Greenspan sees modest recovery
Fed chairman says economy emerging from recession, but it still has problems.
February 27, 2002: 3:06 p.m. ET
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NEW YORK (CNN/Money) - Federal Reserve Chairman Alan Greenspan expressed cautious optimism about the U.S. economy Wednesday, saying a recovery from its first recession in a decade was on the way, but it would likely be muted.
"Despite the disruptions engendered by the terrorist attacks of Sept. 11, the typical dynamics of the business cycle have reemerged and are prompting a firming in economic activity," Greenspan said in his prepared remarks.
But Greenspan, delivering the Fed's semiannual outlook for the economy to the House Committee on Financial Services, also warned that "an array of influences unique to this business cycle, however, seems likely to moderate the speed of the anticipated recovery."
He also said the spectacular collapse of Enron Corp. could have an impact on the economy if it raises uncertainty about other companies' accounting practices. But that apparently hasn't happened yet, and Enron could be a long-term positive for the reliability of corporate accounting, he said.
The Fed cut its target for short-term rates 11 times in 2001 to levels not seen in 40 years, in an effort to make borrowing easier for consumers and help set the stage for a recovery from a recession that some economists think began in March 2001.
The Fed left rates alone after its first policy meeting of 2002, and some economists think it will start to raise rates again in the middle of the year in an effort to fend off inflation.
But Greenspan said long-term interest rates - which rise in reaction to inflation fears - haven't shown any signs of concerns about inflation, and Fed policy makers expect mild inflation throughout 2002. Economists took his testimony to mean that the Fed would likely wait a little longer before raising rates again.
"Today's comments will go a long way to dispelling the idea that the Fed is in a rush to raise short-term interest rates," said Anthony Chan, chief economist at Banc One Investment Advisors.
"[Greenspan's testimony] is good for the bond market ... because they realize the recovery is going to be gradual in nature," Chan added. "It's good for the equity market because the Fed won't stand in the way of recovery."
U.S. stock prices and Treasury bond prices rose as Greenspan spoke, but stocks lost steam later in the afternoon.
Greenspan said Fed policy makers expect economic growth in 2002 of between 2.5 percent and 3.0 percent, weaker than that usually seen in other recovery periods. Even that sluggish recovery, however, would be a "truly remarkable performance" for the economy in the wake of the Sept. 11 attacks, Greenspan said.
"Doubtless, the substantial improvement in the access of business decision makers to real-time information has played a key role," Greenspan said. "Today, businesses have large quantities of data available virtually in real time. As a consequence, they address and resolve economic imbalances far more rapidly than in the past."
One major headwind for the economy is the effect of rising unemployment on consumer spending, Greenspan said. Consumers fuel two-thirds of the U.S. economy, and they could be less inclined to spend money if their jobs are threatened.
Greenspan said Fed policy makers expect the unemployment rate, currently at 5.6 percent, to rise to between 6.0 percent and 6.25 percent this year. Unemployment is a lagging indicator, meaning it tends to rise even as the economy recovers.
But Greenspan also noted that the jobs cut by businesses in response to falling profitability could have saved other jobs by cutting costs for businesses, making it possible for wages to go higher and encourage spending.
Ironically, another factor hampering a robust recovery is the fact that consumers never really stopped spending during the latest downturn, meaning the economy won't benefit from a sudden burst of pent-up consumer demand as it has after other recessions.
"Although household spending should continue to trend up, the potential for significant acceleration in activity in this sector is likely to be more limited than in past cycles," Greenspan said.
Higher levels of consumer debt and falling stock prices could also impact consumer spending, but their impact should be moderate, Greenspan said. Also worrisome is an apparent tightening of bank credit, but Greenspan said there was nothing the Fed could do to affect that. Credit should loosen again as the recovery gathers steam, he said.
Click here for more on the Fed and rates
Crucial to the recovery, however, will be business spending, Greenspan said. Businesses started the latest downturn when they abruptly cut back spending at the end of a boom in the late 1990s, leading to a buildup of unsold goods and unused factory equipment.
But businesses in recent months have worked inventories down to levels not seen since November 1999, and Greenspan pointed out that falling inventories, coupled with even moderate demand, will fuel more industrial production. He said the potential existed for a "gradual" recovery in corporate spending and noted that he already saw evidence of a rebound in spending on high-tech goods.
Greenspan also addressed the unfolding scandal associated with the bankruptcy of energy trader Enron, saying it could have an impact on the economy by creating uncertainty about the viability of other firms like it, but that impact likely would be minimal.
"After the fact, we will look back on the Enron episode as a period when we put corporate governance back on track," Greenspan said. "That is favorable to the long-term outlook. If it were going to have significant impact on the economy in the short run, we'd already be seeing it, and we are not."
He also called for reform in accounting practices but was skeptical about the possible effectiveness of independent audit committees and other proposed solutions, saying the only real answer is to find a way to make it worthwhile for companies to be straightforward.
"Unless and until you change incentives for CEOs to do things a different way, the issue of 'gaming' the ... rules, endeavoring to make it appear as though short-term earnings growth reflects long-term earnings growth, I don't care what else you do, it will not work," he said.
He also noted a need to account for businesses such as Enron that have assets other than traditional brick-and-mortar physical goods and equipment. Enron's primary asset, for example, was merely "reputation," he said.
"The physical assets of such a firm comprise a small proportion of its asset base," Greenspan said. "Trust and reputation can vanish overnight. A factory cannot." 
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