Greenspan: Fed Watching Asset-Price Rise

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Federal Reserve (search) Chairman Alan Greenspan (search) said Friday the U.S. central bank was paying increasing attention to asset price rises since these were having a growing impact on world economic activity.

He warned also that buying power fueled by higher prices for such assets as stocks and homes could disappear if investors turn cautious.

In remarks prepared for delivery to the annual central bank symposium sponsored by the Kansas City Federal Reserve (search), the Fed chief said the vast increase in market value of assets stemmed partly from faith that economic risks were low.

"Such an increase in market value is too often viewed by market participants as structural and permanent," said Greenspan, who is due to step down as the U.S. central bank's chairman at the end of January. "To some extent, those higher values may be reflecting the increased flexibility and resilience of our economy."

But he added that "newly abundant liquidity can readily disappear" if investors grow wary for some reason and demand a higher risk premium for lending.

Greenspan said the Fed had to focus on such issues since global economic activity was being influenced by capital gains on various types of assets and on the debt that sustains them.

"Our forecasts and hence policy are becoming increasingly driven by asset price changes," the Fed chief said.

Economists said his remarks indicated the Fed will press on with its steady-as-she-goes rate rise campaign.

"From his comments, it is clear that the Fed will keep raising rates, hoping to bring the housing market to a very soft landing," said Drew Matus, an economist at Lehman Brothers in New York.

Greenspan said increased investor caution, by elevating the premiums investors demand in compensation for risk, could lead to a swift reversal in asset values if it forced the liquidation of debts that support them.

"This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums," he said.

In wide-ranging remarks that touched on the changes in policy-making over his 18-year tenure, the Fed chairman said the U.S. central bank has moved toward a risk-management approach as globalization has become more important.

"Forecasts of change in the global economic structure — for that is what we are now required to construct — can usefully be described only in probabilistic terms," he said. "In other words, point forecasts need to be supplemented by a clear understanding of the nature and magnitude of the risks that surround them."

If flexibility could be maintained, he said, "some of America's economic imbalances, most notably the large current account deficit and the housing boom, can be rectified by adjustments in prices, interest rates and exchange rates rather than through more-wrenching changes in output, incomes and employment."

He said the growing stability of the world economy over the past decade seemed to be encouraging investors to accept less compensation for the risks they take.

"Whether the currently elevated level of the wealth-to-income ratio will be sustained in the longer run remains to be seen," he said.

Greenspan said trade protectionism and a failure of the U.S. government to come to grips with fiscal problems were a concern.

"The developing protectionism regarding trade and our reluctance to place fiscal policy on a more sustainable path are threatening what may well be our most valued policy asset: the increased flexibility of our economy," he said.