In remarks prepared for delivery to Congress, Greenspan said that the Fed was prepared to leave interest rates at low levels "for as long as it takes" - even though rates are at a 45-year low. The goal would be to get the economy growing at a faster pace, he said.
Greenspan's comments - part of the central bank's twice-yearly report to lawmakers - signaled that the Fed, which has already reduced a key interest rate to the lowest level since 1958, is prepared to cut rates again. This could happen as soon as its next meeting on Aug. 12 if the economy is not showing convincing signs of a post-Iraq rebound.
The Fed "stands ready to maintain a highly accommodative stance of policy for as long as it takes to achieve a satisfactory economic performance," Greenspan said in testimony to the House Financial Services Committee.
At its last meeting on June 25, the central bank's interest rate-setting Federal Open Market Committee cut the funds rate by a quarter-point to 1 percent. The next day banks reduced their prime rate to 4 percent, the lowest for this benchmark rate for millions of consumer and business loans since 1959.
The central bank had signaled at its May meeting that it was concerned that inflation had fallen to such a low level in this country that there was a danger that the sluggish economy might actually trigger a prolonged bout of deflation. That would be a destabilizing period in which prices are actually falling, something not experienced in the United States since the Great Depression of the 1930s.
Greenspan told House lawmakers on Tuesday that the Fed remained worried about the possibility of deflation, even though he characterized such an outcome as remote. If it occurred, it would threaten extensive damage, he said, especially if the economy were to be hit by any type of shock.
"A very low inflation rate increases the risk that an adverse shock to the economy would be more difficult to counter effectively," Greenspan said.
The quarter-point reduction in the funds rate last month disappointed many investors on Wall Street, who had been expecting a larger half-point reduction. Some analysts speculated that the Fed might have gone for the smaller rate move in an attempt to conserve the limited amount of rate cuts it had remaining.
Some economists said the Fed would want to stop well short of 0 percent on the funds rate, possibly cutting no further than 0.5 percent or 0.75 percent, because of the need to leave money market mutual funds with enough of a margin to meet expenses and still pay a return to their investors.
However, in his testimony Tuesday, Greenspan debunked that view, saying that financial firms had demonstrated "considerable flexibility" in the past in finding ways to make a profit even at low interest rates.
"With the target funds rate at 1 percent, substantial further conventional easings could be implemented if the FOMC judged such policy actions warranted," he said.
Greenspan said that he and other members of the FOMC discussed at some length at the June meeting the possibility of using "alternatives" for influencing interest rates beyond the Fed's conventional lever of adjusting the federal funds rate. Greenspan said that Fed policy-makers had concluded that it was "unlikely" that these methods, such as buying longer-term securities, would have to be used.
Greenspan presented the committee with the Fed's latest economic forecasting, predicting that the economy would grow this year in a range of 2.5 percent to 2.75 percent. That represented a significant cut from the Fed's Febraury forecast, when it had predicted growth this year would be a faster rate of between 3.25 percent to 3.5 percent.
The economy, weighed down early in the year by falling consumer and business confidence reflecting worries about the Iraq war, has shown disappointing growth so far in 2003. The sluggish growth pushed the unemployment rate to a nine-year high of 6.4 percent in June.
Greenspan in his testimony noted a number of promising developments that the economy should post stronger growth in the second half of his year, including the fall in interest rates and President Bush's latest round of tax cuts.
For 2004, the Fed predicted a significant rebound in economic growth to 3.75 percent to 4.75 percent, a rate that the Fed said could bring the unemployment down to as low as 5.5 percent by the end of the year.
Greenspan emphasized that the central bank was prepared to leave interest rates low for as long as necessary to achieve this optimstic forecast because of a belief that the threat of deflation, not inflation, was the biggest concern at the moment.
"Policy accommodation aimed at raising the growth of output, boosting the utilization of resources and warding off unwelcome disinflation can be maintained for a considerable period without ultimately stoking inflation pressures," Greenspan said.