Greenspan: Fed Will Have to Raise Interest Rates

U.S. Federal Reserve Former Chairman Alan Greenspan said Friday the Fed will have to tighten monetary policy to put a brake on inflation and said the worst of the U.S. credit crisis may have passed.

J. Scott Applewhite / AP Former Fed chairman Alan Greenspan

Growing inflationary pressures have led the U.S. central bank to recently shift to more aggressive anti-inflation rhetoric, and expectations are rising that policymakers will raise benchmark U.S. 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 U.S. 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 almost cult status for his insight into financial markets as head of the U.S. central bank, said weakness in financial markets probably peaked in March but that it was hard to say how long the crisis would 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 U.S. 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.

Credit Crisis

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

Mortgage lenders have since said the loans on their books are worth billions of dollars less than previously thought.

Greenspan said the financial market problems could continue until the stated value of those loans 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 U.S. economy) if the financial crisis is over," Greenspan said.

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