September 16, 2007 / 10:52 PM / 12 years ago

Greenspan warns on sharp Fed rate cuts: FT

WASHINGTON (Reuters) - Former Federal Reserve Chairman Alan Greenspan said his successors at the U.S. central bank should act cautiously in lowering interest rates because of inflation risks, according to an interview published on Sunday.

Alan Greenspan speaks at Book Expo America in New York in this file photo from June 1, 2007, to promote his new book "The Age of Turbulence", due out this fall from Penguin Press. REUTERS/Eric Thayer/Penguin Press/Handout

Greenspan said the Fed should be careful not to cut rates too aggressively because the risk of an “inflationary resurgence” is greater now than when he was chairman, the Financial Times reported.

The U.S. central bank meets on Tuesday and is widely expected to cut benchmark federal funds rates by at least a quarter-percentage point to help the economy weather a housing downturn and a credit crunch.

Greenspan said the U.S. housing slump is likely to deepen more than many analysts expect, recording as much as a double-digit drop.

The Fed is currently weighing the adverse impacts of the housing downturn on the broader economy, and recent report employers shed 4,000 jobs in August raised warning flags.

Greenspan said he would expect “as a minimum, large single-digit” percentage declines in U.S. house prices from peak to trough, the newspaper reported. The former Fed chair said he would not be surprised if the drop was “in double digits.”

UNDERLYING STRENGTH

But Greenspan, who is promoting a memoir that hits bookstore shelves on Monday, said that while home prices have not yet hit bottom, turmoil in housing and credit markets does not look like it will produce a broader economic downturn.

“There is an underlying strength in the United States,” he said in an interview on the CBS program 60 Minutes.

“And indeed, when you look around the world, even with this extraordinary credit problem, the economies seem to be holding up. But for the moment it does not look sufficiently severe that it will spiral into anything deeper,” he said, according to a transcript made available before air time.

Greenspan stepped down as chair of the Federal Reserve in January 2006 after more than 18 years at the helm of the U.S. central bank. His book is entitled, “The Age of Turbulence: Adventures in a New World.”

Greenspan warned in the interview that it won’t be clear for a while whether the housing downturn and turmoil in credit markets from a wave of delinquencies among mortgages to borrowers with blemished credit will hurt the broader economy economy or not.

“This is fundamentally, originally caused by the flattening out of home prices. And that is only now just beginning,” he said.

But he expressed confidence the credit crisis would recede.

“This is a human behavior phenomenon and it will pass. The fever will break and euphoria will start to come back again,” he said.

INFLATION WORRIES

The former Fed chair, who earned wide praise for guiding the economy through its longest expansion on record and for his crisis-management skills, cautioned in his book that the biggest long-term threat to the U.S. economy is not the current housing correction but the likelihood that inflationary pressures will resume over time.

“Our problem over the long run is the re-emergence of inflation,” he writes.

As economic globalization winds down — as workers from the former centrally planned economies of Eastern Europe are absorbed and as the costs of Chinese imports begin to rise — the forces that have kept prices down will disappear, he said.

Inflation in the United States could rise to a rate of between 4 percent and 5 percent a year, Greenspan said, well above the 1 percent to 2 percent that some Fed officials have identified as their preferred inflation range.

The Fed could keep inflation lower, but to do so might have to raise interest rates into the double-digits, Greenspan writes. The U.S. central bank could well face powerful political pressure not to raise borrowing costs to such draconian levels.

“Whether the Fed will be allowed to apply the hard-earned monetary policy lessons of the past four decades is a critical unknown,” he writes. “We could see a return of populist, anti-Fed rhetoric, which has lain dormant since 1991.”

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