Washington, DC, Apr. 21--Federal Reserve Chairman Alan Greenspan said on Tuesday that U.S. companies were regaining the power to raise prices and that a long period of worry about the potential for price deflation was over.
"It's fairly apparent that pricing power is gradually being restored and, as I'll indicate tomorrow, threats of deflation, which were a significant concern last year, by all indications, are no longer an issue for us," Greenspan said in answer to questions from lawmakers before the Senate Banking Committee.
Treasury bond prices and stocks sank on Greenspan's words, as traders saw them as raising the chances of a near-term increase in interest rates from 1958 lows of one percent.
Greenspan said deflation concerns had evaporated in the last few weeks and called this a "long overdue and most welcome change" in the economic outlook.
Deflation, in which prices spiral downward, is a stubborn phenomenon rare in U.S. economic history that was last seen during the Great Depression of the 1930s.
Greenspan did not specifically say risks of inflation and deflation were balanced, though analysts increasingly expect Fed officials to reach that conclusion at their next policy session on May 4.
Greenspan said fast growth in U.S. productivity, or hourly output per worker, should keep a lid on price pressures for some time. That gives the Fed some leeway to take its time in raising rates back to what economists call a "neutral" stance--between three and four percent--rather than being forced by surging price pressures to increase credit costs.
"The inflationary pressures will be reasonably well-contained so long as productivity is moving at a reasonably good clip and unit labor costs, as best as we can judge, are still going down," Greenspan said.
He said the economy has weathered multiple shocks well in recent years, helped by 13 Fed interest-rate cuts. Greenspan indicated policy-makers were ready to do whatever was necessary to keep expansion on track.
In his prepared testimony, Greenspan said he thought U.S. banks were well-positioned for higher interest rates. His formal remarks dealt exclusively with the banking industry but on Wednesday he is scheduled to discuss the broader economic outlook before the congressional Joint Economic Committee.
"All told, the available data, industry and supervisory judgments, and the long and successful experience of the U.S. commercial banking system in dealing with changing rates suggest that, in general, the industry is adequately managing its interest-rate exposure," Greenspan said.
"The (banking) industry appears to have been sufficiently mindful of interest-rate cycles and not to have exposed itself to undue risk," he added.
The Fed's current federal funds rate on overnight loans between banks, a bellwether for broader lending rates, has been set at 1 percent since June last year.
Greenspan's two days of testimony this week give the influential central banker a chance to prepare financial markets for the future without rattling them unduly.
Despite his efforts to tamp down worries about future inflation, markets reacted with typical volatility to the prospect of rate rises in the future.
Stocks fell while the dollar strengthened against other currencies, since higher rates make U.S. investments more attractive. Treasury bond prices tumbled.
Greenspan said the size and number of U.S. bank failures had been exceptionally small and regulators look for more improvement in the industry's asset quality this year.
"The system remains strong and well-positioned to meet customer needs for credit and other financial services," the Fed chief said.
