AP Federal Reserve Chairman Alan Greenspan warned that interest rates may have to go up to fend off inflation.

In his twice-a-year report on the economy before Congress, Greenspan Thursday declared the current good times "unprecedented in my half-century of observing the American economy." But he cautioned that inflation dangers still exist and put financial markets on notice to expect further interest rate increases.

Greenspan said conditions are remarkable with the 9-year-long expansion, a record, turning in exceptionally rapid growth that has driven unemployment to a 30-year low of 4 percent.

Ninety minutes before Greenspan spoke, the Labor Department reported that wholesale prices were unchanged in January and that when the volatile energy and food sectors are excluded, the Producer Price Index fell by 0.2 percent.

Wall Street viewed Greenspan's remarks to the House Banking Committee as confirmation that the Fed will continue to rachet up interest rates this year until the economy slows to a more sustainable pace.

Even though inflation has remained low outside of a burst in energy prices, Greenspan said, this favorable condition cannot last unless the growth rate slows to less than the 4 percent-plus gains of the past three years.

Greenspan tied his worries to the tight labor markets and fears that workers will begin to demand higher wages that could set off an inflationary spiral. Since last June, the central bank has been trying to slow the economy, raising a key interest rate it controls by a full percentage point.

'Mr. Greenspan is telling us to expect higher interest rates' — Sung Won Sohn

However, Greenspan said Thursday there is little evidence that those four quarter-point increases in the federal funds rate have had much impact.

"To date, interest-sensitive spending has remained robust and the FOMC (Federal Open Market Committee) will have to stay alert for signs that real interest rates have not yet risen enough to bring the growth of demand into line with that of potential supply," Greenspan said in testimony to the House Banking Committee. "Achieving that alignment seems more pressing today than it did earlier."

Analysts believe that the FOMC, the group of Fed board members in Washington and Fed regional bank presidents that sets interest rate policy, will boost rates for a fifth time March 21 and very likely will raise rates a sixth time in May.

"Mr. Greenspan is telling us to expect higher interest rates," said Sung Won Sohn, chief economist at Wells Fargo in Minneapolis. "He is warning that this economic prosperity will be jeopardized unless we contain the imbalances."

On Wall Street, the Dow Jones industrial average closed down 46.84 points at 10,514.57. The Nasdaq rose 121.22 points to 4,548.87, surpassing its record close of 4,485.63, set Feb. 10.

David Jones, chief economist at Aubrey G. Lanston & Co. said that while Greenspan "was hawkish in tone ... it doesn't imply anything more than we were expecting. That is why the markets have not reacted very much."

In response to questions, Greenspan told the committee that he was concerned about the recent rise in oil prices, which have pushed the per-barrel price above $30 for the first time since the Persian Gulf War in 1991.

Greenspan said oil inventories have fallen to exceptionally low levels, leaving the country vulnerable in coming months to a big price spike if supplies suddenly drop further.

But he also noted that because of conservation moves by businesses, the amount of energy needed in U.S. production has declined significantly in recent years.

In his testimony, Greenspan noted that tight labor markets have yet to increase wage pressures and in fact unit labor costs, a measure of wages tied to output, actually declined in the second half of 1999.

He tied this good news to a remarkable rebound in the growth of productivity, the amount of output per hour of work, which helps keep inflation low by allowing employers to pay for higher salaries through increased production rather than raising prices.

But even if the gains in productivity continue, he said, they could have a downside for the economy by pushing soaring stock prices even higher. The Wall Street boom has contributed to the surge in consumer demand as investors have spent their stock gains with abandon.

As part of his testimony, Greenspan presented the Fed's new economic forecast for 2000. In terms of growth, the Fed was slightly more optimistic than the administration or the Congressional Budget Office, predicting the gross domestic product will expand by around 3.5 percent this year. President Clinton based his current budget on a slower 2.9 percent prediction.

"Although the outlook is clouded by a number of uncertainties, the central tendencies of the projections ... imply continued good economic performance in the United States," Greenspan told the committee.

The Fed was also more optimistic that inflation will slow this year, predicting that an inflation gauge tied to the GDP will rise by around 1.75 percent to 2 percent, compared to an increase of 2 percent last year.

As he has in the past, Greenspan urged Congress to devote the huge federal budget surpluses being generated by the good economic times to paying down the national debt rather than using the money for increased federal spending or cutting taxes.

"Maintaining the surpluses and using them to repay debt over coming years will continue to be an important way the federal government can encourage productivity-enhancing investment and rising standards of living," Greenspan said. "We cannot afford to be lulled into letting down our guard on budgetary matters."

— The Associated Press and Reuters contributed to this report.