Alan Greenspan has warned that a baffling and persistent drop in long-term interest rates won't last forever, putting a caveat on an otherwise clean bill of health for the U.S. economy.
The Federal Reserve Board chairman yesterday forecast "sustained economic growth and contained inflation pressures" for the United States in the months ahead.
But in a note of caution reminiscent of his famed 1996 "irrational exuberance" line, he said all good things come to an end -- most notably the low interest rates that have fuelled an historic housing boom.
"History cautions that long periods of relative stability often engender unrealistic expectations of its permanence and, at times, may lead to financial excess and economic stress," Mr. Greenspan told the U.S. House of Representatives' financial services committee.
The remarks came at what could be one of the last appearances at a congressional committee for Mr. Greenspan, 79, who is due to retire at the end of January. He appears again today before the Senate banking committee.
At the hearing, Mr. Greenspan dispelled any notion that the Fed is ready to stop ratcheting up its benchmark short-term interest rate after nine successive quarter-percentage-point hikes in 13 months.
"There is no hint in this testimony that the Fed sees that process drawing to a close any time soon," remarked John Ryding, chief U.S. economist at Bear Sterns.
The Fed has pushed its key short-term interest up to 3.5 per cent, from 1 per cent where it was in June, 2004, in a pre-emptive move against nascent inflation.
Mr. Ryding predicted the Fed rate will hit 4.25 per cent by year-end and 5 per cent by mid-2006.
Meanwhile, the long-term rates that consumers and businesses depend on for so much of their borrowing have moved in the opposite direction for the first time that anyone can recall. The yield on 10-year U.S. Treasury notes -- the standard for long-term interest rates -- now stands at roughly 4.25 per cent, or half a percentage point below where it was last June.
As a result, yields on corporate bonds and commercial or home mortgages are actually lower than they were a year ago, at least partly blunting the Fed's effort to rein in economic activity.
Among other things, this has created a housing boom and some "froth" in local real estate markets, according to Mr. Greenspan.
The Fed chief offered the committee a long and convoluted explanation of why short- and long-term rates have moved in opposite directions. His theory -- one favoured by former Fed governor and now White House economic adviser Ben Bernanke -- is that there is an excess of so-called intended savings around the world, particularly in oil-producing and emerging economies. This has produced a surplus of capital with nowhere to invest, pushing down long-term interest rates.
Mr. Bernanke is among the favourites to take over as Fed chief next January.
Mr. Greenspan identified two other key risks to his largely positive forecast for the U.S. economy: rising unit labour costs and the threat of higher oil prices.
"We have an oversupply of high-skilled jobs and an undersupply of people to fill them, the effect of which is to create a significant acceleration in average incomes of the highly skilled segment of our labour force," he said.
He also said energy prices would contribute little to inflation if prices don't rise much further. But Mr. Greenspan acknowledged that if oil prices do spike again, it would "cut materially into private spending, and thus damp the rate of economic expansion."
In its twice-yearly report to Congress, the Fed cut slightly its forecast for growth in gross domestic product (to 3.5 per cent this year from 3.75 to 4 per cent) and raised its inflation forecast (to 1.75 to 2 per cent, from 1.5 to 1.75 per cent).
Committee members praised his firm hand at the helm of the Fed for 18 years. Brad Sherman, a California Democrat, provided a moment of levity when he suggested members might chant "five more years" to convince him to stay.
"Does my wife have a vote in this?" Mr. Greenspan asked, prompting laughter.
"Thank God, she does not," Mr. Sherman replied.