NEW YORK, Nov 13 (Reuters) - Following are some highlights from Federal Reserve Chairman Alan Greenspan's testimony on Wednesday before the Joint Economic Committee of Congress in the question and answer period.
On the economy:
"Our best judgment is that we're going through a soft patch. That is not something which is the precursor of far more significant weakening. The reason for it, as best we can judge, is a combination of the after-effects and still marginally important issues of the decline in stock prices, but increasingly to the fallout from corporate governance malfeasance problems and, of course, more recently and perhaps most importantly, currently the geopolitical risks surrounding the negotiations with Iraq."
"The economy as such is not evidently significantly out of balance. That is, we do not have excess inventories. We do not have, as best we can judge, a debilitating large overhang of capital stock from over-building of plant and equipment. We don't have the usual internal weaknesses that presage an economy going down in a cumulative manner. But we do have is a very large degree of uncertainty, both as a consequence of corporate governance and as a consequence of geopolitical risks. And they are creating some significant hesitation mainly in the business sector, but presumably at least in part amongst consumers, as well."
"Our judgment is when this uncertainty is lifted, when this risk premium essentially is restored to normal, as it will, that a number of the activities which are basically built in to the type of market economy that we have will take force and begin to increase the rate of growth. And while I, obviously, cannot speak for other forecasters around the country, you're quite right that the general consensus is for a gradual pickup in the rate of growth next year. But that, I suspect, pretty much rests on the presumption that that overhang of uncertainty is lifted."
On the recent decision to cut interest rates:
"In the current period what we are observing is a gradual erosion of economic activity which occurred sometime in the summer. Remember, most of the GDP growth in the third quarter is largely from sharp increases in July, and in some cases, early August. But it's been softening since then. Our best judgment, and, indeed, the data to date confirm that this is a gradual, not a cumulative decline. But there is a probability, small as it may be, that we may be wrong; that this may be the beginning of something more than appears most likely."
"And because the probability or the emergence of inflationary pressures now seem so remote that the insurance premium, if I may put it that way, for going down 50 basis points, which would be the right policy, if, indeed, we are wrong on our expectation that we're going through a soft patch which will unwind very quickly, if we are wrong on that, then the 50 basis points was the right policy."
"If we turn out to be right on that, as we expect we will on the outlook, then, clearly, we will reverse the policy at some point in the future because you cannot stay at 1.25 federal funds rate indefinitely without ultimately engendering inflationary pressures."
"But all of the evidence that we have on the question of pricing power in this economy suggests that there is very little evidence that any pressures will reemerge in a time frame which is too short for us to respond sufficiently adequately to fend it off."
"So it was our conclusion that even though the expectation of a significant decline is -- I should say the probability of a significant acceleration is quite small, the cost of taking out insurance against it was so low that it, in effect, tilted the decision to 50 basis points."
On the threat of deflation:
"Our view is that we are quite a far distance from deflationary forces taking hold. We've been looking at this process for quite a long period of time."
"Theoretically, it clearly is a concern and, indeed, we are watching it about as closely as we can because there is an asymmetry between the impact of inflation and deflation, and it is somewhat easier to contain inflation than to contain deflation. And our view is that price stability is the optimum position, as I've mentioned to you before.
"So, yes, we are looking at it. Our conclusion is that we are not close to a deflationary cliff. If we ever get to that point -- remember, we are not limited with respect to purchasing only assets which affect the overnight federal funds rate. We, in the past, have engaged in purchasing assets all along the maturity spectrum of the yield curve and, indeed, during World War II and until the accord with the Treasury in 1951, the Federal Reserve essentially pegged the long end of the treasury market accumulating at some points very significant amounts of treasury issues."
"So if we ever got to the point -- and I must say to you, I find it extraordinarily remote that that will happen -- and we got to the point where we could no longer lower the target federal funds rate, we could, nonetheless, increase the liquidity of the system by moving out on the maturity schedule as far out as we wanted. And as a consequence, there's virtually no meaningful limit to what we could inject into the system were that necessary."
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