U.S. Rates Moving Up?

U.S. Federal Reserve Board Chairman, Dr Alan Greenspan, addressed the Senate Banking Committee on Tuesday, in his semi-annual Humphrey Hawkins testimony. The major issues covered by Dr Greenspan were the possibility of recession in the United States after eight years of economic growth, the fact that U.S. stock market may be overvalued and the appropriateness of the three U.S. interest rate cuts in late 1998.

Dr Greenspan indicated that he believed economic growth to sit around 2.5 to 3 per cent in 1999, well below the 1998 average of 4 per cent. He also noted that a tight labour market, combined with an overvalued stockmarket and high level of private debt, could cause some upward pressure on inflation, which may force the Federal Reserve to push up rates.

Some of the more interesting points that Dr Greenspan raised were…

“But, after eight years of economic expansion, the economy appears stretched in a number of dimensions, implying considerable upside and downside risks to the economic outlook. The robust increase of production has been using up our nation's spare labour resources, suggesting that recent strong growth in spending cannot continue without a pickup in inflation unless labour productivity growth increases significantly further. Equity prices are high enough to raise questions about whether shares are overvalued. The debt of the household and business sectors has mounted, as has the external debt of the country as a whole, reflecting the deepening current account deficit. We remain vulnerable to rapidly changing conditions overseas, which, as we saw last summer, can be transmitted to U.S. markets quickly and traumatically…In light of all these risks, monetary policy must be ready to move quickly in either direction should we perceive imbalances and distortions developing that could undermine the economic expansion…The Federal Reserve must continue to evaluate, among other issues, whether the full extent of the policy easings undertaken last fall to address the seizing-up of financial markets remains appropriate as those disturbances abate. “

Dr Greenspan notes that the three interest rate cuts in late 1998, which were made in the wake of the Russian and Asian meltdowns, may need to be re-evaluated in the light of a return to stability in the financial system. However, with economic growth abating he also said that the Federal Reserve would cut rates should the need occur.

So, the question always is, “what does this mean for Australia?” Well, with inflation in Australia currently under the Reserve Bank’s target range, and the Australian stockmarket displaying none of the “irrational exuberance” that Dr Greenspan describes, it would appear that there is no short term need for the Reserve to lift Australian interest rates. As the main concern currently in Australia is to keep economic growth moving along smoothly, it would appear that the Reserve bank would be holding an interest rate cut up its sleeve. We wouldn’t expect to see any signs of action until growth has slowed down significantly, perhaps in the later half of this year. Then again, six months is a long time in economics…