“Federal Reserve chairman Alan Greenspan said the threat of deflation is small, but the harm it could do is so serious that the central bank might have to lower interest rates to minimize the likelihood of it occurring,” writes Greg Ip in today’s Wall Street Journal.

“Appearing before the Joint Economic Committee of Congress, Mr. Greenspan declared that the war over inflation has been won. The threat of deflation, he said, ‘though minor, is sufficiently large that it does require very close scrutiny and maybe — maybe — action on the part of the central bank.’ “

“The Federal Reserve said two weeks ago that the risks of inflation going too low now outweigh the risks of it going up. Investors took that to mean the Fed is on guard against deflation, or generally declining prices. They also concluded that the Federal Reserve will keep short-term interest rates low until well into an economic recovery, since the Fed would rather see underlying inflation rise a bit from its current range of 1% to 1.5% than risk it falling further, and perhaps turning negative.”

“In his testimony Wednesday, Mr. Greenspan didn’t signal any urge to cut the Fed’s target for the federal-funds rate, charged on overnight loans between banks, from its current 1.25%. While recent economic data have been ‘on the weak side’ he said, ‘many more weeks of data will be needed’ to discern whether the expected postwar pickup is under way. Other Fed officials are more pessimistic than Mr. Greenspan, but have deferred to his desire to wait rather than cut rates. Mr. Greenspan did cite concerns that oil prices could head higher and natural-gas prices are already uncomfortably high. Second-quarter growth ‘is going to be quite soft,’ he acknowledged.”

“With the economy stalled, markets are expecting a quarter-percentage-point cut next month in the Fed’s target for the federal-funds rate, now at 1.25%; the rate is charged on overnight loans between banks. Some Fed officials have wanted to cut interest rates, but Mr. Greenspan has urged waiting to see if the economy rebounds now that war uncertainty is ebbing. Yesterday, Mr. Greenspan again counseled patience. ‘Many more weeks of data will be needed,’ to identify the economy’s trend, he said, adding that it is ‘unclear as to whether we’re at a fulcrum of a fairly significant economic recovery.’ “

“But he also conceded that growth in the current quarter ‘is going to be quite soft,’ and recent data have been ‘on the weak side.’ He fretted over high oil and natural-gas prices, and said there would be little downside risk to taking out ‘insurance’ against weak spending — and thus deflation — with another rate cut.”

“For years, Mr. Greenspan has refused to be pinned down on what inflation rate he considered ideal, simply saying that the Fed’s goal was price stability, a condition when inflation no longer significantly affected economic decision making. Wednesday, for the first time, he said that condition had been met: ‘Inflation is now sufficiently low that it no longer appears to be much of a factor in the economic calculations of households and businesses.’ “