Federal Reserve Keeping an Eye on Asset Prices

The Federal Reserve is paying closer attention to the rising values of assets such as stocks, bonds and homes, as low interest rates encourage more risk-taking, Fed Chairman Alan Greenspan said.

Greenspan also said that bloated trade and budget deficits threaten the long-term health of the U.S. economy.

His warnings, made at a high-profile economic policy conference, came as the Fed chief and prominent economists pondered his 18 years at the central bank and the legacy he will leave. He is expected to step down in five months.

Rising house and stock prices have made many people feel more wealthy and have helped to support consumer spending, a key ingredient of the economy’s good health.

Greenspan, however, said people shouldn’t count on that paper wealth, which can evaporate if economic conditions deteriorate rapidly.

"What they perceive as newly abundant liquidity can readily disappear," he said. "Any onset of increased investor caution" could cause home and stock prices to drop, he noted.

"Enhanced flexibility provides the advantage of allowing the economy to adjust automatically, reducing the reliance on the actions of monetary and other policymakers, which have often come too late or been misguided," Greenspan said.

He said the flexibility of the US economy is the most important policy asset in handling any shocks from a fall in asset values.

The US Fed chairman also said that creeping trade protectionism and bloated budget deficits pose a risk to the long-term US economic vitality.

"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, which has fostered our extraordinary resilience to shocks," he said.

Greenspan made the speech to an annual Fed conference titled "The Greenspan Era: Lessons for the Future." Other Fed policy-makers, economists, academics and central bank officials from around the world attended the conference.