Washington, DC, June 8--Federal Reserve Chairman Alan Greenspan said the central bank ``is prepared to do what is required'' to stem inflation pressures building in the U.S. economy.
Policy makers have ``provided ample liquidity to the financial system that will become increasingly unnecessary over time,'' Greenspan said in the text of a speech to an international monetary panel in London, delivered via satellite.
Fed officials are ``of the view, as you know, that monetary policy accommodation can be removed at a pace that is likely to be measured,'' he said. ``That conclusion is based on our current best judgment of how economic and financial forces will evolve in the months and quarters ahead.''
Greenspan said the commitment of the Fed's rate-setting Open Market Committee's to a ``measured'' increase in rates, set forth in their May 4 policy statement, is conditional and can be revoked if necessary.
Deflation concerns are `now presumably safely behind us,'' Greenspan said, and there has been a ``restoration of a significant degree of pricing power.''
At the same time, inflation should be capped by competition. ``Fears of losing market share should dissuade businesses from passing these high costs fully through to prices,'' he said.
If their judgment that inflation will remain contained proves incorrect, Greenspan said, the FOMC ``is prepared to do what is required to fulfill our obligations to achieve the maintenance of price stability.''
The U.S. central bankers left the overnight rate unchanged at 1 percent, nearly a 46-year low, on May 4, saying ``policy accommodation can be removed at a pace that is likely to be measured.''
Federal funds futures contracts show traders expect the U.S. central bank to raise the overnight lending rate by a quarter percentage point at the conclusion of their two-day meeting on June 30. Fed officials at that time will also pool their forecasts for employment, inflation and economic growth in preparation for Greenspan's semi-annual Congressional testimony on monetary policy the following month.
The Fed chairman suggested the central bank is not concerned that rising interest rates will cause a disruption in financial markets, as happened in 1994.
``Unlike 1994, there has been an appreciable increase of market rates in anticipation of policy tightening,'' he said, ``though history cautions that investors' anticipations of the cumulative magnitude of policy actions and their timing under such circumstances is far from perfect.''
Hedging of mortgage securities has fallen to ``exceptionally low levels'' as higher market rates have pushed up mortgage costs, Greenspan said. ``This suggests that the vast secondary market for home mortgages has largely adjusted to the recent increase in mortgage rates.''
Other investors have adjusted their portfolios as well, he said. ``An unwinding of carry trades is notably under way, at least judging from the shift in the trading portfolios of primary dealers,'' Greenspan said.
Greenspan also presented his analysis of inflation, saying, as have other Fed officials, that he's skeptical that the U.S. is at the beginning of a sustained escalation in prices.
For the year ended March 2004, Greenspan said, unit costs for nonfinancial corporations declined. He concluded that the 1.1 percent increase in final goods and services prices produced during that period ``was the consequence of a rise in profit margins.''
Demand for both labor and capital should accelerate as businesses try to exploit these profit opportunities, Greenspan said, and that is likely to increase wages and interest rates.
