Greenspan sees Fed getting tough on inflation


Posted at Jun 14 2008 11:23 PM | Updated as of Jun 15 2008 07:23 AM


MEXICO CITY - Former US Federal Reserve Chairman Alan Greenspan said on Friday the Fed will have to tighten monetary policy to put a brake on inflation, adding that the worst of the credit crisis may have passed.

Growing price pressures have led the US central bank to recently shift to more aggressive anti-inflation rhetoric, and expectations are rising that policymakers will raise benchmark US interest rates within months.

"If you're going to keep inflation rates down ... the Federal Reserve is going to have to put increasing pressure on the money supply and reserves, and as a result we're going to see interest rates rising," Greenspan said via video link to an event in Mexico.

Soaring gasoline prices helped drive up the US consumer price index in May at the fastest rate in six months, the government said on Friday, although "core" prices, excluding food and energy, remained tame.

Greenspan, who attained cult status for his insight into financial markets as head of the US central bank, said weakness in financial markets probably peaked in March but that it was hard to say how long the crisis would last.

"It can struggle along for a while. It could get worse, it could get better," he said.

Federal Reserve officials have recently harshened their tone about inflation, marking an important shift away from an emphasis on the risk that financial turmoil, tighter credit, and a deep housing contraction could tip the US economy into a deep recession.

Fed Chairman Ben Bernanke, together with other senior Fed officials, said this week the bank was watching for any sign that a self-feeding inflationary psychology could take hold. Past inflation spirals have been fueled by workers asking for big increases in pay.

While the Fed is expected to hold rates steady at its upcoming meeting on June 24-25, financial markets now expect policymakers to raise rates as early as their subsequent meeting on August 5. A signal of their intentions could come when they announce their next decision.

Credit crisis

The credit crunch, which has infected markets globally, erupted last year when the US subprime mortgage sector melted down.

Banks holding mortgage loans that were repackaged into so called "structured finance" securities have since said that those assets are worth billions of dollars less than previously thought.

Greenspan said the financial market problems could continue until the stated value of those assets fully reflect the fall in house prices in the United States.

"Until prices are clarified ... we will be dealing with a not fully functioning financial intermediary system," he said.

He said that convergence could happen "perhaps by the end of this year but maybe not. It may require some going into next year."

Greenspan said market watchers would know the crisis was coming to an end when the gap between three-month London interbank offered rates, or Libor rates, and Overnight Index Swap rates narrowed to about 50 basis points.

The closely-watched spread -- a key gauge of money market stress -- was around 74 basis points on Friday, its lowest since mid-April. It has been consistently above 70 basis points since mid-March.

"The worst is over (for the US economy) if the financial crisis is over," Greenspan said.