[Senate Hearing 107-147]
[From the U.S. Government Publishing Office]
S. Hrg. 107-147
FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT FOR 2001
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SEVENTH CONGRESS
FIRST SESSION
ON
OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU-
ANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978
__________
JULY 24, 2001
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
______
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
PAUL S. SARBANES, Maryland, Chairman
CHRISTOPHER J. DODD, Connecticut PHIL GRAMM, Texas
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York WAYNE ALLARD, Colorado
EVAN BAYH, Indiana MICHAEL B. ENZI, Wyoming
ZELL MILLER, Georgia CHUCK HAGEL, Nebraska
THOMAS R. CARPER, Delaware RICK SANTORUM, Pennsylvania
DEBBIE STABENOW, Michigan JIM BUNNING, Kentucky
JON S. CORZINE, New Jersey MIKE CRAPO, Idaho
DANIEL K. AKAKA, Hawaii JOHN ENSIGN, Nevada
Steven B. Harris, Staff Director and Chief Counsel
Wayne A. Abernathy, Republican Staff Director
Martin J. Gruenberg, Senior Counsel
George E. Whittle, Editor
(ii)
C O N T E N T S
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TUESDAY, JULY 24, 2001
Page
Opening statement of Chairman Sarbanes........................... 1
Opening statements, comments, or prepared statements of:
Senator Gramm................................................ 3
Senator Dodd................................................. 5
Senator Bennett.............................................. 6
Senator Reed................................................. 6
Senator Allard............................................... 7
Senator Bayh................................................. 7
Senator Enzi................................................. 7
Senator Miller............................................... 7
Senator Bunning.............................................. 7
Senator Carper............................................... 8
Senator Stabenow............................................. 8
Senator Corzine.............................................. 9
Prepared statement....................................... 47
Senator Ensign............................................... 34
WITNESS
Alan Greenspan, Chairman, Board of Governors of the Federal
Reserve System, Washington, DC................................. 10
Prepared statement........................................... 47
Response to written questions of:
Senator Sarbanes......................................... 53
Senator Ensign........................................... 56
Senator Schumer.......................................... 57
Additional Material Supplied for the Record
Monetary Policy Report to the Congress, July 24, 2001............ 58
(iii)
FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT FOR 2001
----------
TUESDAY, JULY 24, 2001
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:05 a.m., in room SH-216 of the Hart
Senate Office Building, Senator Paul S. Sarbanes (Chairman of
the Committee) presiding.
OPENING STATEMENT OF SENATOR PAUL S. SARBANES
Chairman Sarbanes. The Committee will come to order. I am
very pleased this morning to welcome Chairman Greenspan before
the Committee on Banking, Housing and Urban Affairs, to testify
on the Federal Reserve's SemiAnnual Monetary Policy Report to
the Congress.
I do want to note for the Members that once we have a
quorum, I intend to interrupt our proceedings in order to lay
before the Committee the nomination of Harvey Pitt, to be a
Member of the Securities and Exchange Commission.
We held that hearing, as Members will recall, last
Thursday, and we want to move the nomination forward. As soon
as we have a full quorum, we will turn to that, presumably,
very briefly. I think it will go very quickly.
The oversight hearings traditionally held by the House and
Senate banking committees on the Federal Reserve's monetary
policy report were given a statutory basis in legislation last
year, which Senator Gramm and I and other Members of the
Committee developed, in consultation, I might note, with the
Federal Reserve.
These hearings have come to play, in my view, an important
role in informing the Congress, the financial community, and
the general public about the conduct of monetary policy by the
Fed. And I want to thank Senator Gramm for his very
constructive contribution in crafting last year's legislation,
and I am pleased the Committee is holding this hearing pursuant
to the authorities that were provided in that legislation.
We now confront a troubling outlook for the U.S. economy.
While excess inventories have been reduced, we still seem to
face continuing downward pressures, both from weakening
domestic investment activity and weakening export markets.
In the last year, U.S. economic growth has been sluggish,
too slow to keep the unemployment rate from rising. On Friday
of this week, the Commerce Department will release the report
on economic growth in the second quarter and it is expected to
show the fourth consecutive quarter of slow growth.
Private-sector job count has fallen by 350,000 in the last
3 months. Initial claims for unemployment insurance stand at
the highest level since the last period of rising unemployment
during and after the last recession.
The Fed's index of manufacturing output has dropped 5
percent, 5.0 percent, in the last 9 months, which is almost the
5.3 percent drop that was experienced in the last recession.
The unemployment rate has already risen by 6 tenths of a
percentage point to 4\1/2\ percent. It would have risen to 5\1/
2\ percent, had there not been such a large exodus from the
labor market over the last year.
On the positive side, inflation at both the consumer and
producer levels appears to be under control. Core inflation of
personal consumption expenditures, which is a different measure
than the CPI, was only 1.7 percent in the last year. The core
producer price index is up only 1.6 percent. In both cases,
these levels are little different from the average rate of core
inflation for the entire expansion.
Wage pressures also appear to be contained.
Consumer spending, which has been the principal source of
growth, has held up, despite the weakness of the economy and
the decline in the stock market. But whether that will be
sustained
remains to be seen.
It is also hoped that the business inventories that have
been shrinking all year will soon get down to the desired level
and begin to add growth to the economy rather than subtract
from it.
To its credit, the Federal Reserve has lowered interest
rates repeatedly over the past 6 months. I would point out,
however, that the real Federal funds rate--in other words, when
measured relative to the core rate of inflation--is still
above, well above the
levels to which the Federal Reserve lowered the real Federal
funds rates in the last economic downturn and the ensuing
recovery.
And that is a matter that I hope to pursue with the
Chairman in the question period.
There are obviously a great many questions about the
outlook for the United States and the world economy which the
Committee will want to raise with Chairman Greenspan this
morning and I, like my colleagues, look forward to hearing his
statement and his responses to our questions.
Senator Gramm.
Senator Gramm. Mr. Chairman, I understand a quorum is now
present. Do you want to go ahead and do the vote before I
speak?
Chairman Sarbanes. Yes, why don't we go ahead and do that.
A quorum is now present. I ask unanimous consent that we
consider the nomination of Harvey L. Pitt to be a Member of the
Securities and Exchange Commission, for the remainder of the
term of Paul Carey, a term which expires June 5, 2002, and for
a subsequent term expiring June 5, 2007.
The Clerk will call the roll.
The Clerk. Chairman Sarbanes.
Chairman Sarbanes. Aye.
The Clerk. Mr. Dodd.
Senator Dodd. Aye.
The Clerk. Mr. Johnson.
Senator Sarbanes. Aye, by proxy.
The Clerk. Mr. Reed.
Senator Reed. Aye.
The Clerk. Mr. Schumer.
Senator Schumer. Aye.
The Clerk. Mr. Bayh.
Senator Bayh. Aye.
The Clerk. Mr. Miller.
Senator Miller. Aye.
The Clerk. Mr. Carper.
Senator Carper. Aye.
The Clerk. Ms. Stabenow.
Senator Stabenow. Aye.
The Clerk. Mr. Corzine.
Senator Corzine. Aye.
The Clerk. Mr. Akaka.
Senator Sarbanes. Aye, by proxy.
The Clerk. Mr. Gramm.
Senator Gramm. Aye.
The Clerk. Mr. Shelby.
Senator Gramm. Aye, by proxy.
The Clerk. Mr. Bennett.
Senator Bennett. Aye.
The Clerk. Mr. Allard.
Senator Allard. Aye.
The Clerk. Mr. Enzi.
Senator Enzi. Aye.
The Clerk. Mr. Hagel.
Senator Gramm. Aye, by proxy.
The Clerk. Mr. Santorum.
Senator Gramm. Aye, by proxy.
The Clerk. Mr. Bunning.
Senator Bunning. Aye.
The Clerk. Mr. Crapo.
Senator Gramm. Aye, by proxy.
The Clerk. Mr. Ensign.
Senator Gramm. Aye, by proxy.
The Clerk. The ayes are 21, the noes are zero, Mr.
Chairman.
Chairman Sarbanes. Very good. The Committee will report the
nomination of Harvey Pitt to the Senate. We will leave the
record open so that those Members who are not present and had
not left a proxy have an opportunity to vote.
Senator Gramm.
OPENING STATEMENT OF SENATOR PHIL GRAMM
Senator Gramm. Well, Mr. Chairman, first I want to thank
you for the prompt attention you have given to the President's
nominees. I think it is very important that we confirm people
for these financial positions, especially positions like
Chairman of the SEC.
Your leadership has been very constructive toward achieving
that goal, and I want to thank you again for this quick action.
Chairman Greenspan, I want to welcome you back before the
Committee.
I think it is clear, in looking at our economic
circumstances, that we are in a slowdown, and at this point,
everyone is trying to determine exactly what is happening in
the economy.
It is obvious to me this is not a traditional post-World
War II slowdown or recession. It is further obvious to me that
when, several years back, you were talking about irrational
exuberance, you were right.
I have tried, in the limited amount of time that I have had
to think about this problem, to look at what was happening in
terms of the economy, the acceleration of economic growth, and
the reaction of the capital market.
Perhaps now we can say with more certainty than we could
then, that there was an over-reaction.
Clearly, just as the explosion in equity values had a
positive impact on investment, as people sought to get in front
of this technological explosion, the readjustment, the
restructuring, the bursting of this speculative bubble has had
the opposite effect in terms of investment.
I wonder if we are not in some new situation that is very
parallel to old business cycles.
If I had time, I would go back and read some of the stuff
that we read as graduate students on business cycles that were
primarily produced by over-reactions to spurts in technological
growth and the speculative bubbles that result from it.
It is also clear now that we made the right decision in
passing the tax cut. If we had known then what we know now, we
might have been more expansive.
Obviously, now we are caught up in some political
gamesmanship of debating whether we should have done the tax
cuts and were they too big or too small?
I think there is, to some extent, a potential debate as to
whether the economy, if this slowdown continues, can carry the
big surplus that we are running.
I hope it can. I like paying off debt. I would like to
begin to take the Social Security surplus and see it invested.
But I think that is a decision we are going to have to make
as we get further along.
I know everyone is interested in hearing you, Mr. Chairman.
I am grateful, at this moment, when there is some uncertainty,
that we have someone as knowledgeable and thoughtful as you.
I conclude, Mr. Chairman, by saying that, despite the
decline in equity values, I still cannot imagine a safer
investment than the long-term future of the American economy,
unless it is investing in Texas.
[Laughter.]
As I tell people, when they come visit my State, if a long-
term investment in Texas is not a good investment, there is not
a good investment on the planet. And, to a very slightly lesser
extent, you can say that about the American economy.
So uncertainties are out there. But when you look at the
long-term future, an investment in America and an investment in
American equity is still the best long-term investment you can
make. And in the end, if that is not a good investment, then
there is no good investment.
And so, Mr. Chairman, thank you for your great work. This
Committee is certainly proud of its friendship and association
with you.
Chairman Sarbanes. I think I should note for the record
that we think Maryland is equally a good investment.
[Laughter.]
And I am sure that each Member of the Committee feels the
same way about his own State, and we will register that for the
record so that each Member doesn't have to do it.
[Laughter.]
Senator Gramm. Whether that is irrational exuberance or
not, I don't know.
[Laughter.]
Chairman Sarbanes. Senator Dodd.
OPENING STATEMENT OF SENATOR CHRISTOPHER J. DODD
Senator Dodd. Texas has never been accused of irrational
exuberance.
[Laughter.]
Thank you, Mr. Chairman, for allowing that unanimous
consent request to be made so that we can all be part of the
record.
Let me welcome you as well, Mr. Chairman. It is a pleasure
to have you back before the Committee. We have had you here in
better times, obviously, as the economic indicators show. But
as Senator Gramm has just said, I cannot think of anyone better
I would rather have at the helm than you at a time like this,
and as we try to sort all of this out.
Many of us here, of course, unlike my good friend from
Texas, have a different point of view with regard to the tax
cut. I know you share a similar view with that of Senator
Gramm. But there are many of us who are worried about the size
of that tax cut--not a tax cut, per se--and whether or not it
is going to crowd out our ability to do other things which also
contribute to economic growth.
I offered an amendment to the tax bill that would have
reduced that tax cut but it would have made a smaller tax cut,
and invest dollars in the infrastructure of the country.
I realize at the time, procedurally, that is hard to do in
a tax bill, to target dollars specifically to one area of the
budget.
But the point I wanted to make was that I don't know of any
period in the history of our Nation where we have ever had
sustained economic growth where the physical infrastructure of
America was deteriorating. And certainly, no one had to go any
further than to read the accounts of what happened to my good
friend and the Chairman's beloved City of Baltimore in the last
week or so, the tragedy in that city.
That is a problem that could have occurred in almost any
city in this country. So I will come back to the questions on
this, but I was concerned about whether or not we are going to
be able to have the room within our budget to do this.
I am anxious to still pursue that with you a bit, the
strength of the dollar, the weakness of growth in foreign
markets, making it more difficult for us to export goods and to
what extent you see that continuing on the horizon as a serious
problem for us.
I will get to those in due time. But, again, I do want to
thank you immensely. You have been a great pilot over the last
decade or more on these matters and I am confident that you
will give us some good advice as well, as we try and get this
righted again so that our economy can enjoy the kind of
prosperity we did during the 1990's.
And I look forward to your testimony. Thank you.
Chairman Sarbanes. Senator Bennett.
OPENING STATMENT OF SENATOR ROBERT F. BENNETT
Senator Bennett. Thank you, Mr. Chairman.
Chairman Greenspan, welcome again with all of my
colleagues. I look forward to the questioning period. I simply
want to take the opening statement as an opportunity to thank
you for your doggedness in seeing to it that the rate
reductions have been as large as they have been.
A reading of the minutes indicates that there are some of
your colleagues in the Federal Reserve System who would have
gladly opted for 25 basis points when 50 was clearly what was
needed. And if it had not been for your leadership, 25 is
probably what we would have gotten.
In several of those circumstances, I think the rate would
be
higher than the 3.75 that it is now, maybe as high as 4.75. And
I think that would make things substantially worse if we had
had that result. So, as I read the tea leaves, it has been your
personal persistence and spine that has gotten it down to 3.75.
I would be happy if it were 3.0.
I will leave that to you because your past performance has
been stellar in that area and I think it needs to be pointed
out the Federal Reserve System is not unanimous. There are
disagreements within it. And it has been a time when somebody
has had to step up. And you have done it and I want you to know
that it does not go unnoticed or unappreciated.
With that, Mr. Chairman, I will pass and look forward to
the testimony from our witness.
Chairman Sarbanes. Thank you very much, Senator Bennett.
Senator Reed.
OPENING STATEMENT OF SENATOR JACK REED
Senator Reed. Thank you very much, Mr. Chairman, and
welcome, Chairman Greenspan.
As my colleagues have said, in these challenging times, we
are all grateful that your experience is there, working as
Chairman of the Federal Reserve Board.
We have some interesting developments, troubling in some
respects. There is a rise in consumer debt. It seems to be
rising inexorably. A decline in national and personal savings
that we have to deal with. A gap in our current account deficit
that is persistent. And then worldwide, economies seem to be
softening and not responding to individual national stimulus
attempts.
Nevertheless, with your stewardship, and your colleagues',
inflation remains in check and unemployment remains relatively
low, although it is beginning to edge up. Consumers continue to
spend and sustain the economy.
In many respects, we are at a crossroads. This morning, we
hope that you can give us some clarification of the best route
to proceed forward at this critical juncture.
I thank you for your service and look forward to your
testimony. Thank you.
Chairman Sarbanes. Senator Allard.
OPENING STATEMENT OF SENATOR WAYNE ALLARD
Senator Allard. Thank you, Mr. Chairman. I want to thank
you for holding this hearing. And I would like to join my
colleagues in welcoming the Chairman. I am anxious to hear what
he has to say today and look forward to hearing what he has to
say, particularly about monetary policy and other economic
issues.
As we are all aware, as was mentioned by some of my
previous colleagues here, America is facing increasing economic
uncertainty. And therefore, I think it is critical that
Congress address the issues of long-term solvency for Social
Security and Medicare and put the government on a plan to
continue to pay down the national debt and also continue to cut
taxes.
Thank you, Mr. Chairman.
Chairman Sarbanes. Senator Bayh.
OPENING STATEMENT OF SENATOR EVAN BAYH
Senator Bayh. Mr. Chairman, thank you for attending today.
I am looking forward to hearing your comments and will give my
own in response to your testimony.
Chairman Sarbanes. Senator Enzi.
OPENING STATMENT OF SENATOR MICHAEL B. ENZI
Senator Enzi. Thank you, Mr. Chairman. I welcome Chairman
Greenspan and look forward to hearing his testimony.
Chairman Sarbanes. It will be included in the record.
Senator Miller.
OPENING STATEMENT OF SENATOR ZELL MILLER
Senator Miller. It is good to have you with us Chairman
Greenspan I have no remarks at this time.
Chairman Sarbanes. Senator Bunning.
OPENING STATMENT OF SENATOR JIM BUNNING
Senator Bunning. Mr. Chairman, I would like to thank you
for holding this hearing and I would like to thank the Chairman
of the Federal Reserve for testifying.
Last year at this time, we were concerned that the Fed was
thinking about raising rates. The Fed very wisely did not.
Things were going pretty well last July. I know that you were
very concerned about the bubble in the equity markets,
especially in the Nasdaq. But the economy was still growing at
a very strong pace.
Well, obviously, much has changed in the last year. The
growth rate of the economy has slowed tremendously, almost
stopped. Unemployment is up and trillions of dollars have
evaporated from the economy because of the losses in the equity
markets.
As you know, I have been very critical of the Fed's
reluctance to act last fall. I believe the Fed waited too long.
I don't think we would be having the problems we are now having
if the Fed had acted sooner.
I know the Fed has a different opinion on that and I am
sure we will continue to disagree. The Fed has acted. It did
not act as quickly as I thought necessary and I think that the
last Fed Fund rate cut should have been cut substantially, 50
basis points rather than 25.
We must get our country back on track. The Fed has cut
rates and hopefully, the President's fiscal policy, along with
the Fed's monetary policy moves, will fix the economy that is
ailing very badly.
Mr. Chairman, I once again thank you for coming before our
Committee and I look forward to the opportunity to talk with
you during the question and answer period.
Thank you, Mr. Chairman.
Chairman Sarbanes. Thank you, Senator Bunning.
Senator Carper.
OPENING STATEMENT OF SENATOR THOMAS R. CARPER
Senator Carper. Mr. Chairman, welcome. Far be it for me to
carp about your performance and that of the Federal Reserve.
I think you are right on target with respect to your
management of our monetary policy. And I am not going to Monday
morning quarterback what you do.
Thank you for being aggressive. Thank you for continuing to
apply your stewardship to the economic needs and direction of
our country and I look forward to your comments.
Welcome.
Chairman Sarbanes. Senator Stabenow.
OPENING STATEMENT OF SENATOR DEBBIE STABENOW
Senator Stabenow. Thank you, Mr. Chairman. And Chairman
Greenspan as well. I welcome you today.
This is a time of nervousness and uncertainty and we
welcome your thoughts. I know there will be a lot of debate and
discussion this morning about the issue of tax cuts and fiscal
policy.
Let me just indicate that as we are now seeing checks in
the mail, as they say, most of us on our side of the aisle wish
those in the short term had been larger. We actually had
proposed something in the range of $1,000, as opposed to $300,
but with more caution in the long run, rather than locking in
10 years of decisions at some point, doing something more
substantial to help American families and move the economy now,
but with more caution in the long run.
As to that caution, I hope that you will this morning speak
as you did in January, when you told the Senate Budget
Committee, of which I am a Member, that Congress should
consider some type of trigger along with our tax and spending
decisions to make sure that we don't return to deficits
sometime in the next 10 years, which I am gravely concerned
about.
A prominent Member of this Committee, Senator Bayh, and
Senator Snowe and myself took your suggestion to heart and made
a proposal before the Senate. We achieved 49 votes, not enough
to pass it, but certainly a substantial vote for the kind of
trigger that would indicate that if tax cuts or spending put us
back into deficits and dipped into Social Security and
Medicare, that they would be suspended until there were
revenues available to proceed with the tax cut.
So I would certainly hope that you would respect and speak
about that, given the recent sluggishness in the economy and
weak economic projections.
Many of us are gravely concerned about what is going to
happen long term as it relates to our debt and, unfortunately,
gravely concerned about putting us farther into debt in the
long run and what happens to us starting in 2011 with the baby
boomers, many of us in this room, who are beginning to retire
at that point and the strains on Social Security and Medicare.
So we welcome you again and look forward to your comments
and testimony. And I am hopeful that, as you did at the
beginning of the year, give us wise counsel about how we can
proceed in a way that does not dip into Social Security and
Medicare or put us back into large deficits, which many of us
worked very, very hard to eliminate.
Thank you, Mr. Chairman.
Chairman Sarbanes. Senator Corzine.
OPENING STATEMENT OF SENATOR JON S. CORZINE
Senator Corzine. Welcome, Mr. Chairman.
I am grateful for your insights and respected judgment. I
think it is particularly important in a period of acute
uncertainty that I think we now face, to have the kind of
balance that you bring to the judgments in monetary policy and
fiscal recommendations.
I hope that we will be able to draw out some of your
perspectives on an issue that is very much in the public debate
that we are now only beginning to talk and that is the
restructuring of Social Security, having many of the same kinds
of implications that we faced as we put in place what I think
is a poorly framed 10-year fiscal policy which leaves us very
few options.
And so, I hope that we can wean some of those insights that
you might bring to that process into the discussion today.
I look forward to hearing your comments.
Chairman Sarbanes. Thank you very much.
I just want to note for the benefit of Members and actually
to the people attending, with respect to the Harvey Pitt
nomination, we confirm him to become a member of the Securities
and Exchange Commission.
The President has the authority under the statute to choose
a chairman from amongst those composing the commission. And
President Bush has indicated his intention to name Harvey Pitt
as the Chairman. But the Congress does not actually deal with--
unlike the Federal Reserve Board, where actually, we deal with
the chairmanship of the Federal Reserve Board and it comes to
us for confirmation.
And that is why the approval we gave was for membership on
the SEC and not as chairman of the SEC.
Chairman Greenspan, we are happy to turn to you and we look
forward to hearing from you.
STATEMENT OF ALAN GREENSPAN, CHAIRMAN, FEDERAL RESERVE SYSTEM
Chairman Greenspan. Thank you, Mr. Chairman, and Members of
the Committee. I appreciate the opportunity this morning to
present the Federal Reserve's semi-annual report on monetary
policy.
I have excerpted my remarks from a rather long written text
and would appreciate the full text be included for the record.
Chairman Sarbanes. The full text will be included in the
record.
Chairman Greenspan. Monetary policy this year has
confronted an economy that slowed sharply late last year and
has remained weak this year following an extraordinary period
of buoyant expansion.
By aggressively easing the stance of monetary policy, the
Federal Reserve has moved to support demand and, we trust, help
lay the groundwork for the economy to achieve maximum
sustainable growth. Our accelerated action reflected the
pronounced downshift in economic activity, which was
accentuated by the especially prompt and synchronous adjustment
of production by businesses utilizing the faster flow of
information coming from the adoption of new technologies.
A rapid and sizable easing was made possible by reasonably
well-anchored inflation expectations, which helped to keep
underlying inflation at a modest rate, and by the prospect that
inflation would remain contained as resource utilization eased
and energy prices backed down.
In addition to the more accommodative stance of monetary
policy, demand should be assisted going forward by the effects
of the tax cut, by falling energy costs, by the spur to
production once businesses work down their inventories to more
comfortable levels and, most important, by the inducement to
resume increases in capital spending. That inducement should be
provided by the continuation of cost-saving opportunities
associated with rapid technological innovation. Such innovation
has been the driving force raising the growth of structural
productivity over the last half dozen years. To be sure,
measured productivity has softened in recent quarters,
but by no more than one would anticipate from cyclical
influences
layered on top of a faster long-term trend.
But the uncertainties surrounding the current economic
situation are considerable, and until we see more concrete
evidence that the adjustments of inventories and capital
spending are well along, the risks would seem to remain mostly
tilted toward weakness in the economy. Still, the Federal Open
Market Committee opted for a smaller policy move at our last
meeting because we recognize that the effects of policy actions
are felt with a lag, and with our cumulative 2\3/4\ percentage
points of easing this year, we have moved a considerable
distance in the direction of monetary stimulus. Certainly,
should conditions warrant, we may need to ease further. But we
must not lose sight of the prerequisite of longer-run price
stability for realizing the economy's full growth potential
over time.
Despite the recent economic slowdown, the past decade has
been extraordinary for the American economy. The synergies of
key technologies markedly elevated prospective rates of return
on high-tech investments, led to a surge in business capital
spending, and significantly increased the growth rate of
structural productivity. The capitalization of those higher
expected returns lifted equity prices, which in turn
contributed to a substantial pickup in household spending on a
broad range of goods and services, especially on new homes and
durable goods. This increase in spending by both households and
businesses exceeded even the enhanced rise in real household
incomes and business earnings. The evident attrac-tiveness of
investment opportunities in the United States induced
substantial inflows of funds from abroad, raising the dollar's
exchange rate while financing a growing proportion of domestic
spending.
By early 2000, the surge in household and business
purchases had increased growth of the stocks of many types of
consumer durable goods and business capital equipment to rates
that could not be sustained. Overall, capacity in high-tech
manufacturing industries, for example, rose nearly 50 percent
last year, well in excess of its already rapid rate of increase
over the previous 3 years. Hence, a temporary glut in these
industries and falling short-term prospective rates of return
were inevitable at some point. Moreover, as I testified before
this Committee last year, the economy as a whole was growing at
an unsustainable pace, drawing further on an already diminished
pool of available workers and relying increasingly on savings
from abroad. Clearly, some moderation in the pace of spending
was necessary and expected if the economy was to progress along
a more balanced growth path.
In the event, the adjustment occurred much faster than most
businesses anticipated, with the slowdown likely intensified by
the rise in the cost of energy that until quite recently had
drained businesses and households of purchasing power.
Moreover, weakness emerged among our trading partners in
Europe, Asia and Latin America. The interaction of slowdowns
in a number of countries simultaneously has magnified the
softening each of the individual economies would have
experienced
on its own.
Some backup in inventories occurred, especially in the
United States. Innovations, such as more advanced supply-chain
management and flexible manufacturing technologies have enabled
firms to adjust production levels more rapidly to changes in
sales. But these improvements apparently have not solved the
thornier problem of correctly anticipating demand. Although
inventory-sales
ratios in most industries rose only moderately, extrapolation
of the downtrend in inventory-sales ratios over the past decade
suggests that considerable imbalances emerged late last year.
As a result, a round of inventory rebalancing was
undertaken and the slowdown in the economy that began in the
middle of 2000 intensified. The adjustment process started late
last year when manufacturers began to cut production to stem
the accumulation of unwanted inventories. But inventories did
not actually begin falling until early this year as producers
decreased output levels considerably further.
At some point, inventory liquidation will come to an end
and its termination will spur production and incomes. Of
course, the timing and force with which that process of
recovery plays out will depend on the behavior of final demand.
In that regard, demand for capital equipment, particularly in
the near-term, could pose a continuing problem. Despite
evidence that expected long-term rates of return on the newer
technologies remain high, growth of investment in equipment and
software has turned decidedly negative. Sharp increases in
uncertainties about the short-term outlook have significantly
foreshortened the timeframe over which business are requiring
new capital projects to pay off.
In addition, a deterioration in sales, profitability, and
cashflow has exacerbated the weakness in capital spending.
Pressures on profit margins have been unrelenting.
Much of the squeeze on profit margins of domestic
operations results from a rise in unit labor costs, which has
reflected a faster upward movement in hourly compensation,
coupled with the cyclical slowdown in the growth of output per
hour. In part, fixed costs, nonlabor as well as labor, are
being spread over a smaller production base for many
industries.
The surge in energy costs has also pressed down on profit
margins, especially in the fourth and first quarters. The
decline in energy prices since the spring, however, should be
contributing positively to margins in the third quarter.
Moreover, the rate of increase in compensation is likely to
moderate, with inflation expectations contained and labor
markets becoming less taut in response to the slower pace of
growth in economic activity. In addition, continued rapid gains
in structural productivity should help to suppress the rise in
unit labor costs over time.
Of course, investment spending ultimately depends on the
strength of consumer demand for goods and services. Here, too,
longer-run increases in real incomes of consumers, engendered
by the rapid advances in structural productivity, should
provide support to demand over time. And thus far this year,
consumer spending has indeed risen further, presumably assisted
in part by the continued rapid growth in the market value of
homes, from which a significant amount of equity is being
extracted. Moreover, household disposable income is now being
bolstered by tax cuts.
But there are also downside risks to consumer spending over
the next few quarters. We can expect the decline in stock
market wealth that has occurred over the past year to restrain
growth of household spending relative to income, just as the
previous increase gave an extra spur to household demand.
Furthermore, while most survey measures suggest consumer
sentiment has stabilized recently, softer job markets can
induce a further deterioration in confidence and spending
intentions.
While this litany of risks should not be downplayed, it is
notable how well the U.S. economy has withstood the many
negative forces weighing on it. Economic activity has held up
remarkably in the face of a difficult adjustment toward a more
sustainable pattern of expansion.
The economic developments of the last couple of years have
been a particular challenge for monetary policy. Once the
financial crises of late 1998 that followed the Russian default
eased, growing optimism, if not euphoria, about profit
opportunities produced a surge in investment that outstripped
what the Nation could finance on a sustainable basis from
domestic saving and funds attracted from abroad.
The shortfall showed through in a significant rise in
average real long-term corporate interest rates starting in
early 1999. By June of that year, it was evident to the Federal
Open Market Committee that to continue to hold the funds rate
at the then-prevailing level of 4\3/4\ percent in the face of
rising real long-term corporate rates would have required a
major infusion of liquidity into an economy already threatening
to overheat, and the Federal Open Market Committee began to
raise its Federal funds rate target.
By summer of last year, it started to become apparent that
the growth of demand finally was slowing, and seemingly by
enough to bring it into approximate alignment with the
expansion of potential supply, as indicated by the fact that
the pool of available labor was no longer being drawn down. It
was well into autumn, however, before one could be confident
that the growth of aggregate demand had softened enough to
bring it into a more lasting balance with potential supply.
Growth continued to decline to a point that, by our
December meeting, the Federal Open Market Committee decided
that the time to counter cumulative economic weakness was close
at hand. We altered our assessment of the risks to the economy,
and with incoming information following the meeting continuing
to be downbeat, we took our first easing action on January 3.
We viewed the faster downshift in economic activity, in part a
consequence of the technology-enhanced speed and volume of
information flows, as calling for a quicker pace of policy
adjustment. Acting on that view, we have lowered the Federal
funds rate 2\3/4\ percentage points since the turn of the year,
with last month's action leaving the Federal funds rate at 3\3/
4\ percent.
In reducing the Federal funds rate so substantially this
year, we have been responding to our judgment that a good part
of the recent weakening of demand was likely to persist for a
while and that there were significant downside risks, even to a
reduced central tendency forecast. Moreover, with inflation low
and likely to be contained, the main threat to satisfactory
economic performance appeared to come from excessive weakness
in activity.
As a consequence of the policy actions of the Federal Open
Market Committee, some of the stringent financial conditions
evident late last year have been eased. Real interest rates are
down on a wide variety of borrowing instruments. Private rates
have benefited from some narrowing of risk premiums in many
markets. And the growth of liquidity, as measured by M2, has
picked up. More recently, incoming data on economic activity
have turned from persistently negative to more mixed.
The period of sub-par economic performance, however, is not
yet over, and we are not free of the risk that economic
weakness will be greater than currently anticipated and require
further policy response. That weakness could arise from softer
demand from abroad, as well as from domestic developments. But
we need also to be aware that our front-loaded policy actions
this year coupled with the tax cuts underway should be
increasingly affecting economic activity as the year
progresses, and for 2002, the Federal Reserve Governors and
Reserve Bank Presidents see significant growth and contained
inflation.
As for the years beyond that horizon, there is still, in my
judgment, ample evidence that we are experiencing only a pause
in the investment in a broad set of innovations that has
elevated the underlying growth in productivity to a rate
significantly above that of the two decades preceding 1995. By
all evidence, we are not yet dealing with maturing technologies
that, after having sparkled for a half-decade, are now in the
process of fizzling out. To the contrary, once the forces that
are currently containing investment initiatives dissipate, new
applications of innovative technologies should again strengthen
demand for capital equipment and restore solid economic growth
over time that benefits us all.
Thank you, Mr. Chairman. I look forward to your questions.
Chairman Sarbanes. Yes, thank you, Mr. Chairman.
I am concerned by this--I hope it is not a growing
sentiment that, in a sense, nothing can be done. But it is
reflected in an article this morning in The New York Times
which says--first,
the lead paragraph: Despite six interest rate cuts by the
Federal
Reserve this year and the possibility of more to come, analysts
say that monetary policy is packing less of a punch so far
than expected.
And one of the investment houses not too long ago stated
that a number of factors have, ``blunted the power of monetary
policy compared to past easing campaigns.''
And there seems to be a perception that the easing campaign
that the Fed has followed over the last 7 months has sort of
come close to running out the string.
The question I wanted to put to you is to take a look at
the real Federal funds rate, which is of course the market rate
less core inflation.
Here's where the Fed has us now, on the real funds rate.
This is where the Fed went to in the early 1990's, when we had
that very significant economic downturn.
The conclusion I draw from this, and I want to ask you
about this, is that there is still substantial room for the Fed
to ease in an effort to try to stimulate the economy. And in
any event, regardless of any judgment made on what the Fed has
done so far, you have done it very rapidly. I recognize that,
month after month. But what the Fed has done so far doesn't
match the actions the Fed has taken on previous occasions,
actually, under your leadership.
Your leadership has been there for a long time now, under
your leadership. And therefore, there is still room for the Fed
to take substantial measures in terms of trying to move the
economy with respect to interest rate cuts.
Would you address that?
Chairman Greenspan. Certainly, Mr. Chairman.
First, let me just say that, clearly, where monetary policy
goes from here will depend crucially on the evolving situation
in the economy.
With respect to the notion of the ineffectiveness of Fed
policy, I think it is important to understand that when you
evaluate monetary policy, which we tend to do by disaggregating
its impact in short-term rates, long-term rates, the exchange
rate, and a few other different variables, we never quite, even
after we add up all of our evaluations of those so-called
channels of monetary policy effect, replicate the broader
correlations that exist between monetary policy and economic
growth, in effect implying that we don't fully capture all of
the various different channels which impact on the economy
because of movement in short-term Federal funds rates.
The article to which you refer--which is an interesting
and, I think, thoughtful article--lines up these individual
items. And if indeed that was all that was involved in the
process, then I would say that we would be concerned about what
the impact of monetary policy is.
But if you look back historically, that does not explain
the full impact. I am not saying that there is a black box or
anything of that nature. But the complexity of our economy is
such, and the way liquidity flows through the system is such,
that you essentially get very complex differences in the way
monetary policy plays out.
But at the end of the day, it does seem to be effective.
Chairman Sarbanes. Well, I just want to note that there is,
it seems to me, room to continue to move with respect to the
real Federal funds rate. We hope the Open Market Committee will
consider that.
Let me ask you one more question because my time is about
to expire.
You say in your statement, you ask this question: Do we
have the capability to eliminate booms and busts in economic
activity?
And then you say: Can fiscal and monetary policy, acting at
their optimum, eliminate the business cycle?
And then you say: The answer is no because there is no tool
to change human nature, and you develop that.
Now, is the no answer to eliminating booms and busts, or is
the no answer to eliminating the business cycle? Because we
could not, presumably, have a business cycle movement without
having the extremes of it--in other words, having booms and
busts.
I am prepared to sort of entertain reasonably the one
possibility, but I am very much against entertaining the other
possibility.
Did you mean to say no to both or to the notion of, well,
we sort of have a business cycle that we have to deal with. But
don't we
have the tools to prevent these extremes and have the booms and
the busts?
Chairman Greenspan. I think it is a question of
nomenclature.
The point that I was endeavoring to make, for which I think
there is ample evidence, is that we have had business cycles
before there was a central bank or, more exactly, during the
whole period when there was no central bank in this country.
And so the business cycle is such, clearly, from what
historical analysis suggests with some degree of forcefulness,
that there tends to be a general attitude amongst those who are
committed to the economy, that as things stabilize over an
increasingly protracted period of time, euphoria tends to build
in, and it is very difficult to contain by policy.
The point I was trying to make, not that fiscal and
monetary policy are ineffectual. I am saying that to presume
under all conditions that monetary and fiscal policy can create
a stable, sustained, not fluctuating economy, seems to be alien
to historical data.
Chairman Sarbanes. Senator Gramm.
Senator Gramm. Well, thank you, Mr. Chairman.
I would just say, in adding to what you just said, that the
greatest bust in American history occurred when we did have a
central bank, in the Great Depression. And I think that as
economists have looked at that period, the conclusion is that
they were doing the wrong thing.
First of all, let me say that I don't have a firm fix on
exactly what is happening in the American economy. I guess if
somebody forced me to go into an economics classroom somewhere
and give a lecture today, trying to explain it, I would start
by talking about the end of the cold war and the release of
resources from defense to other economically productive
activities.
I would talk about the failure of the Soviet Union,
discrediting not just communism, but socialism, around the
world, and the profound changes that have occurred in places
like South America, with the rise of more virulent capitalism
and democracy.
I would talk about the unleashing of human energy that came
from winning the cold war and, in the process, bringing
enhanced freedom to everybody, but freedom for the first time
to literally hundreds of millions of people.
And I would try to look at that in terms of what all of
this unleashed in terms of new energy, new technology, new
investment, the evolution of new products, and the evolution of
a new marketing system using electronic communications.
And I would guess that probably with that background, it is
easy to understand how the capital market would have had
difficulty in assimilating all this information and coming to a
correct decision.
It is probably inevitable that in the process, there are
periods where investment would overrun the reality, where you
would have an effort to assess what all these changes mean to
equity values, and there have to be periods where the
overassessment occurred.
Going back to the boom and the bust, since we have lived in
a golden age since roughly 1982, if this is the bust, the boom
was sure as hell worth it.
You agree with that, right?
Chairman Greenspan. Yes, Senator.
Senator Gramm. Now if the bust turned out to be a lot
worse, then we might want to reevaluate. But as of today, this
has been a miraculous economic period.
It seems to me that we don't know how much adjustment has
to occur. But the same technology and basic environment is out
there. And again, I return to the notion of an economic bubble
that has burst with equity adjustments going through the
retrenchment.
Clearly, at some point, this process has to begin again.
The question is, how long is that--and back to the Chairman's
question--what can we do in terms of policy that would speed it
up without doing so much that we contribute to a problem in the
future, given this lag of some 18 months, between changes in
monetary policy and the full effect on the economy.
I would like to give you a chance to respond.
Chairman Greenspan. Senator, I think the underlying
structure of technological advance is in place, as I indicated
in my remarks. By all of the measures, by all of the
evaluations that we make, we are only partway through a major
technological expansion which has elevated the underlying
growth of structural productivity, meaning the trend growth in
productivity over periods of years.
In the context of that, the long-term expected rate of
return has risen, as has the long-term expected rate of growth
of earnings. That automatically induces a reevaluation of what
the equity values in the economy are.
Whenever you get into that sort of process, there is always
the danger--and it seems to happen more often than not--that if
there are real underlying forces to raise equity values because
of the structural productivity advances which have occurred,
there
is a tendency to overdo it. In other words, as I said
previously, in
many of the technological areas, as I think I put it in my
prepared
remarks, we have seen demand doubling for certain newer
technologies every year, but the supply goes up three or four
times a year. And so what happens is that you get a glut, a
huge retrenchment, but it doesn't undercut the fact that that
demand was essentially there. And it may indeed even slow down
because of the supply shock effect. But it doesn't change the
longer-term structural possibilities for higher earnings,
higher rates of return, and higher productivity.
And in that regard, as I have indicated in my prepared
remarks, I see nothing in what has been going on in the most
recent period to alter the view that when we are through this
period, and it has been a very traumatic adjustment process, we
will go back to a rate of increase which is significantly above
where we were in the two decades prior to 1995.
We will not go back to some of the 50 percent increases in
capacity, which is what occurred last year in the high-tech
area. At least I hope not. But we will have solid expansion in
those areas because we have to complete this set of the
synergies of a very significant number of technologies. And we
have not completed them yet. They still have a significant way
to go.
Senator Gramm. Thank you, Mr. Chairman.
Chairman Sarbanes. Thank you. Senator Dodd.
Senator Dodd. Thank you very much, Mr. Chairman.
Again, I raise the issue--let me just get a quick answer,
if I can for you, on the issue of--I realize we are talking
about monetary policy here. But nonetheless, the issue of, the
physical infrastructure issue. I made the statement that I
cannot recall or I don't know of a period of economic growth,
sustained economic growth, without a sustained investment in
the maintenance of America's physical infrastructure.
I just wonder if you would question that, the legitimacy of
that statement.
Chairman Greenspan. Senator, I am not familiar with the
various measures that one would be required to determine
whether a particular infrastructure is adequate or not.
We know what the capital stock in, say, State and local
governments is. We know what our highway system is. We know
what our sewage issues are. And we know, as was pointed out,
pretty much about, for example, the urban infrastructure,
specifically things like that very significant tunnel near
Camden Yards. We know what those things are. But whether they
are adequate or inadequate is difficult to say because, in one
sense, nothing is ever adequate. In other words, there is
always more to be done.
So it is a question of judgment and I think one of the
important aspects of a democratic society is to make those
judgments as to what proportion of economic activity is devoted
to public infrastructure or the private infrastructure which
goes along with it. But there is no question that there has
been significant capital investment by State and local
governments in the last 4 or 5 years.
Senator Dodd. Thank you. And I will come back to the
subject at hand here.
Let me raise two questions, if I can. One is regarding the
international scene. And you referenced that in your statement
here. Again, no one knows better than you the indications we
are seeing, the recent problems in Argentina, certainly
throughout Latin America, by and large, anyway, the Asian
problems, even Europe.
We saw the Department of Commerce report, the trade
deficit, a low number of around $28 billion in the last
quarter. But while at first it may seem like a great number, it
also indicates a lack of activity. And obviously, the strength
of the dollar is contributing significantly to that as well.
Now the obvious question, given the globalization of the
marketplace and the dependency of the United States on
relatively strong economies internationally.
As you look ahead and speak with some optimism about a
recovery beginning toward the end of this year or next year, I
wonder if you could give us some indication of how directly
linked you believe the recovery of the United States is going
to be dependent upon a modest recovery or some recovery
internationally as well. And particularly in the Asian and
European markets.
Chairman Greenspan. Senator, the best way to describe it is
that we are all dependent on each other. It is a simultaneous
interaction in which all economies are working in a manner
which reinforces either strength or weakness for each other.
The problems that we have seen are, in one sense, more
domestic than they are international. And clearly, Argentina
has got some fairly significant problems which they are
addressing and, indeed, as we have observed in recent days, the
financial markets, which are always the best way to tell how
well things are going because they somehow learn what is
actually going on, have actually improved somewhat with respect
to Argentine securities, bonds, interest rates, and pressure on
the peso-dollar link.
One thing I think we can say is that, unlike 1997, when we
had been through a period of extraordinary acceleration in
economic
activity, especially amongst the so-called Asian tigers, we got
hit
with a number of problems in which a lot of the difficulties we
ran
into were the result of endeavors to hold fixed exchange rates,
to
arbitrage those exchange rates in a manner which tried to pick
up profits on differential interest rates, and the profits
would depend solely on the maintenance of those fixed exchange
rates.
And they broke, as indeed one would have expected that to
happen. That created a lot of contagion in the sense that the
investors in these emerging markets generally pulled back from
all emerging markets.
The tinder out there, if I may use the term, is much less
than it was in 1997. There are very few fixed exchange rate
problems. The extent to which debt was extended is much less.
The reserves are better.
That is not to say that we don't have a problem. I am just
merely saying that the resources are far better than they were
back then. And the probabilities of running into the type of
crises which we ran into there are certainly less.
Having said that, obviously, the United States was in much
stronger shape back then and we acted as a support, as did
others in Europe and elsewhere.
But, overall, I think that as I said, the tinder is less
and one presumes that it can be contained without much of a
problem.
Senator Dodd. Thank you. My time is up. Your comments on
capital spending in the high-tech area, I hope I get a chance
to come back. That is a very important part of your testimony.
Thank you for your answer on this question. Thank you, Mr.
Chairman.
Chairman Sarbanes. Thank you, Senator Dodd.
Senator Bennett.
Senator Bennett. Thank you, Mr. Chairman.
Chairman Greenspan, we have a circumstance where we have
some interesting bedfellows getting together right now on
economic issues--the unions and the National Association of
Manufacturers. Both seem to be very concerned about the strong
dollar and the impact of the dollar.
We have some economists, some of whom are friends of yours,
complaining about commodities, basic material prices going down
everywhere at very significant lows.
And all of this comes to the question of the amount of
liquidity--that is, the amount of money--available in the
economy. The
assumption being that if there were more money available, more
liquidity, the dollar would not be as strong as it is and that
commodity prices would begin to recover.
Taking a basic commodity that is produced out in Utah, as
one fellow put it to me, he says, when copper is scarcer than
money, the price of copper goes up. When money is scarcer than
copper, the price of copper goes down. And the price of copper
is going down.
Would you address that whole question of liquidity and
commodity prices and a strong dollar?
Chairman Greenspan. First of all I think that the demand
for commodities is, to a substantial extent, more an indicator
of industrial activity and its use than it is of financial
liquidity. In fact, I rarely use commodity prices as a single
useful indicator for broad inflation, which is really where the
issue of liquidity rests. I use it, however, to a substantial
extent as a measure of what is going on in areas of new orders,
industrial activity, and, indeed, world trade in various
commodities.
The reason why copper and aluminum and, say, steel scrap
prices----
Senator Bennett. And gold.
Chairman Greenspan [continuing]. Are down is more an issue
of the question of what is industrial activity doing. If
liquidity were a crucial factor in determining commodity
prices, then they should be buoyed at this stage because, for
example, M2 has been going up at double-digit annual rates in
the last number of months. And we don't see that.
And I think that the issue with respect to demand for
copper is going to depend very critically on what it always
depended on--underlying demand. Demand goes up, industrial
production goes up, industrial demand goes up, the price of
copper goes up.
Senator Bennett. So you would disagree with Lawrence Kudlow
and David Gitlitz and others who say that we are in fact on the
edge of a liquidity crisis. And the word deflation should begin
to be in our vocabulary now.
Chairman Greenspan. Yes, Senator, I do disagree.
Senator Bennett. Let's talk about deflation in Japan
because there are these economists who are saying that the
Japanese model indicates that inflation is the big problem we
worry about, but in Japan, they are deflating the economy.
Are we in any risk whatsoever repeating the Japanese
circumstance?
Chairman Greenspan. I think not, Senator. The problem in
Japan is a rupture in their financial intermediation process,
meaning moving savings into investment. The major financial
intermediary in Japan has been banks. And indeed, unlike the
United States where we have got many alternate mechanisms to
move savings through capital markets, through secondary
mortgage markets and the like, the banking system in Japan is
disproportionately what is employed to move savings into
investment.
With the dramatic decline in the value of commercial real
estate, which is, I would say, really the vast majority of the
collateral which underlies loans in the banking system there,
they have had a huge increase in nonperforming loans, as the
Japanese officials have indicated and have been endeavoring to
address.
But the consequence of that is that lending has come off
very dramatically because the banks are most concerned about
the capital position which they have, and the uncertainties
with respect to the nonperforming loans have induced a
significant contraction in lending. And the result is that the
Japanese system, which is, remember, the second largest economy
in the world, is endeavoring to function without an operating
financial intermediation system.
They are addressing the issue. Clearly, their endeavors at
reforms are exactly what they should be, and I hope that they
move as expeditiously as possible in that regard.
But whatever one may say about the United States, and we
have quite significant problems, and unquestionably, the loss
of a very large amount of stock market wealth does press down
on the economy, but it is scarcely an issue of lack of
liquidity or a lack of financial intermediation that creates
problems for us. I would say that the issue of Japan versus the
United States is really two separate types of problems. We do
not have that particular problem.
Senator Bennett. Thank you very much.
Chairman Sarbanes. Senator Reed.
Senator Reed. Thank you very much, Mr. Chairman. And again,
thank you, Chairman Greenspan.
Long-term interest rates are higher now than they were at
the start of the year. It raises the question, as short-term
rates have been pulled down through Federal Reserve action, why
have the longer-term rates not fallen also?
Chairman Greenspan. Well, actually, Senator, they declined
quite significantly in the latter part of last year, actually
in anticipation of the fact that at some point, monetary policy
would be kicking in, and you could start to see it very late in
the year in Federal funds futures markets. So that the markets
were already adjusting as of January the 1st.
In addition, the changing attitudes toward what the size of
the surpluses was going to be and, hence, the amount of
liquidation of U.S. Treasury securities was altered. That is,
the rate of decline in Treasury outstanding debt moved from a
sharp decline to one which was somewhat more modest, which in
effect implied that there was going to be a greater supply of
Treasury bonds, which is of course a crucial part of our bond
market, and that tended to keep rates somewhat higher.
Nonetheless, they have moved in a way in which some
commentators have questioned whether there is an inflation
expectation out there. And the best measure that we have got
for that is the so-called differential in the Treasury market
which tries to infer the expected inflation rate in the
Consumer Price Index as the difference between our Treasury
index bonds, the ones that we use for inflation indexing, and
the regular bonds. That gap is a useful measure. That did rise
significantly for a while, but it has retraced most of the
rise. And I would conclude that the failure of long-term rates
to come down more than they have is largely a supply issue and
not one of real concerns about inflation.
If anything, one would have to argue it is an expected
higher real rate of return which would be consonant and
consistent with rising economic activity in 2002.
Senator Reed. Mr. Chairman, the tax cuts, a very small part
of it that is being distributed this year in the form of
rebates, tends to cut against your efforts because it might be
slightly inflationary. It is putting more money, more
incentives for people to go out and spend.
Do you see that in any way impeding your efforts to keep
inflation down?
Chairman Greenspan. Senator, it could, under certain
circumstances. I don't see it as impeding us at the moment
because, as I indicated before, all of our measures suggest
fairly firmly that inflation is being contained and that there
is no evidence of which
I am aware that the tax cut has significantly altered those
infla-tion expectations.
Senator Reed. One of the longer-term consequences of the
tax cut is the potential to further erode national savings
since, essentially, government savings are being dissipated.
We have a consistent problem over time of marshaling
sufficient savings for investment. As you see the long term,
does this continue to bother you about the lack of not only
household savings, but now, a significant departure from
governmental savings?
Chairman Greenspan. Well, I certainly agree with you. In
other words, it is not only an issue of normal savings flows to
finance capital investment. But with the demographics changing
quite dramatically a decade from now, it is fairly apparent
that we are going to have to pick up the rate of productivity
growth, which clearly requires capital investment, if we are
going to concurrently supply the amount of goods and services
that both retirees, which will be increasing in very rapid
numbers, as well as workers, will require in the decade, or I
should say, in the years beyond, say, 2010, 2011.
Senator Reed. It seems that without a productivity
increase, and I think your testimony suggests that at least we
are in a productivity pause, a lot of the projected benefits of
the tax cut, indeed, the projected hopes of your policy, would
come undone, that a lot rests upon your presumption or
assumption that productivity will continue to increase as it
has over the last several years. And that is historically--
again, one could raise the issue of whether that is
historically borne out.
Chairman Greenspan. Well, it is not clear to me that the
tax cut, which is really quite a modest size, is having any
material effect on the underlying productivity structure of the
economy. As I said before, it could, if it were very large, and
it could have an effect if there were underlying inflationary
implications in a lot of it. But I cannot say that I see any of
that at the moment.
Senator Reed. But, again, Mr. Chairman, a lot of your, I
think the basis of your analysis, not just in the tax cut, but
many other issues, turn on the notion of productivity
increases.
That is probably the biggest uncertainty that we face
today.
Chairman Greenspan. Well, I don't know if it is quite
uncertain, but I certainly agree with you that a goodly part of
the way I look at the evolution of the American economy does
presuppose the resurrection of measured productivity growth
coinciding with what I believe to be the level of structural
productivity growth.
Senator Reed. Thank you, Mr. Chairman. Thank you, Chairman.
Chairman Sarbanes. Thank you very much, Senator Reed.
Senator Allard.
Senator Allard. Thank you. Chairman Greenspan, I think you
would agree with me that housing has played a significant role
in our economy, historically, and continues to play a
significant role today.
These are not necessarily high-tech jobs. And I wondered if
you could elaborate--and you did not mention that, make comment
in your remarks about housing. I just wondered if you could
maybe elaborate on the trends for housing prices, spending on
residential structures, and mortgage interest rates.
Chairman Greenspan. Senator, I think one of the things that
is occurring in this country is the evolution of housing into a
very sophisticated, complex industry, in the sense that we not
only have got the standard homebuilding aspects of
homeownership-related activities, but we are also beginning to
find that as homeownership rises, and as the market value of
homes continues to rise, even in a period when stock prices are
falling, we are observing a rather remarkable employment of
that so-called home equity wealth in all sorts of household
decisions.
Indeed, as I point out in my written remarks, it seems to
us that the rise in the value of homes, which if anything, has
accelerated during this period of rapid decline in stock
prices, has created a very substantial buffer of unrealized
capital gains which are being drawn upon through the home
equity market, through cash-outs, and through the turn-over of
existing homes, which has been, as you know, quite substantial
despite the weakness in the economy.
In that regard, the housing sector, thinking in terms of
the total sector, has been a very important contributor to the
American economy, and I think one of the major reasons why, as
I put it in my prepared remarks, that that litany of all the
negatives which you can easily line up has not in fact cracked
the economy's underlying stability.
And in that regard, I would say that we are still seeing an
increase in homeownership. The rate of ownership has risen, as
I recall, to 67 percent. And it is interesting in the sense
that, as I indicated before the House last week, a
disproportionate amount of that rise in homeownership is
amongst minorities, and a goodly part of implied construction
and existing home turn-over is being impacted by immigration,
strangely enough.
Senator Allard. Thank you. In light of other factors such
as the wage rate, what do you see happening to the national
homeownership rate?
Chairman Greenspan. Well, it has been rising at a fairly
pronounced pace. And I should certainly expect that at the
existing level of new home construction that it will continue
to do so. And there is still a fairly large number of
households who would like to become homeowners. And until we
see that dissipating, the underlying demographics will push us
forward.
Remember, unlike European economies or the Japanese
economy, where labor forces are not growing as fast percentage-
wise as ours are, the level and contribution of new home
construction is much less in their GDP than ours. And I think
this is an area where expanding population is a crucial factor
in impacting on economic activity, as it works its way through
home-building and the overall infrastructure of the system.
Senator Allard. Mr. Chairman, I have one last question.
From an economic perspective, what can be done to address
the issue of affordable housing?
Chairman Greenspan. Well, obviously as technology improves,
the ability to significantly increase modular and manufactured
housing in one form or another, you do see the impacts of the
ability to own homes improve especially in the moderate- to
lower-income groups.
To be sure, you are not getting--let's put it this way:
when I was young, a mobile home was something which you dragged
along behind a car on a highway and, if necessary, lived in.
The manufactured home industry has changed very dramatically,
as you know, and has constructed innumerable, multifaceted
types of structures which has enabled the productivity that is
embodied in the manufacturing process that has been doubtless
the fastest part of productivity growth in this country, and
that has been a significant factor in getting available homes
at all levels.
Going beyond manufactured homes, there is still an awful
lot of technology which is going into the improvement of
construction capabilities, and I should think that that is by
far the best way to create affordable housing.
You can subsidize it, if you want, and that can obviously
impact on the availability of homes. But there is nothing like
American productivity to create lower-cost, usable--in fact, in
many cases, quite impressive--homes, at relatively low prices.
Senator Allard. Thank you, Mr. Chairman. Thank you,
Chairman Sarbanes.
Chairman Sarbanes. I think some of us were also hoping you
would add lower interest rates as a way of getting more
affordable housing since, if you look at the little book about
what you pay monthly, it is very markedly affected by what the
interest rate is.
Senator Bayh.
Senator Bayh. Thank you, Mr. Chairman.
Chairman Greenspan, one brief observation and then three
very brief questions.
My observation, I wanted to note the confirmation of Roger
Ferguson, a good individual, by an overwhelming margin in the
U.S. Senate.
I think the vote was something like 98 to 2, or
thereabouts.
I thought you might be interested to know that one of our
colleagues who was in opposition opined that the reason,
therefore, was his similarity to you.
But I wanted to reassure you that the 98 of us who voted
for
Mr. Ferguson felt exactly the same way. So, indirectly, you had
a
significant vote of confidence in the U.S. Senate surrounding
the
Ferguson nomination.
My three brief questions, Mr. Chairman, really build off of
the
questions of my colleagues.
First, with regard to productivity and your comments in
response to Senator Reed. You were very sanguine about
following the temporary downtick we have had here, productivity
resuming its more robust pace of recent years.
In previous testimony, I have heard you mention past
historic parallels where we have had new technologies come on
the scene, whether it is the proliferation of electricity, the
automobile, the railroad, or what have you.
And you have indicated previously that there was a spurt of
productivity growth for a period of years. It is hard to define
exactly how long. Eventually that regresses to some sort of
mean.
How do we go about determining when the current
productivity acceleration, once it resumes, will experience a
similar regression?
Chairman Greenspan. Senator, that is the most difficult
question we have in this particular area. As I said before, we
know that we are only partway through capturing or exploiting
all of the various new technologies which are in front of us.
But the rate of growth in productivity obviously is a function
of how fast we exploit that unknown, unrealized potential. And
that is very difficult to judge.
We will know when we are getting to a point when we have
run out of possibilities, as indeed we noticed, for example, in
the big railroad boom. Remember, the railroad boom was
extraordinary. It changed the face of the American economy in,
indeed, a very similar sort of way that information technology
is doing today.
It peaked in 1920--or, I should say, as I recall, the
mileage of tracks in the United States peaked in 1920. So,
obviously, it would go, but you could see the rate of increase
starting to slow down and you knew that there was going to be
saturation at some particular point.
It is when we begin to see elements of saturation. We have
seen some at least early signs in personal computers in
households because there has been a very big surge. But still,
we have a long way to go to get it up to where, for example,
television is. I think we will have some advance warning, but I
am not sure we will be able to project very far into the
future.
All I can say at this moment is that we are nowhere near
there as yet. But I do believe that when we start to run into
the maturities and saturations that invariably hit
technologies, we will have some advance warning of that.
Senator Bayh. An interesting additional element with the
proliferation of information technology. It is not just its use
through the economy, but the restructuring of the organization
of work itself around the new technology, which perhaps is an
additional productivity kicker that exists today.
Chairman Greenspan. In fact, Senator, that may be more
important than we realize. Indeed, that clearly was the case,
as best I can judge, in how electric power worked from the
latter part of the 19th century into the 1920's. You did not
get the real kick in productivity until the buildings in which
you housed electric power and electric motors and ran
production systems changed. So that there is this effect of how
you do things which gets changed. And it is increasingly the
case that it is not the technology, the hardware, or even the
software itself. It is how you reorganize, and it takes a long
while before that takes place.
Senator Bayh. I see my yellow light is on. I will ask my
two final questions together, Mr. Chairman. I will try to be
succinct.
One is an issue that you and I have discussed before with
the increased percentage of trade or the increased bubble of
trade as a percentage of world growth and the increase in
capital flows.
You mentioned with regard to, I think Senator Dodd's ques-
tion, some of the strengths in the world economy today that
perhaps
can reassure us against the effects of a global financial shock
of
some type.
My question to you is in regard to the International
Monetary Fund.
With the growth of world trade, the potential size of the
shock at some future point might be larger. Does the fund have
the resources, the wherewithal, to address a future shock?
Is that an issue that we should be focusing on, ensuring
that they do have such resources? Number one.
Number two, with regard to Senator Allard's question, my
final question with regard to home equity. This has been a good
thing for the American economy, and temporarily helpful in
addressing the consumer issue and the current sluggishness.
My question to you is, since it has historically been a
significant percentage of household savings, is this a
worrisome long-term trend, people drawing down their home
equity substantially?
Those are my two questions--the IMF and the home equity
draw-down, in the long run.
Chairman Greenspan. Let me address the home equity issue
first. If unrealized capital gains were declining, which, of
course, is what happens when you extract equity from homes,
yes, it would be a problem. But there is no evidence of that.
Indeed, despite the fact of significant extraction of home
equity gains, the level of unrealized capital gains in homes
continues to rise apace. So it is not a depleting asset, if I
may put it that way. It could be, but, fortunately, it is not.
The IMF issue is a more fundamental and more difficult one
to address because what we do know, as we have discussed
before, is that the real volume of trade tends to increase
faster than gross domestic products. The amount of financing of
trade increases even faster than the underlying growth in
trade, which means, effectively, that the ratio of
international finance to the tax bases of the industrialized
countries--let's assume that is the major players in the IMF--
is rising inordinately. And that somehow suggests that if we
were to maintain an international presence proportional to the
increase in the aggregate finance, it would mean that an ever
larger proportion of the tax base of the industrialized
countries would have to be dedicated to that particular
process.
Since that is readily dismissable as most unlikely, it
therefore says that, yes indeed, we do have certain limits that
must of necessity be imposed on international financial
organizations, largely because of the allocation of resources
and the technologies which have so augmented the size of
international finance.
And I think everyone is becoming increasingly aware of
that, which means that how you come at international financial
problems has to be altered and, in a sense, fitted into what
the degree of finance is available from the industrialized
countries to finance the IMF, the World Bank, and the long
series of developing banks that we have in our system.
Senator Bayh. Thank you, Mr. Chairman.
Chairman Sarbanes. Thank you, Senator Bayh.
Senator Enzi.
Senator Enzi. Thank you, Mr. Chairman. I want to continue
some of the international questions because we are learning
that we are more internationally connected all of the time.
Both the House and the Senate have passed a Sudan peace
act. They are substantially the same with one exception. And
that is the one that prohibits companies that are developing
oil and gas in the Sudan from being able to raise capital in
the United States or to have their securities traded in the
U.S. market.
The New York Times had condemned that in an editorial. What
are your views of the provisions of the possibility of
politicizing the capital markets?
Chairman Greenspan. Well, it seems like a very minor issue,
Senator but it is obviously far more important, as you imply.
The clear outcome of such a law would effectively be to move
financing from New York to London. Indeed, there is even some
concern within the banking system that in order to comply with
such a law, the banks would have to make certain that their
customers were not in violation of the statute, which is very
difficult to do.
The effect of that I think would be essentially to move a
con-siderable amount of financing out of the United States to
London, Frankfurt, Tokyo. And since such a crucial part of the
effectiveness of the American economy is a very sophisticated
capital market and its financial infrastructure, I am most
concerned that if we move in directions which undermine our
financial capacity, we are undermining the potential long-term
growth of the American economy.
I find the motive for the legislation obviously
commendable. But I think it is not been thoroughly thought
through and I don't think that the implications of this
particular type of statute are useful to the United States and,
indeed, I think it is downright harmful.
Senator Enzi. Thank you. And another international issue
that has come to my attention--and you and I have been
corresponding about it and I appreciate all the information you
have provided, is about the Bank for International Settlements.
Of course, the private shareholders in the United States, about
130,000 shares' worth, are owned by mutual funds and private
investors.
I am kind of concerned about what is going to be done with
those shares that are being repurchased. And of course, I am
also concerned about a price that appears to be below the fair
value.
What is going to be done with those shares and when will
the Federal Reserve make a decision as to whether or not to buy
or receive these private shares?
Chairman Greenspan. Well, of course, we are not involved as
purchaser in any way with those shares. Our sole relationship
here is the fact that we have two seats on the board of the
Bank for International Settlements: myself and the president of
the Federal Reserve Bank of New York, Bill McDonough. We very
recently joined the board on the grounds that it was our
increasing conclusion that it was in the best interests of the
United States for us to be on that board after having for many
generations decided not to be there.
We consulted with the State Department, the Treasury
Department, and a number of people on the Hill to be sure that
they saw it the way we did and, indeed, that was the case.
With respect to the individual share issue, this was
handled in a way which as best I can judge, was reasonably
sensible. They had a number of investment banks, reputable
investment banks, try to make evaluations of what the
appropriate price should be for those minority shareholders,
and it is the same procedure that goes on in the private sector
all the time. And while we raised questions in the beginning
and certain things got changed, as I recall as a consequence.
But at the end, we looked at the results, thought them fair,
and voted in favor.
Senator Enzi. It was my understanding that this was being
done so that the central banks would own all of the shares.
Our central bank will not own any of the shares?
Chairman Greenspan. We do not own shares and will not own
shares.
Senator Enzi. I will be addressing a few additional
questions on that that don't pertain to the economy. But I do
have a definite interest in it and think that it will have some
effect on the economy.
So I thank you for your answer.
Chairman Greenspan. I would be glad to answer in any detail
you need.
Senator Enzi. Thank you.
Chairman Sarbanes. Thank you, Senator Enzi.
Senator Corzine.
Senator Corzine. Yes, thank you, Mr. Chairman.
Mr. Chairman, I identify with one item that you put in your
written statement. You said forecasts of inflation, however,
like all economic forecasts, do not have an enviable record.
We have seen, and I would look at some of the forecasts
that we had at the first part of the year relative to where
growth is now and at least in an evolving sense, that maybe the
second half is not going to be as strong as was projected by
both outside and public economists.
But I want to tie this to a view that we have, a personal
view, and some would call it political view that we have, over-
committed with regard to our tax cut.
You used the term, modest tax cut, earlier in responding to
a question. And certainly, if one looks at this certainly in
the context of extenders, sunsets, omissions that are almost
certain to be included in any interest expense, one could at
least make the case that modest is not where we are.
And my framing of this is, we are about to address another
issue that is going to take forecasting activities into account
with regard to Social Security, withdrawing 2 percent of the
payroll taxes potentially to finance private accounts.
I am concerned about our ability to be effective in these
forecasts and dealing with decisions on a discrete, 10- or 25-
year timeframe, as opposed to how I believe the Fed very
appropriately looks at an evolving situation.
I guess my first question is, have we been too aggressive
in using these kinds of forecasts to put in place judgments
with regard to how flows of revenues will come to the Treasury?
I am concerned that actually that yield curve that you
spoke so eloquently about may reflect--and I think when you
used the
word supply, it actually implies that people think we have a
sub-stantial change in the underlying conditions of our debt
markets
going forward.
And aren't we running a serious risk of aggravating that
potentially by some of the discussions with regard to Social
Security?
So I will give you an open field there. But I am very
troubled by the commitment that we are making to the political
arena to these long-term decisions that can be very damaging to
the long-run underlying health of the economy.
Then one more technical situation.
We seem to be having a debate about whether trust funds and
assets that go into trust funds may be real or accounting
devices.
It strikes me that IOU's from the Federal Government in a
Social Security trust fund are real assets. They have interest
rates maybe administered as opposed to market-implied, but they
are real.
And I wonder if you would have any insights that would help
us with a problem that seems to recur in the political debate.
Chairman Greenspan. Senator, I think the problem that we
have is lack of a choice to make long-term forecasts because
the policies which are being discussed are of that nature. Go
back, as you remember, 30, 40 years ago. It was very rare that
budgetary processes or tax policies extended beyond 1 or 2
years. And the major reason was we did not have to. But as we
have gotten to an ever increasing proportion of the budget
which are entitlement programs, and as we have endeavored to
make long-term commitments in one form or another which
necessarily imply both the receipt side and the outlay side as
we go forward, we have had no choice but to try to do the best
we can in making long-term forecasts and making judgments as to
the fiscal impact of both the receipt side and the outlay side.
It is a precarious exercise.
Indeed, I think when I was here in February, or certainly I
do remember in early Budget Committee discussions in the Senate
on that issue, that there is a great deal of uncertainty as you
get into the 5-, 7-, 10-year period. But if you introduce the
policy or the law, there is an implicit forecast that you are
making with respect to that statute. And it is better to do as
best you can even though, admittedly, the farther out you go,
the less certain you can conceivably be.
So I grant you there is a problem in these longer-term
forecasts and these longer-term estimates. I do not deny that
people make decisions on the basis of them without full
understanding, I believe, of how weak some of the forecasts
are, and how weak, as the people who make them such as myself,
perceive them to be.
There is no choice and we have just got to do the best we
can.
With respect to the trust funds----
Senator Corzine. And with regard to that, is there a time
when
it would be proper public policy to review those with changed
conditions?
Do you believe that we should?
Chairman Greenspan. I think we should be doing that all the
time. In other words, you are in continuous session, if I may
put it that way, and the basic purpose is to continuously
evaluate what is in the law, what has been done. And I think
that is the purpose of a number of the hearings that at least I
appear at is to review what the statutes that you passed are
doing. And clearly, in many instances, and appropriately so,
you have changed them.
With respect to the trust fund question, I think there is a
tricky question here. And the issue essentially is, as I
pointed out earlier, that the crucial question of savings in
this economy really relates to the ability for us to build an
adequate capital stock to pro-duce enough goods and services in
the future to accommodate both
retirees and workers in the future. The finance that is
involved
to do that is utterly a secondary question. If you don't
achieve that
end result, it is an exercise that cannot be called an
effective retire-ment program.
The issue with Social Security should be are we building
the level of capital assets that will be required to produce
the real goods and services? And in order to do that, are we
accumulating the amount of savings that we need to finance the
investments which will produce the goods and services? And
here, whether you are talking about a private system or whether
you are talking about a public system, the question is not what
assets are in the fund, but whether the claims are increasing.
It is wholly irrelevant whether in fact you have U.S.
Treasuries, corporate bonds, or corporate stock. It is
important with respect to what the rate of return is. But I
have argued elsewhere that there is an illusion there, which we
have to be careful about, of shifting retirement funds from the
private sector to the public sector, and I don't think that
that is a particularly good idea.
But I think the standard has got very little, if anything,
to do with what the nature of the securities are, but what is
the rate of savings implicit in the program.
Senator Corzine. They are assets, however they are
generated.
Chairman Greenspan. The crucial question is--are they
ultimate claims on real resources? And the answer is yes.
Senator Corzine. Thank you, Mr. Chairman.
Chairman Sarbanes. Thank you, Senator Corzine.
Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman.
I am sorry Senator Bayh has departed. If he's going to
quote me, I would like to have an opportunity to respond, only
to the point that if he would have followed up and used the
full text of my reasons for voting against Roger Ferguson for a
spot on the Federal Reserve, he would have found out that I
want an independent Federal Reserve. And I did not think that a
person who thought exactly the same as Chairman Greenspan would
be an independent thinker on the Federal Reserve.
Mr. Chairman, I would like to start off by asking the same
question that I asked at Gov. Ferguson's confirmation hearing.
Hindsight being 20/20, do you now think that the Fed waited
too long to reduce the target Fed fund rates? And I am speaking
about last September, October, November, December?
Chairman Greenspan. No, Senator. Let me tell you why.
When we examine the impact of monetary policy on the
economy in the context of the discussion I was having with the
Chairman, we find that there are long and variable lags. And in
that context, the difference of whether or not you move in one
period or 3 or 4 weeks later has very little effect, except
under conditions where there is a potential cracking of the
confidence in the economy.
In fact, back in early December, I remember discussing in a
speech concerns that I had--indeed, I think I may have even
used it before this Committee--about with the sharp reduction
in the rate of growth, the dangers that the fabric of consumer
confidence could be breached was a serious issue because, while
the technology was changing very rapidly, human nature doesn't,
and you could very rapidly induce a major contraction. And I
think that possibility was there in December, early December.
Senator Bunning. You don't think it was earlier than that?
Chairman Greenspan. No. But let me go to the point. The
question you raise
I think is a substantive question which I think would have
been of grave concern, say, in January.
In the event, the fabric of consumer confidence has not
been breached. In other words, we did not get the type of
concerns that could have been affected by a failure of monetary
policy to respond earlier. Had we had that breach, then I would
say the point you are making would have some strength to it. In
the event it did not, and we are now 7 months beyond the event,
and whatever the risks were back then, they have changed. That
is not to say that we don't have risks in the future, but it is
very difficult now to argue----
Senator Bunning. But we have had quite a few alternate
changes by the Fed since that time.
Chairman Greenspan. Sure. No, what I am basically saying
is, to the extent that--in your judgment, for example, not in
mine--but let's assume that it would have been desirable to
move earlier and we did not move, and the event of a breaching
of confidence occurred at that time, then I would say that the
argument you are making is a substantive one.
I am merely saying that it did not happen and by now,
whatever the consequences between moving in, say, November or
January were, are now fairly dissipated in the system----
Senator Bunning. I understand, because we have had quite a
few Fed fund rate cuts since that time.
Chairman Greenspan. Right.
Senator Bunning. Therefore, people are expecting the
economy now to pick back up. But it hasn't. And we don't expect
it to do it, and there is always a lag when Fed fund rates are
cut when the economy starts to respond to them.
That is why I say the Greenspan Fed is great reducing. But
going up, it is another question. We can get into that
argument.
During your testimony last week, you stated: Despite all
the shocks that are involved in both the domestic and
international economy, our economy is still not doing well, but
clearly far better given what has happened than I would have
forecasted 6, 8, 9 months ago.
Considering that 9 months ago places us in the month of
October of last year, why did the Fed wait until January to
begin easing monetary policy?
If you knew what you knew last September and October, then
why did you not act to it and respond to it immediately?
Chairman Greenspan. Let me amend my remarks of last week.
Senator Bunning. Okay.
Chairman Greenspan. It was 6 months, not 8 or 9. In other
words, if I said 8 or 9, I was mistaken.
Senator Bunning. I am just quoting what you said. Those are
your quotes.
Chairman Greenspan. No, no, it is perfectly valid. I am
just saying that I was wrong. I did not mean to say--I had not
actually done the arithmetic.
I think we became aware that we were having a serious
problem in December because the anecdotes were really quite
remarkable. You would see one business person after the other
saying, my
orders have just fallen through the floor.
Senator Bunning. They were coming to you 2 months after
they came to me, then, because I had them coming to me at the
end of September and they are saying, the economy has hit the
wall. What are we going to do about it?
Chairman Greenspan. Now certain parts of the economy were
hitting the wall. The same people came to me.
Senator Bunning. Thank you, Mr. Chairman.
Chairman Sarbanes. Thank you, Senator Bunning.
Senator Carper.
Senator Carper. Has Mr. Schumer already gone?
Chairman Sarbanes. But you were here earlier.
Senator Carper. I was.
Chairman Sarbanes. For quite a while and then left, and
Senator Schumer has just arrived, more or less.
Senator Carper. Mr. Chairman, I guess most questions have
been asked and probably answered during the time that I was
out.
Let me just venture a guess that maybe you haven't spent
much time focusing on energy and the implications of the
change, the drops in energy prices and what effect that that is
having on our economy and is likely to have.
As I look at what is hopefully going to happen here in the
second half of the calendar year of the effect of what you have
done, the monetary policy has to be kicking in right about now.
The effect of the rebates will have some impact, I think a
positive one, in the next couple of months. And the effect of
the energy policy and the drops in prices.
Certainly, in a psychological sense, they have to have an
effect, and also, in a very real dollars and cents sense.
Your thoughts, please.
Chairman Greenspan. Senator, I think it is more than
psychological. It is really quite important.
First of all, as I indicated in my prepared remarks, the
profit margins were very significantly squeezed by the sharp
rise basically in natural gas, electric power, and actually, as
I recall, a number of petrochemical feedstock products. The
result of that was, in the fourth quarter and especially in the
first half, some really significant downward pressure on profit
margins. It was a significant part of the increase in unit
costs in the consolidated
domestic system.
We started, of course, to get very dramatic declines in
natural gas prices starting very late last year. We went from,
as I recall, $10 per million BTU's down to approximately three
today in the spot market. But remember, businesses use longer-
term contracts. And so the contract prices have had much less
of a sharp rise and decline. But they are declining. And as I
indicated in my remarks, we expect that lower prices of energy,
with the exception of electric power, have worked to improve
profit margins by lowering costs.
In the household sector, remember the extraordinary problem
that we had with respect to natural gas during the winter. The
bills that people got were just awesome and unexpected, and
there is no doubt that they impacted on consumer expenditures.
People pulled back. Those rates are falling. You can see them
quite appreciably, to that extent, it is opening up consumer
purchasing power.
The gasoline price changes have been really quite dramatic.
It was a shortage of refinery capacity earlier this year which
prevented the increases in crude inventories being put through
the refineries into inventories of gasoline, especially
reformulated gas, which caused a big spike in prices, which has
now reversed, as the refinery margins, which went up very
sharply earlier this year, have now come all the way back down.
And in that regard, even electric power is beginning to
ease. It has been an extraordinary event in California, as you
know, to run into really quite mild weather. And the
combination of conservation in California and the weather has
brought down the load factor well beneath sort of a restricted
capacity to produce. Now the summer is not behind us yet and
there is considerable concern that you can get spikes and they
can run into trouble. But we have gotten through a goodly part
of the summer with prices very dramatically below where they
were. We are talking well under 10 cents per
kilowatt hour in the wholesale market now. And that has been a
small fraction of some of the prices we saw back earlier in the
year.
Senator Carper. Obviously, this is something that you think
about a great deal. And I do as well.
I think the factors were aligned, the stars were aligned
appropriately earlier this year to, with the energy crisis,
particularly with electricity in California, but natural gas
and others, the stars were aligned in order to compel us as a
Nation to work with our new Administration, our new President,
and the Senate and the Congress, to formulate an energy policy
that says, let's produce more energy, and as we do that, let's
conserve more energy.
And I have a concern now that as the crisis appears to be
abating--I filled up with gas yesterday in Harrington,
Delaware, Mr. Chairman. I filled it up for $1.23 a gallon,
which I haven't seen for a while, before I came over here----
Chairman Sarbanes. People will be coming from all over the
country to buy that gas.
[Laughter.]
Senator Carper. And if they come, they can come to the
Delaware State Fair, which runs through Saturday, Mr. Chairman.
Chairman Sarbanes. It is the same thing in Salisbury,
Maryland, I hasten to add.
[Laughter.]
Senator Carper. But Mr. Chairman, my fear is that as the
crisis abates, we may let this opportunity to formulate a
meaningful
energy policy for our country slip away as well.
Do you have any quick thoughts you would want to add on
that?
Chairman Greenspan. Senator, I fully agree with that. I
think that we have to remember that the reason why energy
demand has come off as much as it has is the economy is
slowing, and that the world economy being the crucial element
in crude oil demand having slowed, has induced a temporary
marked rise in crude oil inventories, especially in the United
States.
It has given us a sense of, well, there is no particular
problem at all. But when you look at it in detail, it gets to
be really quite significant in the sense that, with the
technologies that we have managed to mount over the last decade
or so, we have the capacity to drain natural gas reservoirs at
a far faster pace than we did, say, 10, 15 years ago, which
means that you have to get a continuously increasing amount of
drilling just to stay where you are.
But since we have committed such a substantial part of our
new electric power requirements to natural gas, we are running
into a long-term problem of how do we square this ability to,
one, have natural gas an increasing source within our electric
power system, and at the same time have a rate of drilling and
new finds of natural gas adequate to meet that overall demand.
And I think that we are being sort of tranquilized by the lower
price of natural gas. We are not, incidentally, back to where
we were 2 or 3 years ago, but we obviously have come off a very
extraordinary spike.
So the need to have drilling capacity in the United States
is urgent, largely because, unlike oil, we cannot import
indefinite amounts. Most of our imports--in fact, the vast
proportion--are coming from Canada. And they eventually are
going to run into some problems. As I recall, I think a sixth
of our demand is met from Canadian natural gas.
Liquified natural gas, which we could effectively bring
from
anywhere in the world, is a cryogenic, very complex process of
trans-portation which has got a lot of problems and
environmental
concerns associated with it. Natural gas is a critical issue in
this
country and we have to, one, focus on how we can conserve it
and
how we can produce it because we are going to have a problem
out there.
The electric power grid infrastructure is obviously
something which I think needs to be addressed and that is
something which increasingly we are going to become aware needs
some major
overhaul.
These are issues which you cannot address overnight. They
are long-term problems. And unless we address them while we are
in fact in temporary surplus, we are going to find that it is
going to become really much more difficult and the type of
problem which is going to induce us to make the types of
decisions which are probably mistakes.
Senator Carper. Thank you for your timely and sage counsel
very much.
Thank you, Mr. Chairman.
Chairman Sarbanes. Thank you.
Senator Ensign.
OPENING STATEMENT OF SENATOR JOHN ENSIGN
Senator Ensign. Thank you, Mr. Chairman.
Chairman Greenspan, we are considering some legislation
later this year to raise the minimum wage. Specifically,
Senator Kennedy has a bill to raise the minimum wage $1.50 an
hour over the next 2 years.
Can you comment on what you think the impact will have on
the economy. Should this legislation become law. Is it going to
enhance the slowdown? Will it have any effect at all?
Chairman Greenspan. Senator, I haven't looked at the impact
of the minimum wage on the labor markets and its impact on the
structure of the economy. I did, however, make some extended
remarks on the issue before the House and, indeed, before the
Senate previously on the question that a lot of economists
raise as to whether the minimum wage is an effective tool for
maintaining and supporting long-term growth in earnings.
My major concern here, as I have said previously on
numerous occasions, is that we are dealing with basically a
number of teenagers who, even in the tightest of labor markets,
have been unable to get jobs.
For example, at the peak of the pressures last year and the
year before, we still had a significant amount of teenage
unemployment. And if these individuals were able to work at a
rate lower than the minimum wage because they cannot earn the
minimum wage, they would get the very early technical skills
that you need to enter the work force, and that you enter at
the lowest level and you work your way up. My concern is that
to prevent people from getting in at the lower ladders--cutting
off the lower part of the ladders--I think essentially
delegates a lot of people to a very long and unfortunate period
of trying to find the proper place in the labor market.
So I think, with the evidence showing that the minimum wage
tends to create unemployment, that it is a tool which we should
be very careful about using. And I understand the politics of
this. I am fully aware of the fact that I am discussing a
subject which
everybody thinks I am on the wrong track on. But that is the
way I perceive what the evidence shows. And I must say that a
significant number of economists hold the same view, perhaps
even a majority.
Senator Ensign. Perhaps to follow up further on the impact,
with regard to the economy today, if you could consider that
and get back to me in writing. We know that there are other
wages that are tied to a minimum wage as the baseline.
And so, as the minimum wage is raised, other wages are
raised as well. During good economic times, did the increased
minimum wage weaken the economy? That can certainly be argued.
During more difficult economic times, could increasing the
minumum wage lead us further into a slowing of the economy?
I would be curious to see your comments on that?
Chairman Greenspan. Senator, would you like me to do that
in the form of a letter?
Senator Ensign. In a letter would be fine.
A couple of other things that I want to explore. First, I
want to get back to Senator Corzine's comments on assets.
The op-ed yesterday in The Wall Street Journal was
addressing whether they are real assets. The point of the op-ed
in The Wall Street Journal that was being made was that the
reason that you cannot look at a trust fund or these reserves
that are owed as a real asset is, even though it is the word of
the United States, if those obligations are higher in the
future, as everybody has said, there is only two ways to redeem
those assets.
The first way is, to cut benefits and, the second, is to
raise taxes. The point that you were making about the rate of
return, it was kind of glossed over that whether it is public
or private. The rate of return would seem to me in this
proposal, when we are looking at Social Security reform, that
it is incredibly important to whether or not we can meet the
baby boomers' needs into the future.
In other words, we can raise the rate of return on real
assets. Benefits don't have to be cut and taxes don't have to
be raised.
If we are not able to raise the rate of return, then
something's going to have to give.
Chairman Greenspan. I happen to agree with that. I don't
think that is what the issue is. You have to have increasing
productivity to produce the goods, and implicit in that is a
real rate of return on asset investment.
I think the question really is a different one. If you, for
example, create an amount of savings or let's say an increase
in the Social Security trust fund, all else being equal, that
will create a surplus in the unified budget and a reduction in
the debt outstanding. And in that regard, you could say that
the government surplus is equal to that and, indeed, since it
is also by definition government savings, the question is not
that, but whether the unified budget overall remains in
surplus. Because what the argument has been in the past is,
yes, we did invest in Social Security trust funds, but we
consumed the savings, and in that regard, there was no
government savings associated with it.
I don't think it has anything to do with what type of
securities are there. The question basically is that if you
have a Social Security surplus, even if it is less than what
would be actuarially required were it a private pension fund,
it nonetheless is savings. If, however, you use those funds for
increased government expenditures and therefore, reduce the
unified surplus to balance, the government savings have
disappeared. But you are still holding in the Social Security
trust funds special issues of the U.S. Treasury.
Senator Ensign. Except that, your point is, and I think
that you have argued this before, that the history of these two
bodies up here is to use the surplus, to spend it, and
subsequently to grow the size of government.
I think what many people fear is we are counting on that
money for Social Security. People like to get reelected, and
the easiest way to get reelected is to give things away.
And if you protect that money in a private account,
politicians cannot give that money away.
Chairman Greenspan. No, I have argued in that regard
myself.
Senator Ensign. Thank you, Mr. Chairman.
Chairman Sarbanes. Senator Schumer.
Senator Schumer. Sorry, Mr. Chairman. I am trying to
rearrange my schedule here.
I just have three questions on three different subjects.
The first is, I know that Senators Sarbanes and Reed talked
to you about the somewhat befuddling drop of 275 basis points
in interest and very little effect on long-term rates.
I guess I would like to ask a broader question. Have you
seen any evidence that the cost of credit has dropped for
consumers at all since these rate drops because not only our
country, but I guess the whole world is sort of hanging on
every move of the American consumer, who is supposed to get us
out of this little decline we are in.
Chairman Greenspan. Short-term rates have dropped quite
considerably. And adjustable-rate mortgages have, which are not
insignificant or irrelevant to this. I haven't seen the numbers
lately, but a good deal of consumer credit interest rates are
down.
Senator Schumer. Right.
Chairman Greenspan. So the answer is yes.
Senator Schumer. But what proportion of consumer borrowing
depends on short-term as opposed to long-term rates?
Chairman Greenspan. I would have to supply that for the
record. Clearly, long-term mortgages are the major issue.
Senator Schumer. One other thing. You mentioned that one of
the reasons--I think this was to Senator Reed--that you thought
that rates hadn't come down enough was that the rate of decline
of Treasury debt had been not as great as we thought.
Was that due to the economy, the slowing of the economy? Is
that due to the tax cut?
Chairman Greenspan. I think it is basically due to a series
of things. One, the tax cut, two, expenditure increases, which
were higher than expected. And three, the economy.
Senator Schumer. Right. So the tax cut did have a negative
effect on this.
Chairman Greenspan. Oh, yes, no question.
Senator Schumer. Because one of the things I argue about,
our surplus, which, as you know, when you helped make it happen
with your prodding, was hard-earned, is it gave you and it
gives the Fed the flexibility that they might not have had in a
deficit situation in terms of reduction of rates and things
like that.
Don't you worry that this tax cut might impair some of your
effectiveness in terms of the decline, the ability to get the
economy going?
It seems a direct implication of what you are saying. We
had this discussion once that it would have been more prudent
to go a little more slowly on the tax cut, given the
squishiness of the economy.
It seems to me that what you have said here is vindication
of that view.
Chairman Sarbanes. Especially the future tax cut, not the
tax cut for this year. Or you may argue that you needed a
stimulus. But this projected tax cut.
Senator Schumer. I meant the 10-year deal.
Chairman Sarbanes. Yes.
Chairman Greenspan. I think the qualification that the
Chairman makes is an important qualification. Remember when
this issue of the tax cut came up before this Committee and the
Budget Committee, I said I was in favor of a tax cut. But at
the time, the Congress had a bill up and the administration had
a bill up. And my view was that I was not going to comment on
the merits of either one. But I did think a tax cut was a
desirable thing to do. I still do. And I would like to leave it
at that, if I may.
Senator Schumer. Only because I like you so much, I will
leave it at that, as you may.
[Laughter.]
But there is an obvious follow-up question which I will let
hang in the air and you don't have to answer it. I will just
say, the next question is, it seems to me that even in the
short-term retrospect, the 10-year tax cut was too large for
the good of our economy.
And at least I would say, I wish that had been a more
pointed point at the time. Caution should always be the
watchword of our policies in this regard.
It has taken our party a long time to learn that on the
spending side. And I think we also have to learn it on the tax
cut side.
But let's go on to the next question, unless you want to
answer.
[Laughter.]
Chairman Greenspan. Fortunately, one of my colleagues has
given me some numbers on the interest rates on consumer loans.
For example, between November and May, new car loans are
down by a full percentage point. Personal loans are down almost
as much. And credit card loans are down almost as much.
Senator Schumer. There is some drop. But on the long-term
side, not.
Chairman Greenspan. Correct.
Senator Schumer. And that is what Senator Sarbanes--that is
where the long-term tax cut----
Chairman Greenspan. Long-term, 30-year mortgage rates have
not moved appreciably.
Senator Schumer. I find it just amazing that so quickly we
have learned that maybe we did something--not wrong. I don't
disagree with you that we needed a tax cut. I know that some of
my colleagues do. But we went overboard.
We do need a fiscal watchdog, particularly when people say
it is 1.35 and we all know it is not. We know the debt that we
lose--the paydown on the debt that we lose and with all these
little gimmicks that were put in there--estate tax cut goes
down in 2010, college tuition, up through 2006.
But I will leave it at that. The next question I have is
about
Social Security.
We are now beginning to grapple with the issue. You were
the major voice when first I believe the fellow from Brookings,
whose name escapes me--and then the President proposed that 15
percent, approximately 15 percent of the trust fund be used for
investment in equities, as a way of getting some kick in the
market.
Not doing what the President proposed, which I think takes
the money out of Social Security and lets people invest, but,
rather, have the trust fund itself invest.
And since that time, it seems that there has been some
writings about ways to deal with your very legitimate concern,
which is that you don't want the government--the Sudan problem.
And I agree with--I cannot remember who brought it up, but my
colleague from Wyoming I think it was, that that would be
terrible.
As much as I believe I want to end slavery in Sudan, this
would be cutting our nose to spite our face and send our
capital markets right overseas.
But that there are ways to greatly insulate the
government's--this trust fund, the Social Security trust fund
investing in equities, requiring that it be broad-based funds,
setting a whole group of people whose term expire.
The best proof is you and the Fed. I think you are, as you
should be--as you know, I fought a 20-year battle mostly
against some of my colleagues on the Democratic side when I was
in the House, to insulate the Fed from the political
vicissitudes.
Has your thinking changed at all on that, or evolved a
little bit, or maybe softened a little bit, because these
things that I have read--Aaron is the guy from Brookings. I am
sorry.
Chairman Greenspan. Henry Aaron.
Senator Schumer. Henry Aaron, yes. He has written a pretty
interesting piece, a proposal on how to insulate the trust fund
from that.
Chairman Greenspan. Yes, I vaguely recall.
Let me just say this. As I have testified, there is a big
distinction between defined contribution plans and defined
benefit plans. We have got in the Federal Government several
defined contribution plans, including the Federal Reserve.
Senator Schumer. Right.
Chairman Greenspan. The crucial issue is that in a defined
contribution plan, where the rights to the fund itself in here
in the individual, and should those funds be misused in some
form or another, the losses go to the individual.
In a defined benefit plan where, in effect, the Federal
Government guarantees the benefits, the recipient could not
care less what is in the fund, what they do with it, or
anything else. It has no effect on the individual.
I regret that I haven't had a chance to review Henry
Aaron's piece. I do recall I had problems with it when I read
it. But essentially, my concern is that, as much as we endeavor
to insulate these particular types of funds, we never fully
succeed. And I might say that the evidence of State and local
funds, which are defined benefit plans, generally have not been
as well run. And indeed, there has been a good deal of
political gamesmanship played and I don't want to get back into
political history--but there are people back there who I think
would have found ways very readily around some of these
constrictions and it is that which worries me, mainly.
Senator Schumer. Thank you both, Mr. Chairman.
Chairman Sarbanes. We will now move to a second round for
those who have stayed on, I want to participate.
Mr. Chairman, I want to run through some points with you
very quickly.
First of all, I want to come back to a point made at the
outset because I am very concerned about this sort of drumbeat
in the press. This is a story reporting on your testimony over
on the House side.
It said:
In an effort to stave off recession, the Federal Reserve
has slashed interest rates six times this year, totalling 2.75
percentage points, the most aggressive credit-easing campaign
in nearly two decades.
Now this drumbeat that the Fed has done much more than it
is ever done before and somehow, it is way out at the end of
the string in terms of what it is trying to do, it just runs
directly counter to this chart, on the real Federal funds rate,
which, after all, you have to adjust related to inflation.
Chairman Greenspan. Is that with the PCE deflator or with
the CPI deflator?
Chairman Sarbanes. Core CPI. Here's how far you have come
now. This is where you went back in the early 1990's. It is
also
illustrated by this chart, which shows the--and this is how you
came down back then.
Here, you have done it more quickly, and I commend you for
that. I think that was the right move.
But I just want to make the point that there is still room
to go. I do not regard the Fed as having engaged in the most
aggressive credit-easing campaign in nearly two decades. I
think you have followed a vigorous policy since January. But I
don't think it is the most vigorous and I don't think you ought
to be dissuaded from doing more by some notion that somehow you
have gone out to the limits or close to the limits in terms of
what you have already done.
Now I want to touch just once more on this boom and bust
and business cycle.
We are not in a recession. Correct? Everyone talks this
gloom talk and we are concerned about the economic downturn.
But the fact is we have not yet had a quarter with negative
growth.
Chairman Greenspan. That is correct, Senator.
Chairman Sarbanes. And to have a recession, if we stick
with the definition we have consistently used in the past, we
would need to have two successive quarters of negative growth.
Is that correct?
Chairman Greenspan. That is one definition of recession,
and the one that I suspect is used by most people.
Chairman Sarbanes. Right.
Chairman Greenspan. But there are others. For example, the
National Bureau of Economic Research, as you know, endeavors
after the fact to designate peaks and troughs in the business
cycle.
Chairman Sarbanes. Right.
Chairman Greenspan. And it doesn't always exactly coincide
with the two quarters of GDP negative growth.
Chairman Sarbanes. Of course, I agree with what Senator
Gramm said when he was here. We have had a pretty good run here
on the economy, and to the extent that we are getting this
slowing, which has not yet, in my view, crossed into a
recession, I think we can attribute some of this success to a
careful mix of fiscal and monetary policy that has enabled us
thus far at least to avoid what I would call a bust.
It hasn't avoided the business cycle, but avoided a bust.
And I think we need to continue to work toward that objective.
That leads me to the point, you say in your statement:
Surely, one reason long-term rates have held up is changed
expectations in the Treasury market, as forecasts of the
unified budget surplus were revised down, indicating that the
supplies of outstanding marketable Treasury debt are unlikely
to shrink as rapidly as previously anticipated.
Now, my criticism of the excessive tax cut was that, when
it projected out into future years, not whatever we did to get
a stimulus this year, but projected out into future years, it
led to these forecasts with respect to the unified budget
surplus that were significantly revised down. And that is
occurring all the time. It is constantly being revised
downwards.
And in a sense, it broke the kind of relationship that had
been set up between a restrained fiscal policy and the ability,
then, of the Fed to accommodate or adjust its monetary policy.
So it seems to me that as we look ahead, the task of the
Fed has been made much more difficult in terms of bringing down
the long-term rates because of this development.
Would you agree with that?
Chairman Greenspan. I think it is a marginal issue,
Senator, in the sense that it is true that mortgage rates have
not been lowered and Treasury rates are higher. But as I
indicated to one of your colleagues earlier, if you go back to
the period before we started
to ease, the anticipation was that that was about to happen,
because you could see it in the Federal funds futures markets,
cor-
rectly obviously in retrospect, and you got a dramatic decline
in
long-term rates.
So while I don't deny that clearly--I mean, the logic of it
is indisputable--that the greater the surplus, the lower the
rates, other things equal, I don't think the orders of
magnitude are large enough to really materially affect the
outcome, even though I grant you that----
Chairman Sarbanes. I was just picking up off your own
statement that, surely, one reason long-term rates have held up
is changed expectations.
Chairman Greenspan. Yes, the point you are making I think
is a correct point.
Chairman Sarbanes. Right.
Chairman Greenspan. It is just I don't think the orders of
magnitude are really very large.
Chairman Sarbanes. Senator Bennett.
Senator Bennett. Thank you very much, Mr. Chairman. I
appreciate the second round.
First, Chairman Greenspan, on an issue that nobody else has
talked about and that we can dispose of relatively quickly, I
would like to meet with you or whomever you might designate at
the Fed to talk about critical infrastructure protection
concerns.
You know from my past history with Y2K, I am concerned
about what happens if the computers fail. And when we got
through with the Y2K experience, Senator Dodd and I, it hit me,
well, we have missed this one in terms of what would happen if
the computers failed by accident, what would happen if they
failed on purpose?
And I have now wallowed in the intelligence community and
the defense community and have a sense of what is going on
there.
But if I were someone who wished this country ill, I would
not attack the defense computers. I would try to get into the
Fed wire and see to it that it is shut down.
And you have all kinds of computers, contractors and so on.
And I would like to ask you to allow me to wallow in that as
well in my effort to see to it that the Congress comes up to
speed on the issue of credit infrastructure protection.
Chairman Greenspan. Senator, if the Fedwire got shut down
for any material period of time, with the huge volumes that are
going over it, I can assure you we would have difficulties. And
as a consequence, as soon as you would like to get together on
that issue, we would be more than pleased to make available to
you what we do to prevent that from happening.
Chairman Sarbanes. I might note, Senator Bennett did really
stellar work on the Y2K issue. He headed up a special committee
of this Committee. And with Senator Dodd, I think they made a
really major contribution in pushing various sectors in the
economy to get up to standard.
And I am pleased he's continuing his interest in these
problems.
Senator Bennett. Let me talk now about the national debt.
As we have had these exchanges over the years, when the
surplus first started to rear its lovely head, much to the
surprise of everyone, we immediately tried to decide what to do
about it. And your testimony to us at the time was don't do
anything about it. Just let it run.
Pay down the national debt. If you find that you are paying
down the debt too much, you can always increase it again.
Therefore, you
counseled us to kind of hold our fire on that and let it go
forward.
I think that was wise counsel.
Then as the surplus began to loom even larger, you endorsed
a tax cut as one of the ways to deal with it.
Without engaging in an exchange with my friend from New
York as to the appropriateness of the size of this tax cut, or
the timing of this tax cut, it now looks as if some kind of
surplus is going
to be with us in one form or another, for a relatively long
period
of time.
Maybe not 50 years, but at least to the degree that we can
tell, 10 years.
So let's step aside from the debate on taxes and simply
talk about paying down the national debt and the size of the
national debt that would be a logical number to focus on.
Can you give us any kind of reasonable target as to where
the debt ought to be?
And I always view this not in absolute terms, but in
relative terms. That is, the debt as a percentage of GDP, is
the number that I talk about.
And I would be very grateful if you could respond to that.
If that is the wrong relative relationship, tell me and say
where it is that we ought to be.
Chairman Greenspan. No, no. I agree with you on that,
Senator.
Right now, as you know, our debt to the public is $3\1/4\
trillion, which is roughly 3 percent plus of the GDP.
Senator Bennett. Wait a minute. No. Three percent of GDP?
Chairman Greenspan. What did I say? Three percent?
Senator Bennett. Yes.
Chairman Greenspan. Sorry about that. I am missing a digit.
Senator Bennett. Yes. I was going to say, it sounds closer
to 30 percent to me.
Chairman Greenspan. It is a little over 30 percent of GDP.
Senator Bennett. Yes.
Chairman Greenspan. Well, it is wishful thinking, maybe.
[Laughter.]
The estimates that we make try to figure out how far down
you can get the debt down. And we have come up against the
issue that you still want to have savings bonds, which serve
many useful purposes. There are State and local holdings which
are not an insignificant amount and are very useful to State
and local governments to have U.S. Treasury issues that focus
on their ability to escrow accounts and do a number of other
things. Then there is a significant amount of debt held by
foreign accounts, whether they are central banks or private
foreigners, which probably would be very difficult to reduce
prior to maturity. In other words, theoretically, we could bid
them away, but at extraordinary premiums.
So if you look at the process of the maturities of the
debt, it is evident that when you get below a trillion dollars,
you are running into downside resistance, which at that point
would be less than 10 percent of the GDP. That is a very
valuable thing to do, in my judgment. When you are running into
a situation in which the demographics of the society are such
that you are going to have an ever-increasing problem of
maintaining the retirement benefits that, to start off the
period with a very low Federal debt is probably a wise thing to
do.
And that is indeed what I think we are doing. I think that
is what the policy of this Government and the Congress is, and
I think that is sensible.
Senator Bennett. If we hit the targets in the surplus
forecasts that we had, we will do that on the path that we are
currently on?
Mr. Greenspan. I would think so. Crucial to the forecast,
however, is that structural productivity is fairly close to
where earlier projections have put it, and as far as I am
concerned, there is no reason to doubt that.
Senator Bennett. I see. Thank you. Thank you, Mr. Chairman.
Chairman Sarbanes. Thank you. Well, it is one of the
prerogatives of being the Chairman that you can ask even a few
more questions right at the end.
I am going to impose on you for just a couple of minutes.
First of all, I cannot let the statement about the minimum
wage simply go unchallenged. Alan Kruger at Princeton did a
study of the impact of the minimum wage and reached the
conclusion that it had not had a negative effect on
unemployment.
Chairman Greenspan. I am quite familiar with that study.
Chairman Sarbanes. And contrary to the impression that
might have been drawn from your previous response, that most of
the people drawing a minimum wage are teenagers, in fact,
upwards of two-thirds of them are adults.
Chairman Greenspan. My concern is mainly on the teenagers.
Chairman Sarbanes. Well, the problem there, of course, is
how do you address that without depressing the wage for the
adults?
But there are lots of people who do household work, for
example, and many other activities that I think would simply
see a cut in their wage and in their standard of living without
markedly affecting the job market.
So it is a difficult issue. But we have tried to put this
floor under people and it seems to me a worthwhile endeavor.
The Fed now has under consideration a regulation dealing
with predatory lending. Gov. Ferguson, when he was here,
indicated that it would probably be some time in the fall when
the Fed would be able to finalize that regulation.
I just want to underscore that I think there is a
tremendous
opportunity for the Fed to make a very significant contribution
in
addressing this problem in this regulation as you move toward
finalizing it.
Some of the major players in the sub-prime lending market
are in fact moving now to change their own practices in
response to many of the criticisms that have been leveled.
Clearly, I think there is a perception on the part of many that
there are certain practices going on that really cross the line
in terms of what is
appropriate or reasonable.
And I think the Fed has a real opportunity in this
regulation to really move us ahead on that issue. And I simply
encourage the Fed to do that.
I know you have spoken yourself on the predatory lending
issue and we appreciate the observations you have made. And I
just wanted to leave that with you.
Finally, the Open Market Committee meets 8 times a year,
every 6 weeks. Is that about it, roughly speaking?
Chairman Greenspan. That is correct, Mr. Chairman.
Chairman Sarbanes. And has that always been its pattern?
Chairman Greenspan. That is a good question. I think not.
Let me ask our historians here.
Mr. Kohn. It used to be 12 times a year.
Chairman Greenspan. We used to meet 12 times?
Mr. Kohn. Twelve times a year.
Chairman Greenspan. How did San Francisco Bank handle that
when they had to go by train?
[Laughter.]
Mr. Kohn. Well, in fact, there were 4 times required and
then there was an Executive Committee in the early 1950's that
met.
But at least from the 1970's on, it was about 12 times a
year. And that 12 times a year may have begun before that.
Chairman Sarbanes. Well, I am just inquiring because I
don't think you can probably get away with it, but there is an
inordinate focus that takes place around an Open Market
Committee. You have everyone sort of holding their breath for 2
or 3 weeks before and sort of letting out their breath for 1 or
2 weeks afterwards.
It is almost like polls in a presidential campaign. Nothing
happens in between. Everyone waits for the poll. So you get
everyone waiting for the Open Market Committee.
Actually, we try to do these hearings on a regular and
periodic basis, in part, as we discussed, to make them more a
normal part of the business.
Do you sense that with these Open Market Committees? You
are doing it fairly frequently, I don't know that I have any
suggestion.
But there is a tremendous amount of commotion that springs
up around every Open Market Committee meeting.
Chairman Greenspan. I don't know how you avoid that, Mr.
Chairman I think that so long as we move in discrete fashions,
meaning that we actually alter the rate in a discrete manner,
it has an impact on the money markets.
Historically, when we used to work with so-called net
borrowed reserves, where we were not focusing on interest rates
directly, it was actually quite possible for us to increase and
decrease at very small increments and, indeed, there were many
occasions when big disputes would occur among so-called Fed-
watchers as to whether we had tightened or eased. And in that
context, we did not have the impact that you are referring to.
I am not sure it is a serious problem. One of the reasons I
say that is we have developed a Federal funds futures market.
That means people in the investment community are increasingly
reacting to the same events that we react to. And so more often
than not, when we move, it is not a shock to the system because
it has already been anticipated and embodied in the forward
markets.
There are occasions, whether by deliberate action on our
part or other reasons such as events occurring very quickly
without a chance for anyone to fully absorb them, that we would
move more or less than the market would expect. The consequence
is market adjustments, and we want market adjustments. The
purpose of having a policy is to effectively impact on the
market structure itself. But I know of no way that by altering
the number of meetings or how we do them which could address
the real problem that you allude to.
Chairman Sarbanes. Let me observe that we tried to move
Gov. Ferguson through in short order, so he's now of course
been
confirmed.
The President has announced his intention to nominate--he's
named two people so far for vacancies on the Federal Reserve
Board. But that is an intention to nominate. We have not yet
received those papers here and the nomination has not
officially been sent to us, so we await that development before
we can move forward to holding hearings, which obviously, we
would intend to do in an effort to get the board back up to
full strength.
I mean, you are down so far, you even have had some worries
about a quorum problem, as I understand it.
Chairman Greenspan. Yes. We have five members, and most of
the time we are dealing with quorums of four. But there are
very rare occasions when we would need five votes for certain
actions on our part. So we would be concerned if we fell below
five. And clearly, we would be hopeful that we could be moved
back up to the full complement of seven.
Chairman Sarbanes. We will be very sensitive to that
concern.
And finally, let me announce that the final vote on the
nomination of Harvey Pitt to be a Member of the Securities and
Exchange Commission was 21 to nothing, all Members of the
Committee having voted.
I yield to Senator Schumer right here at the end.
Senator Schumer. Thank you. I have one last question. I
appreciate both Chairs' indulgence. It is not about the
previous subjects.
It is about an issue that greatly concerns me, which is the
balance of payments deficit. I won't get into what it is. We
all know what it is. Just to say that foreign ownership of U.S.
Treasuries because of this is now 35 percent, corporate bonds,
45 percent, and in our huge equity market, it is up to 11
percent already.
So, I guess the worry we all have is that at some point,
foreign investors won't be there to continue paying for our
investments, and then we could face some really catastrophic
disinvestment.
And I know that we are at the end of the hearing, so I know
the answers will have to be brief. But do you have any
historical guidance for us on this? I know you have studied it,
as to what to do about this issue, if anything?
Is recession the only way to deal with it? We all know it
is a problem. What should we be doing about this, if anything?
Chairman Greenspan. Senator, I could say that we have spent
an inordinate amount of time at the Federal Reserve addressing
exactly this issue. And I think, as I have mentioned to you
before, we have concluded that the propensity to import goods
in the United States relative to our incomes is higher than our
trading partners. And so if everyone were growing at the same
rate in the world, we would have a chronic balance of payments
deficit. That, in effect, is the source of the historical
balance of payments deficit.
Most recently, at times, it has been engendered not from
the export and import side, but from the capital investment
side where the desire to hold U.S. dollar-denominated assets
was greater than was being required by our trade deficit and,
in a sense, the trade deficit opened up because the system must
balance.
We think it is a difficult issue. We have long been
concerned about the issue that you are raising. At some point
something has got to give somewhere. But we have had that
concern for over 5 years and it is still maintained itself. We
don't know a simple solution to this. But clearly, it is a
policy problem that engages us and engages the Administration
as well.
Senator Schumer. From the dollar stance that we have had,
does that bear some reexamination?
Chairman Greenspan. As you know, Senator, with respect to
the dollar, I, like all of my colleagues, other than the
Secretary of the Treasury who has been designated the spokesman
by all of us--correctly, in my judgment--on the issue of the
dollar, as a consequence of that, I regret that I cannot
respond.
Senator Schumer. That is twice today.
[Laughter.]
Thank you, Mr. Chairman.
Chairman Sarbanes. Mr. Chairman, one final observation.
I have talked with the Secretary of Commerce, Secretary
Evans, who is interested in this issue of improving the Federal
Government statistics, the statistical infrastructure.
Of course, some of that agency is under his jurisdiction,
although not all of it. We are trying to work together. And I
have also talked with the CEA people about it.
And I just wanted to, in a sense, get you back on record. I
recall you testified before a committee at one point, while you
eschewed advocating any increase in spending--in fact, I think
you said, I have your quote here: I am extraordinarily
reluctant to advocate any increase in spending. So it is got to
be either a very small amount or a very formidable argument
that is involved. And I find in this case that both conditions
are met.
I take it that is still your view about improving the
Federal statistical infrastructure.
Chairman Greenspan. That is correct, Mr. Chairman.
Chairman Sarbanes. Thank you. The Committee is adjourned.
Thank you very much.
[Whereupon, at 12:59 p.m., the hearing was adjourned.]
[Prepared statements, response to written questions, and
additional material for the record follow:]
PREPARED STATEMENT OF SENATOR JON CORZINE
Thank you, Mr. Chairman for holding this important hearing. I want
to thank Chairman Greenspan for appearing before the Committee today.
As we all know, when Mr. Greenspan speaks--America, and much of the
rest of the world, listens.
Mr. Chairman, it is of vital importance that Congress discusses the
many issues that shape our economic and monetary policy so that as we
proceed in our legislative agenda we remain ever mindful of working to
strengthen America's economy and seeking to improve the lives of our
citizens.
As we all are well aware, our economy has struggled of late. The
efforts of the Fed, in attempting to revive our lagging economy, have
been well documented. Yet despite six interest rate cuts this year, our
economy remains sluggish. Our most prominent economists all seem to
disagree as to when the true effects of the Fed's monetary policy will
kick-in. But all agree that the effects, to-date, have been relatively
modest. As Richard Stevenson pointed out in his piece in today's New
York Times:
``. . . in this business cycle the three main vehicles through
which lower rates affect business, investor and consumer
behavior--the stock, bond and currency markets--have remained
persistently unresponsive to the Fed's actions.
There is little doubt that the challenge the Fed finds itself
confronting is a daunting one. Consider our current economic condition.
A long overhang of business investment.
Extraordinary current account deficits.
A negative personal savings rate.
Low productivity growth.
Disappointing corporate earnings.
Long-term interest rates that resist monetary policy and remain
steadfastly high.
Rising unemployment and the reverse wealth effect seem destined to
negatively impact the one thing that has, to this point, served as the
safety pin of our economic fortunes--consumer confidence and spending.
The Fed's task becomes even more daunting when you consider that
the global economy is also showing indications of a slowdown.
That said, our economic situation would certainly be much, much
worse had it not been for the Fed's aggressive actions this year.
Ultimately, I believe the Fed rate-cuts will provide the necessary jolt
to turn our sluggish economy into a healthy one.
The question before us is how we can bring about this economic
revival sooner rather than later.
As always, I look forward to hearing Chairman Greenspan's thoughts
regarding the state of our economy and our future economic outlook.
Judging from the number of flashbulbs, cameras and tape recorders that
are present today, I can tell I am not alone.
Thank you, Mr. Chairman.
----------
PREPARED STATEMENT OF ALAN GREENSPAN
Chairman, Board of Governors of the Federal Reserve System
July 24, 2001
I appreciate the opportunity this morning to present the Federal
Reserve's semiannual report on monetary policy.
Monetary policy this year has confronted an economy that slowed
sharply late last year and has remained weak this year, following an
extraordinary period of buoyant expansion.
By aggressively easing the stance of monetary policy, the Federal
Reserve has moved to support demand and, we trust, help lay the
groundwork for the economy to achieve maximum sustainable growth. Our
accelerated action reflected the pronounced downshift in economic
activity, which was accentuated by the especially prompt and
synchronous adjustment of production by businesses utilizing the faster
flow of information coming from the adoption of new technologies. A
rapid and sizable easing was made possible by reasonably well-anchored
inflation expectations, which helped to keep underlying inflation at a
modest rate, and by the prospect that inflation would remain contained
as resource utilization eased and energy prices backed down.
In addition to the more accommodative stance of monetary policy,
demand should be assisted going forward by the effects of the tax cut,
by falling energy costs, by the spur to production once businesses work
down their inventories to more comfortable levels, and, most important,
by the inducement to resume increases in
capital spending. That inducement should be provided by the
continuation of cost-saving opportunities associated with rapid
technological innovation. Such innovation has been the driving force
raising the growth of structural productivity over the last half-dozen
years. To be sure, measured productivity has softened in recent
quarters, but by no more than one would anticipate from cyclical
influences layered on top of a faster long-term trend.
But the uncertainties surrounding the current economic situation
are considerable, and, until we see more concrete evidence that the
adjustments of inventories and capital spending are well along, the
risks would seem to remain mostly tilted toward weakness in the
economy. Still, the FOMC opted for a smaller policy move at our last
meeting because we recognized that the effects of policy actions are
felt with a lag, and, with our cumulative 2\3/4\ percentage points of
easing this year, we have moved a considerable distance in the
direction of monetary stimulus. Certainly, should conditions warrant,
we may need to ease further, but we must not lose sight of the
prerequisite of longer-run price stability for realizing the economy's
full growth potential over time.
Despite the recent economic slowdown, the past decade has been
extraordinary for the American economy. The synergies of key
technologies markedly elevated prospective rates of return on high-tech
investments, led to a surge in business capital spending, and
significantly increased the growth rate of structural productivity. The
capitalization of those higher expected returns lifted equity prices,
which in turn contributed to a substantial pickup in household spending
on a broad range of goods and services, especially on new homes and
durable goods. This increase in spending by both households and
businesses exceeded even the enhanced rise in real household incomes
and business earnings. The evident attractiveness of investment
opportunities in the United States induced substantial inflows of funds
from abroad, raising the dollar's exchange rate while financing a
growing portion of domestic spending.
By early 2000, the surge in household and business purchases had
increased growth of the stocks of many types of consumer durable goods
and business capital equipment to rates that could not be sustained.
Even though demand for a number of high-tech products was doubling or
tripling annually, in some cases new supply was coming on even faster.
Overall, capacity in high-tech manufacturing industries, for example,
rose nearly 50 percent last year, well in excess of its already rapid
rate of increase over the previous 3 years. Hence, a temporary glut in
these industries and falling short-term prospective rates of return
were inevitable at some point. This tendency was reinforced by a more
realistic evaluation of the prospects for returns on some high-tech
investments, which, while still quite elevated by historical standards,
apparently could not measure up to the previous exaggerated hopes.
Moreover, as I testified before this Committee last year, the economy
as a whole was growing at an unsustainable pace, drawing further on an
already diminished pool of available workers and relying increasingly
on savings from abroad. Clearly, some moderation in the pace of
spending was necessary and expected if the economy was to progress
along a more balanced growth path.
In the event, the adjustment occurred much faster than most
businesses anticipated, with the slowdown likely intensified by the
rise in the cost of energy that until quite recently had drained
businesses and households of purchasing power. Growth of outlays of
consumer durable goods slowed in the middle of 2000, and shipments of
nondefense capital goods have declined since autumn.
Moreover, weakness emerged more recently among our trading partners
in
Europe, Asia, and Latin America. The interaction of slowdowns in a
number of countries simultaneously has magnified the softening each of
the individual economies would have experienced on its own.
Because the extent of the slowdown was not anticipated by
businesses, some backup in inventories occurred, especially in the
United States. Innovations, such as more advanced supply-chain
management and flexible manufacturing technologies, have enabled firms
to adjust production levels more rapidly to changes in sales. But these
improvements apparently have not solved the thornier problem of
correctly anticipating demand. Although inventory-sales ratios in most
industries rose only moderately, those measures should be judged
against businesses' desired levels. In this regard, extrapolation of
the downtrend in inventory-sales ratios over the past decade suggests
that considerable imbalances emerged late last year. Confirming this
impression, purchasing managers in the manufacturing sector reported in
January that inventories in the hands of their customers had risen to
excessively high levels.
As a result, a round of inventory rebalancing was undertaken, and
the slowdown in the economy that began in the middle of 2000
intensified. The adjustment process started late last year when
manufacturers began to cut production to stem the accumulation of
unwanted inventories. But inventories did not actually begin falling
until early this year as producers decreased output levels considerably
further.
Much of the inventory reduction in the first quarter reflected a
dramatic scaling back of motor vehicle assemblies. However, inventories
of computers, semiconductors, and communications products continued to
build into the first quarter, and these stocks are only belatedly being
brought under control. As best we can judge, some progress seems to
have been made on inventories of semiconductors and computers, but
little gain is apparent with respect to communications equipment.
Inventories of high-tech products overall have probably been reduced a
bit, but a period of substantial liquidation of stocks still seemingly
lies ahead for these products.
For all inventories, the rate of liquidation appears to have been
especially pronounced this winter, and the available data suggest that
it continued, though
perhaps at a more moderate pace, this spring. A not inconsequential
proportion
of the current liquidation undoubtedly is of imported products, and
thus will pre-sumably affect foreign production, but most of the
adjustment has fallen on
domestic producers.
At some point, inventory liquidation will come to an end, and its
termination will spur production and incomes. Of course, the timing and
force with which that process of recovery plays out will depend on the
behavior of final demand. In that regard, the demand for capital
equipment, particularly in the near term, could pose a continuing
problem. Despite evidence that expected long-term rates of return on
the newer technologies remain high, growth of investment in equipment
and software has turned decidedly negative. Sharp increases in
uncertainties about the short-term outlook have significantly
foreshortened the time frame over which businesses are requiring new
capital projects to pay off. The consequent heavier dis-counts applied
to those long-term expectations have induced a major scaling back
of new capital spending initiatives, though one that presumably is not
long-lasting
given the continuing inducements to embody improving technologies in
new capital
equipment.
In addition, a deterioration in sales, profitability, and cash flow
has exacerbated the weakness in capital spending. Pressures on profit
margins have been unrelenting. Although earnings weakness has been most
pronounced for high-tech firms, where the previous extraordinary pace
of expansion left oversupply in its wake, weakness is evident virtually
across the board, including most recently in earnings of the foreign
affiliates of American firms.
Much of the squeeze on profit margins of domestic operations
results from a rise in unit labor costs. Gains in compensation per hour
picked up over the past year or so, responding to a long period of
tight labor markets, the earlier acceleration of productivity, and the
effects of an energy-induced run-up in consumer prices. The faster
upward movement in hourly compensation, coupled with the cyclical
slowdown in the growth of output per hour, has elevated the rate of
increase in unit labor costs. In part, fixed costs, nonlabor as well as
labor, are being spread over a smaller production base for many
industries.
The surge in energy costs has also pressed down on profit margins,
especially in the fourth and first quarters. In fact, a substantial
portion of the rise in total costs of domestic nonfinancial
corporations between the second quarter of last year and the first
quarter of this year reflected the increase in energy costs. The
decline in energy prices since the spring, however, should be
contributing positively to margins in the third quarter. Moreover, the
rate of increase in compensation is likely to moderate, with inflation
expectations contained and labor markets becoming less taut in response
to the slower pace of growth in economic activity. In addition,
continued rapid gains in structural productivity should help to
suppress the rise in unit labor costs over time.
Eventually, the high-tech correction will abate, and these
industries will reestablish themselves as a solidly expanding, though
less frenetic, part of our economy. When they do, growth in that sector
presumably will not return to the outsized 50 percent annual growth
rates of last year, but rather to a more sustainable pace.
Of course, investment spending ultimately depends on the strength
of consumer demand for goods and services. Here, too, longer-run
increases in real incomes of consumers engendered by the rapid advances
in structural productivity should provide support to demand over time.
And thus far this year, consumer spending has indeed risen further,
presumably assisted in part by a continued rapid growth in the market
value of homes, from which a significant amount of equity is being
extracted. Moreover, household disposable income is now being bolstered
by tax cuts.
But there are also downside risks to consumer spending over the
next few quarters. Importantly, the same pressure on profits and the
heightened sense of risk that have held down investment have also
lowered equity prices and reduced household wealth despite the rise in
home equity. We can expect the decline in stock market wealth that has
occurred over the past year to restrain the growth of household
spending relative to income, just as the previous increase gave an
extra spur to household demand. Furthermore, while most survey measures
suggest consumer sentiment has stabilized recently, softer job markets
could induce a further deterioration in confidence and spending
intentions.
While this litany of risks should not be downplayed, it is notable
how well the U.S. economy has withstood the many negative forces
weighing on it. Economic activity has held up remarkably in the face of
a difficult adjustment toward a more sustainable pattern of expansion.
The economic developments of the last couple of years have been a
particular challenge for monetary policy. Once the financial crises of
late 1998 that followed the Russian default eased, efforts to address
Y2K problems and growing optimism--if not euphoria--about profit
opportunities produced a surge in investment, particularly in high-tech
equipment and software. The upswing outstripped what the Nation could
finance on a sustainable basis from domestic saving and funds attracted
from abroad.
The shortfall of saving to finance investment showed through in a
significant rise in average real long-term corporate interest rates
starting in early 1999. By June of that year, it was evident to the
Federal Open Market Committee that to continue to hold the funds rate
at the then-prevailing level of 4\3/4\ percent in the face of rising
real long-term corporate rates would have required a major infusion of
liquidity into an economy already threatening to overheat. In fact, the
increase in our target Federal funds rate of 175 basis points through
May of 2000 barely slowed the expansion of liquidity, judging from the
M2 measure of the money supply, whose rate of increase declined only
modestly through the tightening period.
By summer of last year, it started to become apparent that the
growth of demand finally was slowing, and seemingly by enough to bring
it into approximate alignment with the expansion of potential supply,
as indicated by the fact that the pool of available labor was no longer
being drawn down. It was well into autumn, however, before one could be
confident that the growth of aggregate demand had softened enough to
bring it into a more lasting balance with potential supply. Growth
continued to decline to a point that by our December meeting, the
Federal Open Market Committee decided that the time to counter
cumulative economic weakness was close at hand. We altered our
assessment of the risks to the economy, and with incoming information
following the meeting continuing to be downbeat, we took our first
easing action on January 3. We viewed the faster downshift in economic
activity, in part a consequence of the technology-enhanced speed and
volume of information flows, as calling for a quicker pace of policy
adjustment. Acting on that view, we have lowered the Federal funds rate
2\3/4\ percentage points since the turn of the year, with last month's
action leaving the Federal funds rate at 3\3/4\ percent.
Most long-term interest rates, however, have barely budged despite
the appreciable reductions in short-term rates since the beginning of
the year. This has led many commentators to ask whether inflation
expectations have risen. Surely, one reason long-term rates have held
up is changed expectations in the Treasury market, as forecasts of the
unified budget surplus were revised down, indicating that the supplies
of outstanding marketable Treasury debt are unlikely to shrink as
rapidly as previously anticipated. Beyond that, it is difficult to
judge whether long-term rates have held up because of firming inflation
expectations or a belief that economic growth is likely to strengthen,
spurring a rise in real long-term rates.
One measure often useful in separating the real interest rates from
in-
flation expectations is the spread between rates on nominal 10-year
Treasury notes and inflation-indexed notes of similar maturity. That
spread rose more than three-
fourths of a percentage point through the first 5 months of this year,
a not insignifi- cant change, though half of that increase has been
reversed since. By the nature
of the indexed instrument, the spread between it and the comparable
nominal rate
reflects expected CPI inflation. While actual CPI inflation has picked
up this year,
this rise has not been mirrored uniformly in other broad price
measures. For ex-
ample, there has been little, if any, acceleration in the index of core
personal con-
sumption expenditure prices, which we consider to be a more reliable
measure of
inflation. Moreover, survey readings on long term inflation
expectations have remained quite stable.
The lack of pricing power reported overwhelmingly by business
people underscores the quiescence of inflationary pressures. Businesses
are experiencing, the
effects of softer demand in product markets overall, but these effects
have been
especially marked for many producers at earlier stages of processing,
where prices
generally have been flat to down thus far this year. With energy prices
now also
moving lower and the lessening of tautness in labor markets expected to
dampen wage increases, overall prices seem likely to be contained in
the period ahead.
Forecasts of inflation, however, like all economic forecasts, do
not have an enviable record. Faced with such uncertainties, a central
bank's vigilance against inflation is more than a monetary policy
cliche; it is, of course, the way we fulfill our ultimate mandate to
promote maximum sustainable growth.
A central bank can contain inflation over time under most
conditions. But do
we have the capability to eliminate booms and busts in economic
activity? Can
fiscal and monetary policy acting at their optimum eliminate the
business cycle,
as some of the more optimistic followers of J.M. Keynes seemed to
believe several
decades ago?
The answer, in my judgment, is no, because there is no tool to
change human nature. Too often people are prone to recurring bouts of
optimism and pessimism that manifest themselves from time to time in
the buildup or cessation of speculative excesses. As I have noted in
recent years, our only realistic response to a speculative bubble is to
lean against the economic pressures that may accompany a rise in asset
prices, bubble or not, and address forcefully the consequences of a
sharp deflation of asset prices should they occur.
While we are limited in our ability to anticipate and act on asset
price bubbles, expectations about future economic developments
nonetheless inevitably play a crucial role in our policymaking. If we
react only to past or current developments, lags in the effects of
monetary policy could end up destabilizing the economy, as history has
amply demonstrated.
Because accurate point forecasts are extraordinarily difficult to
fashion, we are forced also to consider the probability distribution of
possible economic outcomes. Against these distributions, we endeavor to
judge the possible consequences of various alternative policy actions,
especially the consequences of a policy mistake. We recognize that this
policy process may require substantial swings in the Federal funds rate
over time to help stabilize the economy, as, for example, recurring
bouts of consumer and business optimism and pessimism drive economic
activity.
In reducing the Federal funds rate so substantially this year, we
have been responding to our judgment that a good part of the recent
weakening of demand was likely to persist for a while, and that there
were significant downside risks even to a reduced central tendency
forecast. Moreover, with inflation low and likely to be contained, the
main threat to satisfactory economic performance appeared to come from
excessive weakness in activity.
As a consequence of the policy actions of the FOMC, some of the
stringent financial conditions evident late last year have been eased.
Real interest rates are down on a wide variety of borrowing
instruments. Private rates have benefited from some narrowing of risk
premiums in many markets. And the growth of liquidity, as measured by
M2, has picked up. More recently, incoming data on economic activity
have turned from persistently negative to more mixed.
The period of sub-par economic performance, however, is not yet
over, and we are not free of the risk that economic weakness will be
greater than currently anticipated, and require further policy
response. That weakness could arise from softer demand abroad as well
as from domestic developments. But we need also to be aware that our
front-loaded policy actions this year coupled with the tax cuts under
way should be increasingly affecting economic activity as the year
progresses.
The views of the Federal Reserve Governors and Reserve Bank
Presidents reflect this assessment. While recognizing the downside
risks to their current forecast, most anticipate at least a slight
strengthening of real activity later this year. This is implied by the
central tendency of their individual projections, which is for real GDP
growth over all four quarters of 2001 of 1\1/4\ to 2 percent. Next
year, the comparable figures are 3 to 3\1/4\ percent. The civilian
unemployment rate is projected to rise further over the second half of
the year, with a central tendency of 4\3/4\ to 5 percent by the fourth
quarter and 4\3/4\ to 5\1/4\ percent four quarters later. This easing
of pressures in product and labor markets lies behind the central
tendency for PCE price inflation of 2 to 2\1/2\ percent over the four
quarters of this year and 1\3/4\ to 2\1/2\ percent next year.
As for the years beyond this horizon, there is still, in my
judgment, ample evidence that we are experiencing only a pause in the
investment in a broad set of innovations that has elevated the
underlying growth in productivity to a rate significantly above that of
the 2 decades preceding 1995. By all evidence, we are not yet dealing
with maturing technologies that, after having sparkled for a half-
decade, are now in the process of fizzling out. To the contrary, once
the forces that are currently containing investment initiatives
dissipate, new applications of innovative technologies should again
strengthen demand for capital equipment and restore solid economic
growth over time that benefits us all.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SARBANES FROM ALAN
GREENSPAN
Q.1. Productivity Growth: Structural productivity growth caused
much of the rapid growth that our economy experienced from 1995
to 2000. Chairman Greenspan postulated that structural
productivity growth rates have returned to the pre-1974 rate of
2.75 percent per year, compared to the 1974-1995 rate of 1.5
percent per year. Given that quarterly productivity growth
rates are highly variable, yet the productivity growth rate for
the first quarter of this year was negative 1.2 percent. Do you
think there is enough empirical proof to validate your
hypothesis that we have seen fundamental change in structural
productivity? On the basis of the evidence outstanding, do you
believe that it is wise to make projections and implement
revenue decisions on these 10-year projections of productivity?
A.1. Longer-term projections of output growth necessarily
involve projections of structural productivity growth. The only
issue is what is the appropriate rate of structural
productivity growth to write down. Deriving an estimate of past
growth in structural
productivity is complicated by the inherent volatility of
quarterly
labor productivity data and the important impact economic
cycles
have on measured productivity, often exaggerating the
productivity
numbers in a period of boom and understating them in times of
weakness. In addition, the raw data used to construct
productivity,
output and labor hours, are subject to revision. Indeed, the
most recent revisions to the national income and product
accounts released at the end of July show that productivity
grew 2.6 percent over the 1998 to 2000 period, down from the
previous estimate of 3.2 percent. Still, actual productivity
grew 2.3 percent over the 1995 to 2000 period, substantially
faster than the 1\1/2\ percent pace over the previous twenty
years. Moreover, labor productivity rose 1.6 percent over the
four quarters ending in the second quarter of this year, a time
of cyclical weakness.
Looking ahead, the outlook for structural productivity
depends critically on the prospective returns on investment and
the corresponding growth of business investment. There continue
to be good reasons for expecting returns on investment,
especially in newer technologies, to remain high, and for
investment to turn up and resume solid growth, once many of the
near-term uncertainties that have been holding down capital
outlays recede. In these circumstances, the outlook for
structural productivity growth continues to be favorable, and
it seems reasonable to expect productivity performance in the
coming years to continue to be in excess of that which
prevailed over the 2 decades ending in 1995.
Q.2. Consumer Leverage: According to the OCC, consumers are
more highly leveraged now than at any measured point in
history. Not only are debt service payments at historic highs,
but the increase in debt has been financed through instruments
other than mortgages. For example, The Chicago Sun Times
reported that the average credit card debt per household is
$8,123 and has grown threefold over the past decade. Debt
service payments constitute over 14 percent of disposable
income. If the economy continues to worsen, do you think that
the precarious position that consumers are in today could
create a vicious cycle in which poor economic conditions and
high personal debt interact to reduce demand more than
expected?
A.2. As financial markets have developed over recent decades,
mortgage and consumer credit have become increasingly available
to households. This has contributed to household debt expanding
more rapidly than disposable personal income, bringing the
household debt-to-income measure to higher levels. So long as
household earnings unfold in line with expectations, high debt
levels do not pose much of a problem. But, when employment
conditions and earnings deteriorate more than had been
contemplated, strains
can emerge that potentially could affect demand. The slowdown
in earnings growth in the past year has contributed to a rise
in
the debt-service burden, and delinquency rates on various types
of household debt have risen mildly. Acting to cushion the
impact
of earnings shortfalls for many borrowers, and to cushion
house-hold demand, has been the still-high level of assets.
Indeed, the
excess of household assets over household debt, household net
worth, recently has been about five and a half times disposable
income; despite declines in equity prices over the past year or
so, this continues to exceed historically more typical ratios
of net worth to income of five or a little less. Thus,
household debt positions should not pose a serious threat to
household spending, given generally strong asset positions,
absent a considerable deterioration of labor market conditions.
Nonetheless, this is a matter that deserves continued close
attention in the period ahead.
Q.3. Unemployment: While the standard measure of unemployment
has increased over the past two years to 4.4 percent, there is
some concern that real unemployment is much higher.
Specifically, measures of unemployment that include so-called
``discouraged workers,'' the unemployed who have stopped
looking for work, have been rising at a much faster rate.
Chairman Greenspan, do you think that the real unemployment
problem is larger than is generally perceived?
A.3. The evidence on this matter is not completely clear,
though all measures of unemployment remain below levels that
prevailed in the mid-1990's. An alternative measure that I have
found helpful from time to time, those unemployed plus those
outside the labor force who report that they want a job now,
has risen by an amount similar to the official unemployment
series. Some broader measures published by the Bureau of Labor
Statistics that include discouraged workers, as well as
marginally attached workers and those working part-time for
economic reasons, have registered increases that have been a
little larger than the official series. However, none of these
measures suggest that the rise in the official series is
seriously distorting the deterioration in job market conditions
that has occurred over the past year.
Q.4. Balance of Payments: CBO's budget estimates for the next
decade assume a strong growth in business investment. For the
economy to match this lofty goal, funds have to be available to
be invested. These funds can come from either domestic or
international savings. If the international component of
funding grows, our current account deficit will continue to
grow. But for the funding to come from within, America will
have to save more. Do you agree with CBO that business
investment will be robust over the next 10 years, and if so,
where will the funding for investments come from? Finally, do
you believe that any policy changes will be necessary to ensure
that there is enough funding available for American businesses
to continue to make productive investments?
A.4. There continue to be good reasons to be optimistic about
the outlook for business investment over the next decade. As
noted in the response to Question 1, the prospects for returns
on investments, especially those involving new technologies,
remain favorable, looking beyond the recent period of weakness.
The investment boom of the second half of the 1990's was
financed by the swing from Federal Government deficits to
surpluses, as well as through the current account; meanwhile,
the contribution from personal saving actually fell. Looking
ahead, there are reasons to believe that personal saving will
be providing more resources to support growth in investment,
but probably much more will be needed. Thus, it is important
that the Federal Government preserve discipline in managing its
finances, or else even more will be required from abroad.
Q.5. Consumer Confidence: Chairman Greenspan, in your testimony
you said ``softer job markets could induce a further deteriora-
tion in confidence and spending intentions.'' In your view,
what role does consumer confidence play in setting monetary
policy?
A.5. Consumer confidence plays little direct role in setting
monetary policy, but can play a very important indirect role to
the degree it has a bearing on the outlook for household
consumption or housing spending or risks to that outlook.
Household spending is by far the largest component of aggregate
demand, and shifts in measures of consumer confidence can
provide a helpful early warning of impending shifts in
consumption or housing demand.
Q.6. Economic Effects of the Shrinking Surplus: At the
beginning of the year Congress projected the Federal Government
running a surplus of $281 billion. Today that projection is
down to $160 billion. Chairman Greenspan, what do you believe
the economic implications of the shrinking surplus are with
regard to national savings, investment, and interest rates?
A.6. In assessing the deterioration in the Federal budget, it
is important to keep in mind that portion which is due to a
cyclically weaker economy and to technical factors, such as
timing shifts in corporate receipts. Such influences are only
temporary and will later be reversed. Forthcoming projection
updates by CBO and OMB should prove helpful in sorting out
temporary from more lasting influences on the budget, such as
tax cuts and other factors affecting average tax rates. These
reports should also contribute to the dialogue on potential
output growth in the coming decade. Nonetheless, fiscal
measures approved this year imply smaller surpluses going
forward. Taken alone, this implies an effect on national saving
and interest rates. However, other factors bearing on private
saving and interest rates have also taken on a different cast
since earlier this year, complicating any assessment.
Q.7. Uncertainty: Chairman Greenspan, in your testimony before
this Committee in July 2000, you projected real GDP growth for
the year 2001 to be between 3.25 and 3.75 percent. In February
of 2001, you revised your GDP growth projections downward to
between 2 and 2\1/2\ percent. And last week you again revised
your projections for real GDP down to 1.25 to 2 percent. Does
this mean that we, as policy makers, need to keep a more
vigorous eye on the possibility of even slower growth than your
current projections?
A.7. Economic forecasts should always be viewed as having
confidence intervals around them, the central tendencies of the
Board members and Reserve Bank presidents are no exception.
After each of its meetings from last December to June, the FOMC
has informed the public that it has seen the risks to the
outlook to be weighted on the side of economic weakness,
reflecting its concern that the economy might grow more slowly.
As a consequence, the Federal Reserve has been especially
attentive to the possibility that
the economy could grow more slowly than anticipated and has
responded aggressively to evidence that the weaker growth was
emerging.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR ENSIGN FROM ALAN
GREENSPAN
At the July 24 hearing on the Federal Reserve's semiannual
monetary policy report, you asked me to respond for the hearing
record to a question you raised with respect to the impact of
minimum wages on economic conditions.
I am pleased to enclose my response, which I am also
transmitting to the Committee for inclusion in the record.
As I noted during my testimony before the Senate Banking
Committee on July 24, my opposition to the minimum wage stems
from my belief that by denying jobs to many potentially low-
wage workers--especially younger workers--the minimum wage, on
balance, hurts the very group it is intended to help. I believe
by denying these workers an opportunity to accumulate labor
market skills, the minimum wage inhibits economic growth over
the long term.
You asked whether I thought that an increase in the minimum
wage might retard economic growth in the short term as well,
and whether any deleterious effects would be greater during
periods of relative economic stagnation. Although research into
the economics of the minimum wage has only rarely addressed its
implications for the macroeconomy, I expect that these
implications are relatively small. At the minimum wage levels
currently under discussion, the reduction in aggregate
employment and the accompanying misallocation of human (and
other) resources are not likely to exert much influence on
economic growth. However, I would expect an increase in the
minimum wage to modestly boost inflation.
The economic effects of an increase in the minimum wage are
naturally greater the longer it takes market wages to ``catch
up'' with the new legislated minimum. For a given increase in
the minimum wage, this period is likely to be shorter during
times of strong economic growth or high inflation. Moreover,
the adverse impact of the minimum wage on the employment
opportunities of low-wage workers is presumably mitigated by
the faster job creation that accompanies good economic times.
Conversely, when overall rates of job growth are low, the
negative impact of a higher minimum wage likely would show
through more clearly to higher unemployment rates of low-wage
workers.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SCHUMER FROM ALAN
GREENSPAN
At the July 24 hearing on the Federal Reserve's semiannual
monetary policy report, you asked me to respond for the hearing
record to a question you raised with respect to the proportion
of consumer debt that depends on short-term versus long-term
interest rates.
I am pleased to enclose my response, which I am also
transmitting to the Committee for inclusion in the record.
During my testimony before the Senate Banking Committee on
July 24, you asked for information on the proportion of
household borrowing that depends on short-term interest rates
versus the proportion that depends on long-term rates.
As background, let me present the latest data on the extent
of
the decline in interest rates on both types of household loans
since
the middle of last year, when long-term interest rates began to
drop on signs that the pace of economic growth was moderating.
Since mid-2000, interest rates on both 30-year fixed-rate
mortgages
and adjustable-rate mortgages have fallen about 1\1/2\
percentage
points, while interest rates on home equity lines of credit--
which generally are linked to the prime rate at banks--have
declined 2\1/2\ percentage points. In addition, the average
interest rate on credit cards has fallen 1\1/2\ percentage
points, while the average rate on auto loans has dropped nearly
a full percentage point. In sum, interest rates on all major
types of household credit have declined considerably.
With that background, let me turn to your specific
question. About three-quarters of all household borrowing is in
the form of home mortgages, and most of these mortgage loans
carry fixed interest rates. This year, fixed-rate loans have
accounted for more than 80 percent of home mortgage
originations--an unusually high proportion because households
generally view current fixed rates as quite attractive. As for
non-mortgage borrowing, credit card debt is about 40 percent of
this total, while auto loans and other loans--generally with
maturities of 3 to 5 years--make up the balance.