will not rise.
The performance of the bond market, of course, will depend on monetary policy. Up on Capitol Hill, Greenspan said nothing to suggest an imminent rate hike. But he also concluded his remarks by noting that a central banker's job "is to stay on the lookout for trouble." That vigilance means that the policy door will stay open throughout 1997.