Alan Greenspan signaled Wednesday that the Federal Reserve will keep pushing interest rates higher this year in an effort to keep inflation on an even keel.
The Fed chief had mostly positive things to say about the economy, but he cautioned that a big run-up in already high energy prices could throw a wrench into the outlook.
Greenspan also expressed heightened concern about "speculative fervor" in the booming housing market in some areas of the country.
For now, though, economic barometers suggest that the economy has emerged from a springtime soft spot, Greenspan told the House Financial Services Committee. The job market is improving, retail sales are picking up, business investment is firming and inflation is fairly tame, he noted.
"Our baseline outlook for the US economy is one of sustained economic growth and contained inflation pressures. In our view, realising this outcome will require the Federal Reserve to continue to remove monetary accommodation," he said, referring to further interest rates increases.
The Fed has pushed a key interest rate to 3.25 per cent in nine modest, quarter-point moves. Before the Fed embarked on its credit tightening, that key rate stood at 1 per cent, a 46-year low. Economists viewed Greenspan's comments as cementing another quarter-point increase at the Fed's next meeting, Aug. 9. Some believe the key rate could climb as high as 4.25 per cent by the end of this year.
Greenspan is delivering his final midyear economic outlook to Congress this week. At the helm of the Fed for 18 years, Greenspan is expected to step down next year.
Democratic and Republican lawmakers praised his handling of the world's largest economy. One lawmaker, Rep. Brad Sherman, D-Calif., said he was introducing a bill that would allow Greenspan to serve for another five years, removing the current requirement that will force him off the Fed board next Jan. 31.
"Does my wife have a vote on this?" Greenspan joked, referring to NBC News reporter Andrea Mitchell.
On Wall Street, stocks got a lift from Greenspan's largely good economic assessment. The Dow Jones industrials gained 42.59 to close at 10,689.15.
One of the threats to the favorable economic outlook, Greenspan said, is a jump in energy prices, which surged to a new closing high of $61.28 in early July.
"A further rise could cut materially into private spending and thus damp the rate of economic expansion," Greenspan said.
The rise in energy costs since late 2003 will shave about three-fourths of a per centage point from growth this year, according to Fed staff estimates. The economy should grow by 3.5 per cent this year, the Fed said in a new forecast. That's down slightly from its previous estimate, made in February, of 3.75 per cent to 4 per cent.
Another threat, Greenspan said, comes from exceptionally low long-term interest rates -- especially for home mortgages -- which have helped propel the housing boom and the steep climb in home prices.
"The significant rise in purchases of homes for investment since 2001 seems to have charged some regional markets with speculative fervor," Greenspan said. That marked Greenspan's strongest comments on the possibility that the surge in housing prices in parts of the country could be creating a speculative bubble similar to the one on Wall Street that burst in early 2000.
In some local markets home prices "seem to have risen to unsustainable levels," he said. A drop in house prices in some local markets would probably produce "some economic stress," but it probably wouldn't be substantial, he said.
Greenspan also issued a fresh warning about the increased use of exotic types of mortgages, such as interest-only mortgages, which could leave home buyers "vulnerable to adverse events" if house prices begin to fall.
Rep. Deborah Pryce, R-Ohio, said she's "concerned about the recent surge in home prices in many metropolitan areas."
Another threat, Greenspan said, is the possibility that wage pressures, which have been dormant, will intensify, which would fan inflation.
The Fed's forecast estimates that a gauge of prices that excludes energy and food will increase by around 1.75 per cent to 2 per cent this year. That's up slightly from the February estimate of 1.5 per cent to 1.75 per cent increase in "core" inflation.
The outlook for employment improved a bit to show the jobless rate falling to 5 per cent at the end of this year, compared with the February forecast of a dip to 5.25 per cent. The unemployment rate currently is at 5 per cent, a nearly four-year low.
Rep. Barney Frank, D-Mass., worried that some workers are not reaping the benefits of the economic recovery and globalization. "The fact is that increasingly average workers do not see that the prosperity that results from these policies is benefiting them."