Geenspan Hints Fed Won’t Seek to Cut Rates : Policy: His comments come in an unusual response to a congressman’s letter.

WASHINGTON —  Federal Reserve Board Chairman Alan Greenspan, responding to congressional pressure for more stimulative monetary policy, signaled Tuesday that the Fed is convinced that it does not need to reduce interest rates now to boost the economy.

In a letter to Rep. Henry B. Gonzalez (D-Tex.), chairman of the House Banking, Finance and Urban Affairs Committee, Greenspan indicated that the Fed believes its policies are beginning to have the intended effect of stimulating a recovery.

Since the recession began in mid-1990, the Fed has slashed interest rates by a total of four percentage points in an effort to revive the economy.

But internal studies suggest that the success of the Fed’s policies has been masked by profound structural changes in the nation’s financial system, Greenspan said. Now that the central bank better understands the effect of those changes, it is more confident that the economy is on the mend, according to Fed officials who requested anonymity.

Greenspan’s letter did not address how the Fed would respond if the incoming Bill Clinton Administration pursues more stimulative economic policies next year. But outside economists had some insights.

“He is saying that ‘Mr. Clinton, I won’t stand in your way if you want to do a stimulus package,’ ” noted Allan Meltzer, an economist at Carnegie Mellon University in Pittsburgh and chairman of the Shadow Open Market Committee, a group of private economists who monitor Fed policy. “But he is also saying: ‘I’m not going to do anything to stimulate things further myself.’ ”

On Wall Street, the bond market cheered news of Greenspan’s letter, driving down yields on long-term Treasury bonds after interpreting the Fed chief’s comments as meaning that the central bank may try to limit inflation. On a day when positive economic reports pointed to a strengthening recovery, bond yields normally would have risen.

Greenspan’s letter, dated Nov. 27 but released Tuesday, was written in response to demands by Gonzalez that the Fed move more rapidly to ease monetary policy. The central bank has been repeatedly criticized by Bush Administration officials and members of Congress who contend that it has not moved aggressively enough to cut interest rates.

Sources said Greenspan’s letter reflects the thinking of many of the senior Fed officials who are members of the central bank’s Federal Open Market Committee, which sets interest rate policy.

Although it does not directly address the prospect for changes in interest rate policy, the letter is intended to show that the Fed believes additional easing is unnecessary, at least for now, and could even have negative long-term effects, Fed officials said.

They cautioned, however, that the letter represents a defense of past and current Fed policy, and that future changes in the economy could force them to alter their assessment.

Gonzalez immediately criticized Greenspan’s conclusions, saying that they demonstrate the Fed’s intent “to keep a tight rein” on monetary policy.

“The American public has the right to ask just what is going on at the Federal Reserve,” Gonzalez said in a statement.

In a Nov. 5 letter to Greenspan, Gonzalez warned that the Fed’s cautious approach could prolong the economic downturn, accusing it of “choking the economy down to recession levels by its insistence on maintaining a slow annual monetary growth rate.”

Gonzalez called on the Fed to take actions that would allow the nation’s money supply to expand at a rate midway within the range previously targeted by the central bank.

Traditionally, money supply growth is the key barometer that the Fed uses to determine whether its policies are too tight or too easy.

In the past, when the rate of growth has fallen below the Fed’s targeted range for sustained periods, it has responded by cutting interest rates to revive economic growth. When the money supply exceeded its targets, the Fed has tended to conclude that its policies were too stimulative and threatened to reignite inflation.

Gonzalez argued that the nation’s money supply has been growing at such an anemic pace that the Fed can afford to make dramatic new reductions in interest rates without raising inflationary fears.

But Greenspan said the Fed has found that the money supply data has sent confusing signals about the state of the economy throughout the current downturn, masking recent signs of underlying growth.

The historic relationship between money supply growth and economic activity seems to have broken down because of such problems as the restructuring of the banking system, the desire of corporations and individuals to reduce their debts and the shifting of funds out of the banking system into mutual funds and other investment vehicles.

New studies that clarify and adjust for those problems in the money supply figures have persuaded Greenspan and other Fed officials that the Fed’s policies have been successful in producing growth.

In fact, Greenspan warned that the Fed may have to lower its target range for money supply growth next year, now that it has a better understanding of what is going on with the numbers and the economy.

After adjusting the statistics to reflect the new economic realities, the Fed’s new studies show that money supply does not need to grow as rapidly as previously thought to achieve the desired level of economic growth.

Greenspan said that the Fed will decide by next February whether to reduce its money supply target ranges for 1993.

Fed officials said that reduction, if it occurs, would be merely a technical adjustment and would not necessarily represent a move toward tighter monetary policy and higher interest rates.

But the fact that Greenspan believes that the ranges may have to be lowered suggests that he is sure that the Fed’s current policies are on track and that further interest rate cuts are unnecessary, they said.

“What Greenspan is saying is that our policies haven’t been so bad, after all,” one Fed official said. And, with recent economic statistics pointing to recovery, “there are no compelling reasons to change monetary policy right now,” the official added.

Greenspan’s response to Gonzalez was highly unusual for a Fed chairman and offered analysts a rare look into the Fed’s current thinking on the economy.