Greenspan Sees Need for Tight Money Policy

Federal Reserve Board Chairman Alan Greenspan said today that monetary policy needs to err on the side of restrictiveness because if the economy continues to grow indefinitely at the recent pace, inflation could accelerate significantly.

Greenspan told the House Banking Committee that the gross national product appears to have risen more than 3% in 1988 and there are few signs of any significant impediment to continued expansion in 1989.

Overhangs of inventories are rather isolated and manageable, he said. Industrial capacity is relatively fully utilized, and there appear to be no widespread problems with out-of-control costs and inadequate profit margins.

But Greenspan said this positive outlook does not mean that there is little reason for concern.

Higher Resource Use

Resource use has risen to levels that have been linked in the past with rising inflation, Greenspan said.

“If growth were to continue indefinitely at the recent pace, the concomitant tightening of supply conditions for labor and materials would risk a serious intensification of inflationary pressures at some not-too-distant point in the future,” he said.

The labor market is showing clear signs of tightening, although it is unlikely that a few tenths of a percentage point up or down on the unemployment rate would change the inflation outlook dramatically.

Pressure for Pay Hikes

“Nonetheless, the available evidence points to a high probability of stepped-up wage pressures should unemployment decline significantly further,” Greenspan said.

The jobless rate in December was 5.3%, well within what Greenspan said is the 4.5% to 6.5% range for the “natural rate” of unemployment.

Compensation increased about a percentage point in 1988 as labor shortages grew, and Greenspan said there is some fear that the tenor of wage negotiations may shift further in a direction inimical to cost restraint.

Greenspan said U.S. labor markets and industrial plants may well be flexible enough to allow the economy to operate for some time at higher levels of resource utilization without a visible deterioration in inflation.

“But there is little doubt that margins of slack have been reduced. The risk of greater inflation could be appreciable if real GNP continued to increase at recent rates over the next several years,” he said.