[Senate Hearing 107-503]
[From the U.S. Government Publishing Office]
S. Hrg. 107-503
FEDERAL RESERVE'S FIRST MONETARY POLICY
REPORT FOR 2002
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SEVENTH CONGRESS
SECOND SESSION
ON
OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU-
ANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978
__________
MARCH 7, 2002
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
80-301 U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 2002
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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
Tom Loo, Republican Senior Economist
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
(ii)
C O N T E N T S
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THURSDAY, MARCH 7, 2002
Page
Opening statement of Chairman Sarbanes........................... 1
Prepared statement........................................... 39
Opening statements, comments, or prepared statements of:
Senator Gramm................................................ 2
Senator Johnson.............................................. 3
Prepared statement....................................... 40
Senator Bennett.............................................. 3
Senator Bayh................................................. 3
Senator Hagel................................................ 4
Senator Carper............................................... 4
Senator Bunning.............................................. 5
Senator Stabenow............................................. 6
Senator Crapo................................................ 6
Senator Corzine.............................................. 7
Senator Allard............................................... 7
Prepared statement....................................... 40
Senator Dodd................................................. 11
Prepared statement....................................... 41
Senator Ensign............................................... 11
Senator Akaka................................................ 11
Prepared statement....................................... 41
Senator Miller............................................... 30
Prepared statement....................................... 42
WITNESS
Alan Greenspan, Chairman, Board of Governors of the Federal
Reserve System, Washington, DC................................. 7
Prepared statement........................................... 42
Additional Material Supplied for the Record
Monetary Policy Report to the Congress, February 27, 2002........ 49
(iii)
FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT OF 2002
----------
THURSDAY, MARCH 7, 2002
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:10 a.m., in room SD-106 of the
Dirksen Senate Office Building, Senator Paul S. Sarbanes
(Chairman of the Committee) presiding.
OPENING STATMENT OF CHAIRMAN PAUL S. SARBANES
Chairman Sarbanes. The Committee will come to order.
We are very pleased to welcome Chairman Greenspan back
before the Committee on Banking, Housing and Urban Affairs this
morning, to give testimony on the Federal Reserve's Semi-Annual
Monetary Policy Report to the Congress.
I just note, Mr. Chairman, that yesterday, as I understand,
it was your birthday. We want to wish you a belated happy
birthday, a day late, and many more of them to come.
Chairman Greenspan. Thank you very much.
Chairman Sarbanes. I am sure I speak for all the Members of
the Committee when I say that. It is not like the board of
directors voted, you know, the chief officer was ill and they
voted 5 to 4 for a full recovery.
[Laughter.]
Chairman Greenspan. I am glad you did not take a vote, Mr.
Chairman.
Chairman Sarbanes. Actually, legislation that we enacted in
the last Congress has set out a framework now for the Federal
Reserve to submit a report to Congress twice a year on the
conduct of monetary policy and for the Chairman of the Fed to
testify before the Congress. Before that, it was a matter of
custom. But Senator Gramm and I worked together with the
Chairman, who was supportive of the idea that at regular
intervals, it would serve an important public purpose for the
Fed to come before the Congress and present testimony with
respect to monetary policy in open session.
Now, we alternate back and forth between the House and the
Senate and the Fed testified last week before the House. So in
a sense, much of the Chairman's initial readings of the economy
have already been publicly given, although we have had some
interesting reports since that testimony.
Yesterday, the Fed issued the beige reports from the
various regional banks around the country in terms of how they
see economic conditions, and we have also gotten some
additional statistics.
Since you testified last Wednesday, the Commerce Department
released a report which revised upward U.S. economic growth in
the fourth quarter of last year. The Commerce Department
report, as I understand it, revised it upward from \2/10\ of 1
percent growth to 1.4 percent growth, for the fourth quarter of
last year. Which leads me to ask the question, what kind of
economic statistics do we have, if the margin of error is going
to be of that magnitude?
In other words, when trying to frame public policy, we look
at an economic report and a statistic, it says, the growth in
the fourth quarter was \2/10\ of 1 percent. So your thinking is
geared to that. It is an important figure, that growth figure.
Then they come in and they do the revision and now we are
told it was 1.4 percent. Well, that could lead to a different
judgment, so, I intend in the question period to explore with
you this economic statistics issue. I also want to make a
couple other observations.
I think everyone now perceives the economy as recovering,
but we expect unemployment to increase and that is, of course,
the projection of the Fed. Over the last year, according to the
Bureau of Labor Statistics, the number of people unemployed for
more than 14 weeks has nearly doubled. Those unemployed for
more than 26 weeks, the current cutoff for unemployment
insurance, also nearly doubled. These figures, in my view, make
a compelling case for the extension of unemployment benefits
above the 26 weeks. We have consistently done that in every
previous recession. We have not yet done it in this one. And I
very much hope that the Congress will see its way clear to
doing that in the very near future.
I just want to underscore again that we are pleased that
the Chairman is back with us. The New York Times has a story
this morning about our economic situation. It says: ``The
Recovery That Defied the Forecasts of Economists.'' And we look
forward to exploring that with you.
Senator Gramm.
STATEMENT OF SENATOR PHIL GRAMM
Senator Gramm. Mr. Chairman, thank you very much.
Chairman Greenspan, thank you for coming before the
Committee. I would just like to make a few points.
First of all, I would like to thank you for the great job
you have done. I think in the wake of someone's birthday, it is
always a good opportunity to say something good about them.
I have been somewhat dumbfounded by criticism, especially
the one that you did not take action to combat the
overspeculation in the high-tech area.
You have to wonder where the hell these critics were when
you appeared before this Committee and talked about irrational
exuberance, and the whole world groaned and complained that you
were talking down the stock market.
I would just have to say that I have had the opportunity to
work in this town and be involved in Government for 24 years.
And in that 24 years, no person has done more to promote the
economic well-being of this country and the people that work
here than Alan Greenspan.
I want to thank you for the great service you have
rendered. As I have said on other occasions, millions of people
who will never know your name have benefited from the service
that you have provided.
On behalf of the 21 million of those people that I
represent, I want to thank you for the great job that you have
done. Capitalism grows in fits and starts. It is the very
nature of a dynamic system that is based on individual
initiative and that is based on new ideas, new vision, and new
leadership in the corporate sector, and good and bad leadership
in Government.
The duty of the Fed Chairman is to try to set a monetary
policy that maximizes the economic growth that we can get and
minimizes the variance about that mean.
I just want to conclude by saying that in the 24 years that
I have been involved in public policy, and in the years that
you have been Chairman of the Federal Reserve Bank, I do not
think anybody could have or ever has done a better job of
achieving a combination of those two objectives--to set the
framework in which productivity and the energies of a free
people can promote economic growth, and to provide a monetary
policy that tries to minimize the variance about the mean that
is created by these basic forces in the most dynamic free
society in history. So, I appreciate the great job you have
done and it has been a privilege for me to work with you.
Chairman Greenspan. Thank you very much, Senator.
Chairman Sarbanes. Senator Johnson.
COMMENTS OF SENATOR TIM JOHNSON
Senator Johnson. Thank you, Mr. Chairman, for holding this
hearing.
Welcome to Chairman Greenspan.
In order to expedite an opportunity to hear from Chairman
Greenspan, I have an opening statement relative to some
questions that I would like to present to Chairman Greenspan,
as well as an observation relative to future hearings on the
capitalization needs in Indian country, and I am going to
submit that statement for the record.
Chairman Sarbanes. Without objection, the full statement
will be included in the record.
Senator Bennett.
COMMENT OF SENATOR ROBERT F. BENNETT
Senator Bennett. I have no comment, Mr. Chairman. I will
wait to hear the witness.
Chairman Sarbanes. Senator Bayh.
COMMENT OF SENATOR EVAN BAYH
Senator Bayh. Thank you, Mr. Chairman. I am looking forward
to hearing from Chairman Greenspan and I will save my comments
for the questions.
Chairman Sarbanes. Senator Hagel.
COMMENT OF SENATOR CHUCK HAGEL
Senator Hagel. I have no statement, Mr. Chairman. I look
forward to the comments.
Chairman Sarbanes. Senator Carper.
STATEMENT OF SENATOR THOMAS R. CARPER
Senator Carper. Thank you, Mr. Chairman.
Chairman Greenspan, I was listening to Senator Gramm and
that was one of the nicest things I have ever heard him say
about anybody.
[Laughter.]
I have known him for 20 years.
[Laughter.]
Yesterday might have been your birthday, but that is a
pretty good present a day late. I think it reflects the views
of a lot of us.
For about the last 8 years I was the Governor of Delaware.
Near the end of my tenure as Governor, and Evan Bayh can
probably reflect on this in his time as Governor. But my the
last year as Governor, somebody said to me, were you the
Governor when we had the ice storm of the century?
And I said, yes.
Were you the Governor when we had the blizzard of the
century?
I said, yes.
He said, were you the Governor when we had the flood of the
century?
I said, yes.
He said, were you the Governor when we had the drought of
the century?
I said, yes.
He said to me, do you know what I think? I said, no. He
said, I think you are bad luck.
[Laughter.]
Compare my record to yours. You have been Chairman of the
Federal Reserve when we have had the longest running economic
expansion in the history of our country. And you have been the
Chairman of the Federal Reserve during what appears to have
been the shortest recession, at least as far as we can recall.
That is a pretty good record.
I am one who believes that we should go out on top. But I
do not believe that you should go out any time soon. So, I
would just suggest that to you.
You testified before us, almost 5 or 6 months ago. We were
just beginning at the time to debate what kind of economic
recovery package or economic stimulus package that we should
consider. And your advice to us at the time was something to
the effect, it is better to be right than fast. I do not know
if those were your exact words, but something to the effect, it
is better to be right than fast.
As it turns out, we were not fast. But in the end, I think
we came out all right. And when you look back at how short the
recession was and how we seem to be coming out of it fairly
nicely, I am reminded of at least 3 factors that have been at
play.
The first of those is the most aggressive monetary policy
that I have witnessed in my lifetime that you have led. The
second is just some good luck. Energy prices have dropped
precipitously across the country and around the world. And the
third factor is, we are doing a fair amount of deficit
spending, fighting the war in Afghanistan, the war against
terrorism, helping New York State and the airline industries
and others and pumping a fair amount of red ink into the
economy to help bolster it. All of which I think factor in to
shorten the recession that we have gone through.
We have before us today, this week, probably next week,
comprehensive energy legislation. It is before the Senate. A
number of proposals that would help us to create more energy. A
number of proposals that would help us to conserve more energy.
When we get to the Q&A's, I would hope to have an
opportunity, not just to talk about monetary policy, but to
revisit with you the need for us to move on that front in order
to better ensure a longer lasting economic recovery in the
years ahead. Thank you very much. And thank you again for your
stewardship.
Chairman Sarbanes. Thank you very much, Senator Carper.
Senator Bunning.
STATEMENT OF SENATOR JIM BUNNING
Senator Bunning. Thank you, Mr. Chairman.
I would like to thank the Chairman of the Federal Reserve
for testifying today. It is once again time for the biannual
monetary policy report.
Generally, I agree with Senator Gramm on about 99 percent
of the things that he says. Today, I do not. Mr. Greenspan,
once again today, I will probably be the only skunk at the
garden party. Sometimes I feel like the lone voice crying out
in the wilderness about our monetary policy. I just want to
make sure you know, to quote ``The Godfather,'' it is business,
not personal.
It looks like we are coming out of this recession and I am
guardedly optimistic, but I am not sure that we are not in the
middle of a double-dip, where we start to come out and then go
right back down again. I hope that is not the case.
Mr. Chairman, one thing we have talked about before that I
would like to highlight again today is my belief that we did
not have to have a recession at all. I think that you
unilaterally popped the bubble in the stock markets and that
helped precipitate the economic downturn. And I do not think
that is your job.
I also do not think it is your job to jawbone market gains
and to declare that gains were a product of irrational
exuberance.
No one individual should be able to influence the market so
much and to be able to take trillions of dollars of market
capital out of this economy.
I know many of us have gotten lumps in our throats watching
our 401(k) plans go down recently. We talked about it before,
how the Fed's duty is to focus on monetary policy and should
not overlap into equities.
When I tried to talk to the people back home about these
issues, their eyes sometimes glaze over. But these are real
issues and the millions of workers who lost their job in the
recession now have real problems. These folks are not just
statistics.
It may surprise you that I think you do a good job when you
do what you are supposed to do. I think we all acknowledge the
Fed has moved aggressively over the past year. Once the Fed got
going, it did respond. I also think that the Fed did a very
good job after September 11 to help shore up the confidence in
our markets.
You should be commended for that, and that might have
helped limit the damage. But there was damage even before
September 11, damage that I do not think we should have had.
The Fed came to help, but it was too late in coming.
Mr. Chairman, thank you again for coming before this
Committee and I look forward to digging into these issues a
little bit more during the question-and-answer period.
Chairman Sarbanes. Thank you very much, Senator Bunning.
Senator Stabenow.
COMMENTS OF SENATOR DEBBIE STABENOW
Senator Stabenow. Well, thank you, Mr. Chairman.
I would like to associate myself with Senator Gramm and
reiterate the fact that you did come before our Committee and
talk about irrational exuberance and did speak with caution
about what was occurring in the economy. I appreciate the fact
that the Fed has acted aggressively.
I would only say that, as a Member of the Budget Committee,
as we look to the long term, that while we are seeing some
glimmers of hope, and I certainly want to hear from you this
morning about your view the economy and where we are going, but
we certainly know that we have many challenges left in the long
term as we look at the budget and the economy.
And I would have to say that while academics were debating
last year whether or not we were technically in a recession, in
my great State of Michigan, you only had to look to the iron
ore mines in the upper peninsula or our cities in Detroit or
Flint, or our farmers trying to get a good price for their
products, to understand that this has been a challenging time
for many families and many business people in our country. I
appreciate your being here again and I look forward to your
comments.
Chairman Sarbanes. Thank you very much, Senator Stabenow.
Senator Crapo.
COMMENTS OF SENATOR MIKE CRAPO
Senator Crapo. Thank you very much, Mr. Chairman.
I too want to thank you, Chairman Greenspan, for coming
here for your annual report on monetary policy. And I look
forward, as has been indicated by a number of the others here,
to discussing a number of the issues relating to our monetary
policy with you.
Just to kind of get a heads-up for where I may be headed in
my questioning, as I am sure you are already aware, there is a
proposal now coming up before Congress dealing with derivatives
and whether we are currently governing them in the right way,
and basically whether the Commodities Futures Modernization Act
that we passed a few years ago has approached the issue
properly.
I am very concerned that we may be addressing this issue in
Congress without any hearings, without any analysis, and simply
having an amendment coming up on the floor which has not had
the kind of evaluation that is going to be necessary for us to
make the right decision here. And I am going to be asking for
your input on that issue.
With that, Mr. Chairman, I thank you for holding this
hearing.
Chairman Sarbanes. Thank you very much.
Senator Corzine.
COMMENTS OF SENATOR JON S. CORZINE
Senator Corzine. Thank you, Mr. Chairman.
I would like to join with those who speak about
appreciation for your thoughtful and balanced leadership with
regard to economic issues in this country and your remarkable
tenure. Thank you.
Chairman Sarbanes. Senator Allard.
COMMENTS OF SENATOR WAYNE ALLARD
Senator Allard. Mr. Chairman, I just want to join my
colleagues to welcome Chairman Greenspan and look forward to
his comments. I have some comments that I would just like to
submit for the record.
Chairman Sarbanes. Very good. Mr. Chairman, we would be
happy to hear from you.
STATEMENT OF ALAN GREENSPAN
CHAIRMAN, BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
Chairman Greenspan. Thank you very much, Mr. Chairman, and
Members of the Committee.
Since July, when I last reported to the Committee on the
conduct of monetary policy, the U.S. economy has undergone a
period of considerable strain, with economic output contracting
for a time and unemployment rising.
Chairman Sarbanes. Mr. Chairman, I think if you pulled the
microphone a little closer, it would be helpful.
Chairman Greenspan. We in the Federal Reserve System acted
vigorously to adjust monetary policy in an endeavor both to
limit the extent of the downturn and to hasten its completion.
Despite the disruptions engendered by the terrorist attacks of
September 11, the typical dynamics of the business cycle have
reemerged and are prompting a firming in economic activity. The
recent evidence increasingly suggests that an economic
expansion is already well under way, although an array of
influences unique to this business cycle seems likely to
moderate its speed.
One key consideration in the assessment that the economy is
moving through a turning point is the behavior of inventories.
Stocks in many industries have been drawn down to levels at
which firms will soon need to taper off their rate of
liquidation, if they have not already done so. Any slowing in
the rate of inventory liquidation will induce a rise in
industrial production if demand for those products is stable or
is falling only moderately. That rise in production will, other
things being equal, increase household income and spending.
But that impetus to the growth of activity will be short-
lived unless sustained increases in final demand kick in before
the positive effects of the swing from inventory liquidation
dissipate. We have seen encouraging signs in recent days that
underlying trends in final demand are strengthening, although
the dimensions of the pickup remain uncertain.
Through much of last year's slowdown, however, spending by
the household sector held up well and proved to be a major
stabilizing force. As a consequence, although household
spending should continue to trend up, the potential for
significant acceleration in activity in this sector is likely
to be more limited than in past cycles.
While consumer demand will have important consequences for
the economic outlook in coming months, the broad contours of
the present cycle have been, and will continue to be, driven by
the evolution of corporate profits and capital investment.
The retrenchment in capital spending over the past year and
a half was central to the sharp slowing we experienced in
overall activity. These cutbacks in capital spending interacted
with, and were reinforced by, falling profits and equity
prices. Indeed, a striking feature of the current cyclical
episode relative to many earlier ones has been the virtual
absence of pricing power across much of American business, as
increasing globalization and deregulation have enhanced
competition.
Part of the reduction in pricing power observed in this
cycle should be reversed as firming demand enables firms to
take back large price discounts. Though such an adjustment
would tend to elevate price levels, underlying inflationary
cost pressures should remain contained.
Improved profit margins and more assured prospects for
rising final demand would likely be accompanied by a decline in
risk premiums from their current elevated levels toward a more
normal range. With real rates of return on high-tech equipment
still attractive, that should provide an additional spur to new
investment. However, the recovery and overall spending on
business fixed investment is likely to be only gradual.
Even a subdued recovery would constitute a truly remarkable
performance for the American economy in the face of so severe a
decline in equity asset values and an unprecedented blow from
terrorists to the foundations of our market systems. For, if
the tentative indications that the contraction phase of this
business cycle has drawn to a close are ultimately confirmed,
we will have experienced a significantly milder downturn than
the long history of business cycles would have led us to
expect.
The imbalances that triggered the downturn and that could
have prolonged this difficult period did not fester. The
obvious questions are what has changed in our economy in recent
decades to provide resilience and whether such changes will
persist into the future.
Doubtless, the substantial improvement in the access of
business decisionmakers to real-time information has played a
key role. The large quantities of data available virtually in
real time allow businesses to address and resolve economic
imbalances far more rapidly than in the past.
The apparent increased flexibility of the American economy
arguably also reflects the extent of deregulation over the past
quarter century.
Both deregulation and innovation in the financial sector
have been especially important in enhancing overall economic
resilience. New financial products, including derivatives, have
enabled risk to be dispersed more effectively to those willing
to, and presumably capable of, bearing it. Shocks to the
overall economic system are accordingly less likely to create
cascading credit failure. Despite the concerns that these
complex instruments have induced--and that is an issue that I
will address shortly--the record of their performance,
especially over the past couple of stressful years, suggests
that on balance they have contributed to the development of a
far more flexible and efficient financial system--both
domestically and internationally--than we had just 20 or 30
years ago.
As a consequence of increased access to real-time
information and, more arguably, extensive deregulation in
financial and product markets and the unbundling of risk,
imbalances are more likely to be readily contained, and
cyclical episodes overall should be less severe than would be
the case otherwise.
However, the very technologies that appear to be the main
cause of our apparent increased flexibility and resiliency may
also be imparting different forms of vulnerability that could
intensify or be intensified by a business cycle.
From one perspective, the ever-increasing proportion of our
GDP that represents conceptual as distinct from physical value
added, may actually have lessened cyclical volatility. In
particular, the fact that concepts cannot be held as
inventories means a great share of GDP is not subject to the
type of dynamics that amplifies cyclical swings. But an economy
in which concepts form an important share of valuation has its
own vulnerabilities.
As the recent events surrounding Enron have highlighted, a
firm is inherently fragile if its value added emanates more
from conceptual as distinct from physical assets. A physical
asset, whether an office building or an automotive assembly
plant, has the capability of producing goods or services even
if the reputation of the managers of such facilities falls
under a cloud. The rapidity of Enron's decline is an effective
illustration of the vulnerability of a firm whose market value
largely rests on capitalized reputation. The physical assets of
such a firm comprise a small proportion of its asset base.
Trust and reputation can vanish overnight, whereas, a factory
cannot.
The implications of such a loss of confidence for the
macroeconomy depend importantly on how freely the conceptual
capital of the fading firm can be replaced by a competitor or a
new entrant into the industry. Even if entry is relatively
free, macroeconomic risks can emerge if problems at one
particular firm tend to make investors and counterparties
uncertain about other firms that they see as potentially
similarly situated. The difficulty of valuing firms that deal
primarily with concepts and the growing size and importance of
these firms may make our economy more susceptible to this type
of contagion.
Another, more conventional determinant of stability will be
the economy's degree of leverage, the extent to which debt
rather than equity is financing the level of capital. A
sophisticated financial system, with its substantial array of
instruments to unbundle risks, will tend toward a higher degree
of leverage at any given level of underlying economic risk.
But, the greater the degree of leverage in any economy, the
greater its vulnerability to unexpected shortfalls in demand
and mistakes.
Although the fears of business leverage have been mostly
confined to specific sectors in recent years, concerns over
potential systemic problems resulting from the vast expansion
of derivatives have emerged with the difficulties of Enron. To
be sure, firms like Enron and Long-Term Capital Management
before it, were major players in the derivatives markets. But
their problems were readily traceable to an old-fashioned
excess of debt, however acquired, as well as to opaque
accounting of that leverage and lax counterparty scrutiny.
Swaps and other derivatives throughout their short history,
including over the past 18 months, have been remarkably free of
default. Of course, there can be latent problems in any market
that expands as rapidly as these markets have. Regulators and
supervisors are particularly sensitive to this possibility.
Derivatives have provided greater flexibility to our
financial system. But their very complexity could leave
counterparties vulnerable to significant risk that they do not
currently recognize, and hence these instruments potentially
expose the overall system if mistakes are large. In that
regard, the market's reaction to the revelations about Enron
provides encouragement that the force of market discipline can
be counted on over time to foster much greater transparency and
increased clarity and completeness in the accounting treatment
of derivatives.
How these countervailing forces for stability evolve will
surely be a major determinant of the volatility that our
economy will experience in the future. Monetary policy will
have to be particularly sensitive to the possibility that the
resiliency that our economy has
exhibited during the past 2 years signals subtle changes in the
way our system functions.
Although there are ample reasons to be cautious about the
economic outlook, the recuperative powers of the American
economy, as I have tried to emphasize in my presentation, have
been remarkable. When I presented our report on monetary policy
to this Committee last summer, few if any of us could have
anticipated events such as those to which our Nation has
subsequently been subjected.
The economic consequences of those events and their
aftermath are an integral part of the many challenges that we
now collectively face. The U.S. economy has experienced a
substantial shock, and, no doubt, we continue to face risks in
the period ahead. But the response thus far of our citizens to
these new economic challenges provides reason for
encouragement.
Thank you very much, Mr. Chairman. I would appreciate if my
full remarks were included for the record.
Chairman Sarbanes. The full statement will be included in
the record, without objection. And thank you for your
testimony.
Since the opening statements, we have been joined by
Senators Dodd, Ensign, and Akaka. I will yield to them now for
any opening statement they may have before we go to questions
for Chairman Greenspan.
Senator Dodd.
COMMENT OF SENATOR CHRISTOPHER J. DODD
Senator Dodd. Mr. Chairman, I just ask unanimous consent
that my statement be included in the record and I look forward
to the questions.
Chairman Sarbanes. Very good.
Senator Ensign.
COMMENTS OF SENATOR JOHN ENSIGN
Senator Ensign. No opening statement, Mr. Chairman.
Chairman Sarbanes. Senator Akaka.
COMMENT OF SENATOR DANIEL K. AKAKA
Senator Akaka. Mr. Chairman, I have a statement and I will
submit it for the record.
Chairman Sarbanes. It will be included in full in the
record.
Mr. Chairman, I would like to come back to this two-tenths
of 1 percent growth figure that the Commerce Department gave us
as the initial figure on fourth-quarter growth, revised to 1.4
percent.
Now, I take it that is a revision of sufficient magnitude
and consequence that we ought to have some concern about the
accuracy of our economic statistics.
Chairman Greenspan. Well, the cause of that, Mr. Chairman
is that the Commerce Department, the Bureau of Economic
Analysis, chooses to make an early estimate of the gross
domestic product for a quarter just passed before it has all of
the important information. In this particular case and, indeed,
in all of these advanced reports, two major items of exclusion
which are never available at the point at which they make the
earliest estimate, are, one, inventory change for the last
month of a quarter and, two, the trade figures for the last
month.
Both of those numbers can be really quite difficult to
judge. And what happens in the early data is that technicians
at the Department of Commerce endeavor to make their best
judgments as to what those numbers are likely to be.
They publish their judgments, so it is not a black box
which people who are trying to evaluate the numbers are unable
to understand. And since those of us who endeavor to follow the
GDP as it moves from one month to the next in its quarterly
format are able to judge as the new monthly data comes in,
whether in fact the numbers published--the last published set
of numbers by the Department of Commerce--are going to be
revised.
Most people can reasonably judge what the nature of the
revisions is going to be because they know what plugged numbers
the Department of Commerce put in for data they did not have.
Now, to be sure, that does create significant changes, as
you just cited a particularly large one. The question would be,
would we be better off if we did not have the advanced report?
And I suggest the answer to that is no, it does help. But I do
think it is important to point out that these numbers are
subject to significant revision. Rarely do they give an
impression of the economy which is false.
Chairman Sarbanes. Presumably, they might have some impact
on consumer outlooks and consumer confidence because I want to
move now to consumers in this economic situation.
Generally speaking, consumer demand has held up pretty
well, as I understand it. It is in fact what has cushioned the
downturn. The question then becomes whether it is been used up,
in a sense.
In previous sessions, when consumer demand slackens, it
then picks up as we move into a recovery period and provides a
boost for the economic recovery. That may not be there this
time. What is your view on that question?
Chairman Greenspan. Well, I think that is an important
point to make, Mr. Chairman.
In past periods of significant contraction, when inventory
liquidation was a major factor pushing the economy down,
consumer durable demand and homebuilding also tended to be much
lower. And that was largely because interest rates at the top
of the cycle were usually relatively high and that suppressed
demand for housing and durables.
When we got to the bottom of the cycle, as inventory
liquidation started to slow and turn the economy around, there
was an unmet demand for a number of motor vehicles and other
consumer durable goods and new homes. And they tended to come
back together and as a consequence of that, my recollection is
that the average rate of increase in the first year after a
recession ended has been something like 7 percent.
This is almost certainly not going to be the case this
time. And one of the reasons, as you point out, is we never
went down and, consequently, the ability to go back up is
limited because no matter how one looks at it, both motor
vehicles have been doing really quite extraordinarily well, as
well as homebuilding.
So that there is very little upside potential to carry
through. And that is the reason why I made my remarks in my
formal text about the need for final demands to kick in prior
to when the obvious significant increase in economic activity
that is occurring now as a consequence of inventory liquidation
slowing down finally dissipates.
Chairman Sarbanes. Yes. Well, my time is expired.
Senator Gramm.
Senator Gramm. Thank you, Mr. Chairman.
Alan, I have three short questions and then a longer
question. Let me try and give them to you briefly, and if you
could just give me a short statement on them.
As you know, there is an effort afoot in both the House and
the Senate to raise the level of deposit insurance. Could you
tell me where you stand on that?
Chairman Greenspan. We just recently had letters from both
Chairman Bachus and Congressman LaFalce with respect to where
the Federal Reserve Board is. What we have done is essentially
indicated that for most of the bill which is being considered
in the House, we find ourselves as a Board in agreement.
We do not, however, subscribe to any change in the level of
coverage of deposit insurance because all of our analysis has
indicated the need for it is clearly not evident in the data
that we have.
And obviously, because there is some indication coming from
the Federal Deposit Insurance Corporation that losses will be
rising and, indeed, the so-called ratio of reserves to deposits
that is relevant, as I recall came down to 1.27 at the end of
the fourth quarter, and there is a statutory requirement to do
things at 1.25.
So it strikes me that if we move to any significant
expansion of coverage, we are going to have to start boosting
premiums. And I am not sure that that in total is a
particularly useful activity.
But most importantly, I think that we have to be very
careful about the extent to which we create the levels of
subsidy within our system to make certain that they are
contained so that the probabilities of systemic risk which come
as a consequence of them, are also contained.
Senator Gramm. Okay. Let me go to the next two questions.
We passed a security litigation reform bill, I believe in
1995. We had a series of lawsuits where one big law firm had
about 80 percent of the business and they literally had a
boilerplate complaint. And if a company put out a prospectus on
what it expected to do in the future, and they did better, it
took that boilerplate thing and filed a lawsuit. If it did not
do as well, it filed a lawsuit.
What we tried to do is tighten up on the process, bring all
those lawsuits to Federal court since the securities market is
a national market.
There is an effort underway to try to repeal that provision
or substantially cut back on it. I would like to get you to
comment on that. And also, the effort that might be underway to
regulate energy derivatives and energy swaps.
Chairman Greenspan. Senator, as I recall, when the original
discussions of that legislation a number of years ago
developed, we did not, I think, have a position on it as such,
but I personally thought it struck me as a sensible idea
because we have to be very careful in the functioning of our
financial markets that we do not get swamped with lawsuits or
challenges to the form of corporate governance and the whole
structure of security issuances, beyond what is necessary to
maintain the soundness and stability of the system.
I have not been familiar with how successful, or lack
thereof, that has been, so I cannot really comment on what has
occurred. But certainly, the original principle strikes me as
the correct one. And unless the evidence to date has indicated
that that is wrong, I would presume that, at least from my own
personal view, I would not change.
With the issue of energy derivatives, as you may recall, in
the Commodity Futures Modernization Act of 2000, we went over
that issue in very considerable detail. The main issue involved
was to recognize the extraordinary importance to improving our
financial system of the whole derivatives market. And we were
concerned about a numbers of things which included the
uncertainties with respect to whether or not they were legally
binding.
And we came up with a bill which, I think in retrospect,
was an exceptionally good bill. What it did with respect to
energy derivatives--or I should be more exact--over-the-counter
energy derivatives, was to recognize that public policy
essentially focuses on three issues in this respect. First is
consumer protection. The second is anti-manipulation. And the
third is pricing systems which are not opaque so that we can
understand what is going on.
In the second two, the CFTC still has authorities to act
against manipulation and act against systems in which it
appears that pricing is not being appropriately indicated to
the marketplace.
The issue of consumer protection does not, or did not, in
our view, apply--I am talking about the President's Working
Group, as you may remember. The President's Working Group said
it did not apply to transactions amongst professionals.
Now, it was crucially important that we allow those types
of markets to evolve amongst professionals who are most capable
of protecting themselves far better than either we, the Fed,
the CFTC, or the SEC could conceivably do.
The important issue is that there is a significant downside
if we regulate where we do not have to in this area because one
of the major and, indeed, the primary, area for regulation and
protection of the system is counterparty surveillance; that is,
the individual private parties looking at the economic events,
looking at the status of the people with whom they are doing
business, with whom they have this derivative transaction. We
have to allow that system to work because if we step in as
Government regulators, we will remove a considerable amount of
the caution that is necessary to allow those markets to evolve.
And while it may appear to be sensible to go in and
regulate, all of our experience is that there is a significant
downside when you do not allow counterparty surveillance to
function in an appropriate matter.
Chairman Sarbanes. Senator Bayh.
Senator Bayh. Thank you very much, Mr. Chairman, and
Chairman Greenspan.
I would like to begin by asking two questions regarding
productivity growth, which, as you know, is so critically
important to our economic and fiscal estimates.
There was an excellent paper prepared by Dale Jorgensen of
Harvard, Monhoe and Kevin Sterow--I hope I pronounced that
correctly--regarding the methodology of productivity growth
forecasts.
Their conclusions, if I could just summarize them, were
that the productivity revival of the 1995 to 2000 period
remains largely intact, that information technology investments
were critical to that revival, and that going forward over the
next decade, they project only some slightening of that
productivity growth.
This is an important analysis. I was wondering if, and you
and I have chatted about this, there has been some work at the
Fed.
Any update on their thesis that, to my understanding, the
difference between state-of-the-art technology, the competitive
advantage that it affords, and mean technology is expanding,
giving added impetus for investing in technology, which will
keep this productivity growth advancing.
Chairman Greenspan. Senator, that is a crucial issue which
a number of people are beginning to look at. There have been
certain papers which suggest, indeed, that there has been an
opening up of the difference between what you might say are the
ultimate cutting-edge technologies and the average application
that exists in the economy.
It is too soon to conclude that. Indeed, if the conclusion
is accurate, obviously, it says a great deal about the
potential for the future. But I do not think we have gotten to
the point at this stage where we can confirm that that is the
case.
The general notion, however, that something fundamentally
important happened in the last 4 or 5 years is continuously
being reaffirmed quarter by quarter and in the most recent
period because, even as I indicated at the peak of the
acceleration in economic activity and of productivity growth,
we did not at that point have a real test of how the structure
of productivity would respond when the economy weakened.
Now, we have been through a period like that and the result
is, if anything, somewhat suspiciously too strong, in the sense
that, as you may know, this morning, the Department of Labor
issued an estimate of productivity growth for the nonfarm
business sector in the fourth quarter of last year and they
revised the number up to 5.2 percent at an annual rate.
Senator Bayh. Remarkably robust under the circumstances.
Chairman Greenspan. Not only remarkably robust, but also
very unlikely, if I may put it that way.
Senator Bayh. That gets to your questions, Mr. Chairman.
Chairman Greenspan. But what it does suggest is that, if
you smooth through the noise in the data, we are getting
increasing confirmation that something fundamentally important
did happen in the latter part of the 1990's and it does give us
some confidence projecting forward into the future.
Senator Bayh. Certainly very good news going forward.
Mr. Chairman, I would like to ask if you have an opinion on
an accounting issue that may indirectly, have some impact on
productivity in the longer term, specifically with regard to
the treatment of stock options.
We had some leaders in the high-tech community on Capitol
Hill yesterday. This is a matter of great concern to them.
Their argument is that the change in the treatment of stock
options will limit their ability to attract and retain high-
quality people and that requiring these to be expensed will
affect their income statements, their ability to attract
capital, that even in the event that the options turn out to
not be worth what they originally were calculated at being
worth.
So there is a great deal of concern. Innovation is so
important to the new economy, growing productivity growth
rates. Do you have an opinion about the treatment of these
options?
Chairman Greenspan. I can speak for myself, but I cannot
speak for the Federal Reserve Board because I have not
discussed it with them.
The question basically is that stock options are a
replacement for cash compensation. And if they are not that,
what are they, as I think my good friend Warren Buffet once
said.
The truth of the matter is that if you do not expense the
granting of stock options or their realization in the income
statement, as indeed, we are required in our tax forms, then
you will get a pre-tax income which is higher than one can
argue you really had and the estimates by the Federal Reserve
suggest that somewhere in excess of 2\1/2\ percent of the
growth rate per year in earnings of major corporations is the
result of this nonexpensing of stock options.
I do not deny that earnings would be lower if you expensed
them. I do not deny that there may be greater difficulty in
attracting capital with presumed lower earnings than you would
otherwise have. I do not disagree with the fact that if the
company has lower earnings, that people may not be attracted to
come to the firm. But there is no reason why you cannot issue
stock options if you wish to attract people. It does not affect
them. If the stock price goes up, they get the rewards.
The only thing that is involved is the issue of, the
question, is income being properly recorded? And I would submit
to you that the answer is no. I do not understand why there is
an issue here of great moment. The data does show that when you
have a significant amount of stock options which are not
expensed, and the higher the proportion that that affects pre-
tax income, the greater the volatility of the return from the
stock.
So the answer is yes. People argue that they are likely to
get less capital, but that is only if the people who are
lending to them just do not know how to count because these
data are reported in footnotes. It does not require very much
to figure out what part of the pre-tax income of any
corporation which is issuing stock options is the result of
stock options in lieu of compensation of employees.
So the only issue here is, if you gain something, you are
gaining something because people who are giving you something
just did not quite understand what in fact they were reading.
It is their fault. They should be doing the calculations.
But nothing happens in the real world with respect to this
question because for tax purposes, you have to expense it. If
you issue options and the stock prices goes up, the effect of
what the individual employee gets is there, wholly independent
of what the company did with respect to the issue of earnings.
Now if the stock market does not know what is going on and
it overprices the stock because the earnings numbers are
bigger, that is just because securities analysts are lazy.
Senator Bayh. Thank you, Mr. Chairman.
Chairman Sarbanes. Senator Bennett.
Senator Bennett. Thank you, Mr. Chairman.
Chairman Greenspan, I assume, given all of the other things
that you read, you have been familiar with the three columns
now that have run in The Wall Street Journal by Robert Bartley,
addressing the issue of whether or not spending stimulates the
economy, deficits stimulate the economy, surpluses stimulate
the economy, and for his final effort, marginal tax rates
stimulate the economy.
I find this series very interesting, not only because I
know Mr. Bartley and have respected his opinion over the years,
but also because these are the fundamental questions that we as
policymakers have to face as we address fiscal policy.
Should we encourage surpluses at the expense of everything
else? Should we encourage deficits in the name of stimulating
the economy? Should we say that as long as they are within
various ranges, deficits and surpluses do not really matter?
And the most important thing to focus on is the tax level.
Right now, as a percentage of GDP, the tax burden is the
highest it has been probably in history. And as you look ahead
into the future, with your crystal ball, admittedly, clouded,
but probably a little less clouded than ours, would you comment
on this controversy about the impact of the size of a deficit,
the impact of the size of a surplus, and the impact of the
overall tax burden on the prospect for future economic growth?
Chairman Greenspan. Well, first, Senator, let me just
comment that the ratio of total Federal taxes over GDP is
indeed at a record high, or at least it was up until very
recently. We have to be a little careful because the GDP, the
denominator of the ratio, does not include capital gains, as
you know.
Senator Bennett. Yes.
Chairman Greenspan. Yet a significant part of the tax
receipts in recent years has reflected either the capital gains
tax, which has been quite substantial, or the issue I was just
mentioning with Senator Bayh, namely, a very substantial amount
of tax receipts that occur as a consequence of the exercise of
stock options.
And both of those items have been particularly large parts
of the numerator of that ratio. I have forgotten what happens
if you take them out, but it does look a good deal less
burdensome.
Nonetheless, the issue of taxes rising because, as real
incomes rise, they gradually get up into ever-increasing tax
brackets, so, indeed, one has to be very careful about that.
And I must say I find myself in substantial agreement with Mr.
Bartley on the question of marginal tax rates and I think it is
important. If economic growth is a particular purpose, which it
should be, of economic policy, then I think that is an
obviously critical issue.
The questions of when you have surpluses or deficits and
the like, is a far more controversial issue because I suspect
that it varies depending on the circumstances.
I also come out pretty much where he does on most of those
issues. But in certain places, I do not. On the issue of
surpluses in the most recent period, I think they have created
some value, especially in reducing long-term real interest
rates, and I think that has been an effective factor in the
last several years.
But there is no question that it is important that in
approaching various different forms of economic policy in
Government, that we have answers to those questions.
As you know, Senator, most economists would agree that, in
evaluating the effects of various different fiscal policies, it
would be far better to use what we call dynamic scoring, that
is, the ability to get the interaction of the effect, as well
as the initial impact.
The only problem is that the interaction is a function of
the particular model you are using, and no one can quite agree
on what the appropriate model is. So that we have fallen back
to a static analysis, which we can all somehow agree on as the
first stage of the effect. But the questions that Bob Bartley
is raising get into all of these questions. And while we do not
choose to address them, that does not mean that we are not in
fact making judgments about them.
In certain instances, we are making very specific
adjustments. In our budgetary analysis, we are saying that the
secondary impacts of tax and spending programs are zero. Now,
we know that to be false. But we are making those judgments
because we have no alternative.
So, I think it is an issue which is not going to get
resolved easily, and probably requires continuous evaluation.
But I think that Mr. Bartley is raising some of the crucial
issues which essentially are closely involved with the type of
decisionmaking which this body must make.
Senator Bennett. Thank you.
Chairman Sarbanes. Thank you, Senator Bennett.
Senator Stabenow.
Senator Stabenow. Thank you, Mr. Chairman.
Again, Chairman Sarbanes, we appreciate your comments.
I was particularly interested in your raising the issues of
conceptual capital versus physical assets. I have had concern
for some time particularly, again, coming from Michigan, where
we turn those concepts into physical assets.
We are seeing more and more relationship between Silicon
Valley and Automation Alley, which is a high-tech manufacturing
corridor in Michigan.
I am concerned that we keep that balance. I appreciate what
you have raised, not only the positives of concepts, but also
the negatives that occur from that. I think that is an
important issue for us long-term in the economy, as we move
forward, and particularly, coming from a State that brings iron
ore out of the ground and makes steel and all the implications
that relate to having physical assets, which I think are a
foundation for us in the economy. Many of those involved in
those industries have raised a concern about credit standards
that I wondered if you might speak to.
I understand that lenders are tightening their terms and I
am concerned about the negative impact, particularly for our
smaller businesses, as we come out of the recession.
I am wondering if you think that the higher credit
standards are justified or if they are an overreaction or a
misperception of the current economic risks.
Chairman Greenspan. You are quite correct. Our surveys do
pick up on that evidence of tightening. And it is clearly
appropriate in many respects, if not most respects, because the
balance sheets of borrowers have deteriorated over the last 18
to 24 months. Profit margins are down quite significantly. So
the actual creditworthiness of borrowers has come down.
There has, however, been no evidence of anything remotely
resembling the credit crunch that we had a decade ago, where
you just could not get a loan out of a commercial bank no
matter what your creditworthiness was, at least in some cases.
The data that we have do not suggest that there is a credit
crunch in small business, but undoubtedly numerous small
businesses are having difficulty. One hopeful sign is that the
economy appears to be turning and credit tends to come in with
a lag. So that to the extent that numbers of firms, especially
small firms, are finding difficulty in getting the credits they
need at the prices they can afford to pay, that is likely to
change to the better.
Our commercial banking system has come through this period
really quite effectively. It bodes well to the future of the
system as a whole.
Senator Stabenow. I wonder if you might also address
another issue of concern to our U.S. manufacturing sector.
Glenn Hubbard, the Chairman of the President's Council of
Economic Advisers, noted in a speech that U.S. manufacturing
jobs and our manufacturing exports have been badly hurt by a
strong dollar.
I know we are particularly concerned about the excessively
weak yen. And I wonder if you would comment if you believe that
that is in fact a serious issue and what you would comment
about that.
Chairman Greenspan. When your dollar strengthens, as ours
has, clearly, it creates lesser competitive capability for
exporting. And to the extent that that impacts on the job
market it is a negative in that respect.
But manufacturing jobs have been falling for quite a long
period of time, not because manufacturing is disappearing, but
because productivity, output per hour in manufacturing plants,
has really accelerated and they are doing an exceptional job.
So as a percent of the GDP, there has not been all that much
change in manufacturing. As a percent of the total workforce,
manufacturing jobs have been falling fairly appreciably for a
while.
One can hardly argue--I should say, argue against--gains in
productivity. The vast majority of those people who have left
manufacturing jobs obviously have gone into other parts of the
economy
because, as you know, up until fairly recently, the
unemployment rate had gotten to 4 percent and less, which has
been really quite a remarkable performance indicating a major
improvement in labor market flexibility.
Senator Stabenow. I wonder if I might just quickly ask one
more question. That is, regarding the Treasury rule to allow
banks into the real estate, brokerage, and managing business. I
am wondering when you see a rule or what is happening in terms
of the process of considering that regulation?
Chairman Greenspan. Well, Senator, as I am sure you know
better than anyone, we have had a flurry--I should say a
deluge--of letters, comments and the like, on this issue of the
question of real estate brokerage.
We are in the process of processing the data, all of the
information, as we are required to do, and at some point,
hopefully sooner rather than later, we will be able to address
the issue and in working with the Treasury--as you know, the
statute requires a joint decision on this--we will be coming
forth with some conclusion.
Senator Stabenow. Thank you.
Thank you, Mr. Chairman.
Chairman Sarbanes. Thank you very much, Senator Stabenow.
Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman.
Last year, Chairman Greenspan we were in a recession. I
think that it started early in the fall of 2000. I let you know
my thoughts then, that we should start loosening our monetary
policy. I continued to argue that we should have loosened it
all the way through the fall.
The Fed finally did start seriously loosening it in
January. But by then, the damage had been done. I have been
highly critical of the Fed on the recession for two reasons.
First, I think your attempts to pop the Nasdaq bubble
greatly contributed to the recession. And I think the word you
used about a year and a half ago was something about a wealth
effect. I do not think it is the place of you or the Federal
Reserve to pop these so-called bubbles.
Second, I believe the Fed acted entirely too slowly in
responding to the signs of an economic slowdown. I believe that
this past recession could have been lessened, if not avoided,
and a lot of people would not have lost their jobs.
I also think that part of the problem is you need to have
more independent voices at the Fed who will stand up and say
when they think you are wrong on issues. Nobody needs the
people around them to simply agree with everything they say.
I think the last two nominees to the Board--Mark Olson and
Susan Schmidt Bies--will be independent voices who will stand
up and not be afraid to tell you when they think you are wrong.
I can tell you this, I would not be as effective as I am as a
Senator if I were surrounded by yes men and women.
I am hopeful that the President nominates more independent
voices for the two current vacancies on the Board. And I think
that we should fill those vacancies as quickly as we can so
that the Board has a full complement of members.
I am not privy to the actual discussions of the meetings of
the Board, so I might be wrong about the independence of the
Board members. But I doubt it. Now to the question. Do you
think the stock market gains this week and last Friday are
products of irrational exuberance, or are they normal market
fluctuations?
Chairman Greenspan. Senator, I do not comment on stock
market fluctuations in the short term. The issues that I raise
really
relate to long-term questions. If I may, can I comment on your
various different points?
Senator Bunning. Absolutely.
Chairman Greenspan. Because I think I will endeavor to get
to your conclusion as best I can.
As I think I indicated to you previously, I do not think we
did pop the bubble, as you may put it. We did raise interest
rates in 1999, and the reason we did is real long-term rates
were beginning to rise because the economy was beginning to
accelerate. Had we not raised the Federal funds rate during
that particular period, we could have held it in check only by
expanding the money supply at an inordinately rapid rate. In
other words, suppress the demand, or I should say, hold
interest rates down by flooding the market. We did not have an
alternative to do that.
Senator Bunning. But you squeezed the money out of the
market and therefore, you forced all those Nasdaq companies,
because they could not go to the market, where they got their
money, to look somewhere else.
Chairman Greenspan. I do not think that is factually
accurate, Senator.
Senator Bunning. Well, we will disagree on that.
Chairman Greenspan. The wealth effect is basically an
analytical issue which refers to the fact that asset price
changes do affect economic activity. Since it is the function
of monetary policy to try to maintain long-term, sustainable,
economic growth, by not evaluating factors as important as the
so-called wealth effect on economic activity would be a
dereliction of our duty, in my judgment.
Senator Bunning. Is it your duty, then, to drive the wealth
effect and make sure that there is no wealth effect?
Chairman Greenspan. No, on the contrary. I have said
innumerable times in years past that when I raised the question
in 1996 as to whether monetary policy ought to address asset
price changes, I subsequently concluded, and I think reported
to this Committee, that it would be inappropriate for the
central bank to be overriding the decisions of millions of
investors in making their value judgments. I do not think, one,
we ought to do that. I do not think that we did do that.
Senator Bunning. But, sir, when you say something that is
contrary or detrimental to the market in a public statement,
the market immediately reacts. If you are positive in your
statements about what is going to happen in the future, the
market reacts. Should one person have that power?
Chairman Greenspan. Well, Senator, the reason I did not
answer the question as you put it is it probably could have an
effect on the market in addressing the question about the
recent stock price change.
Senator Bunning. Are you telling me what you have said
today is exactly--I read your statement twice that you gave the
House. It is almost the exact same statement that you gave the
House.
Chairman Greenspan. Correct. What I am trying to say,
basically, is that we should not be, and do not, as best I can
judge, endeavor to address asset valuations and try to change
them.
What we do is take those changes into consideration as they
impact on the economy and review monetary policy as essentially
a vehicle to try to alter the liquidity of the system in a
manner to maximize economic growth.
And we do not address the issue of trying to change the
wealth effect. We respond to the wealth effect. We do not try,
nor do I think we would ever succeed, in changing the wealth
effect, or I should say, asset prices, because human nature
being what it is, people will valuate things one way or the
other. And I do not think monetary policy in the long run
actually could be effective even if we chose to do it.
Senator Bunning. Well, we have a major disagreement on
that.
Chairman Greenspan. I agree. That I do agree with, Senator.
[Laughter.]
Chairman Sarbanes. Senator Corzine.
Senator Corzine. Thank you, Mr. Chairman.
I would like to turn a little bit to the current economic
circumstance. If I read the papers right and hear from my
colleagues, there is an additional stimulus bill making its way
through the House tied to the extension of unemployment
insurance benefits, $43 billion or so of additional tax cuts.
Is the economy in need of additional stimulus, in your view?
Then there is a second concern that I hear--actually, I
think it is reflective of maybe a difference in what we hear
from corporate executives out in the world about the state of
the economy relative to the reported statistics, which is
somewhat in dissonance.
But it has to do with the issue of terrorist insurance and
whether that is having significant impact in our real estate
and construction markets, and whether it is having impact in
our lending markets, and whether you think there is need for us
to act in that area. I would love to hear your comments on
that, and come back to counterparty surveillance issues, if we
have time.
Chairman Greenspan. On the issue of stimulus, as I have
stated before the House and, indeed, before the Senate Budget
Committee at an earlier time, as you may recall, if we are
dealing with an outlook which seems to be reasonably positive,
as the rate of inventory liquidation gradually goes to zero,
then the key question is: will final demand kick in to keep the
economy recovering after the inventory stimulus, so to speak,
dissipates?
If the conclusion is that it might not, then one can argue
a stimulus program is a credible type of thing to try to do,
largely because it rarely is anything useful in the short run
because we can never implement it in time. But what we are
talking about is 4 to 6 months from now, to be effective.
As I indicated before the House, I doubt very much whether
the economy, if it did not get a stimulus, would sag. And I
think the crucial issue that the Congress has to make a
judgment on is whether the cost to the budget and to the level
of debt that is created as a consequence is a useful fiscal
initiative.
We do of course have the problem that the one fact we know
with almost reasonable certainty is the huge demographic bulge
of retirees that is going to occur at the end of this decade.
And that is going to require that we have higher savings rates,
higher capital investment, higher productivity, to make certain
that the retirees can maintain a standard of living at the same
time that the workers at that time continue to enjoy an
increase in their standards of living.
So as the years go on in this decade, we are going to
become increasingly aware of the oncoming big bulge in retirees
and the fiscal policies that that is going to require on the
part of this country.
Senator Corzine. Do I hear you saying that we are getting
late in the game?
Chairman Greenspan. The clock is ticking. And in any fiscal
stimulus program that is started, you have to get that into the
policy mix.
With respect to the question of corporate executives being,
as I think you put it, more subdued than the forecasters, I
think they are just looking at a very low level of corporate
profits, and that is creating a significantly less buoyant view
of the outlook than that which most economists, even those who
work for the corporate executives, have.
On the issue of terrorist insurance, as I said at the House
Committee last week, I do not think that it is possible to get
any realistic view of what a probability distribution of the
costs of a
terrorist act will be.
We know roughly what earthquakes can do. We know that it is
extraordinarily unlikely that you get much above 8, 8\1/2\ on
the Richter Scale and you can sort of figure out what the costs
are. We do not have that ability on a terrorist act. And I am
of the opinion that we probably ought to endeavor to reinsure
such risks with some deductibles, that it may well be, as I
said in the House last week, that if the Congress merely
indicates that it perceives that terrorist acts will be
essentially reinsured by the American taxpayer, how that is
done can be left to after the fact because it is a very tricky
issue.
The question is, has it had an effect on real estate? Some.
It is too soon to get a sense of any large numbers. Whatever
the effect has been to date clearly is not yet showing up as a
significant negative in the economy. But clearly,
nonresidential building is being affected and certainly large
projects are essentially going forward self-insured, which is a
risky issue.
It means that the insurance premium essentially, as you
well know, ends up in the interest rate premium that these
projects are required to pay to get funded.
Senator Corzine. Have you seen that factor show up in rates
and/or spreads in any of the marketplaces?
Chairman Greenspan. I do not really think we see it as yet,
and it would really have to be an analysis of individual
projects because, obviously, the probability of a terrorist
attack in the vast proportion of the area of the United States
is very low. And one would presume that the premium in those
areas would not show up significantly.
Unless you took a look at the self-insurance of individual
projects in areas where the risks of terrorist acts are much
higher, I do not think you get a good sense of what the cost of
self-insurance is.
Chairman Sarbanes. Good. Senator Crapo.
Senator Crapo. Thank you very much, Mr. Chairman.
Mr. Greenspan, you have already answered my question in a
general sense in response to Senator Gramm's inquiry about the
derivatives issue.
I take it from your answer that you do not believe that it
was a mistake to exclude certain derivatives transactions from
regulations under the Commodities Futures Modernization Act?
Chairman Greenspan. I do not. I think that Act, in
retrospect, was a very sound program passed by the Congress. I
do not see any particular need to revisit many of the issues
which were discussed at length at that time.
Senator Crapo. Some have said, or at least have tried to
establish some kind of a link between the failure to regulate
these types of derivatives transactions and the Enron collapse.
Do you have an opinion on whether the failure to regulate
these specific types of derivatives transactions in energy is
linked in some way to the Enron circumstance?
Chairman Greenspan. Well, Senator, obviously, a lot of
people are looking at this and it is quite conceivable that
things will be unearthed at some subsequent date which will
draw linkages.
At the moment, I have not seen any. Clearly, what
essentially undercut Enron were the special purpose vehicles
which were off-balance sheet constructs which happened in
certain respects to use derivatives as a means for trying to
create, which was what the program was, namely, to obscure some
of the underlying debt and potential losses in the firm. They
could have used anything else to do the same thing.
Derivatives are a very effective financial instrument for
good or ill. They in and of themselves are not anything that is
potentially any more dangerous than the underlying assets which
they are derived from.
Remember that the derivatives were used in the Enron case
as an end-user, not as a dealer, and that Enron Online, which
is the derivatives dealer, has apparently not had any
particular problems, except, obviously, that they have lost a
lot of people. But, as you know, that particular part of Enron
was sold and had value.
So, you have to distinguish where the nature of the problem
that created the collapse and what I call capitalized
reputation in Enron came from.
And at least to date, it does not appear to be--I will put
it this way: derivatives do not appear to be a smoking gun. It
is conceivable to me that we will find that the statement I
just made is false on later evaluation of information we as yet
do not have. But on the basis of what I have seen, I have seen
none that suggests that that is a problem.
Senator Crapo. And on sort of the flip side of that
question, has the utilization of derivatives generally in the
marketplace been a positive force in financial markets?
Chairman Greenspan. Well, Senator, as I indicated in my
prepared remarks, it is very difficult to make judgments as to
what the effect of individual instruments are on the economy
overall, but having observed this phenomenon now for a number
of years, it does strike me as being a major contributor to the
flexibility and resiliency of our financial system. Because
remember what derivatives do. They shift risk from those who
are undesirous or incapable of absorbing it, to those who are.
Now that as an economic phenomenon is something which is
always unequivocally positive. The issue is rarely, if ever,
whether that instrument is a useful instrument. Obviously, if
it were not you would not have the vast demand that has
occurred for this type of hedging procedure, whose basic
purpose is to lower risk, not increase it.
And I think it has been a major factor in the resiliency of
our economy and maybe a major player in why the contraction
that we have just been through was so mild, why the financial
system did not breach under the pressures of, one, the sharp
decline in asset prices, and two, the events of September 11.
I also indicated in my prepared remarks that, clearly, when
you are dealing with very sophisticated instruments such as
this, there are risks of things going wrong. But I cannot argue
that you can therefore say it is the derivative that did it. It
is the fact that they were misused or something about them did
not work very well. But there is nothing inherently negative
about them because, were that the case, the extraordinary small
default record of these instruments, which is very low, would
not be the case. And two, the demand for them year after year
expanding at a dramatic rate, would not have occurred.
Senator Crapo. Thank you very much for these good insights.
Chairman Sarbanes. Thank you, Senator Crapo.
To complete the first round, just so Members know where
they are, I have on this side, Senator Dodd, Senator Akaka, and
then Senator Miller. And Senator Allard, you are next on this
side.
Senator Allard. Yes, Mr. Chairman. Do you want me to go
now?
Chairman Sarbanes. No, because we just went from here.
Senator Allard. Right.
Chairman Sarbanes. Senator Dodd.
Senator Dodd. Thank you, Mr. Chairman.
Welcome, Chairman Greespan. It gets said often enough, but
it deserves repeating--you have done a terrific job and we are
all very grateful for your leadership.
The fact that we are coming out of this recession, as brief
as it is, I think you and your staff at the Federal Reserve can
take a great deal of credit for what you have done over the
last year or so, particularly the rate cuts.
Let me, if I can, I will try to lump my questions together,
too. It will give you more of a chance to respond than to
listen to the question.
I appreciate Senator Corzine raising the terrorism
insurance issue. We did a lot of work on that a number of
months ago. But I think your testimony helps this morning give
us a better feel and flavor for that issue. It is one we need
to watch and there will be an effort, I know, to try and
probably revive that issue.
Senator Stabenow raised the question of international. We
have had either flat GDP rates, in Great Britain, zero, in
Germany, I think, Japan, Argentina have problems.
I would like to know if you could take the long-term rate
issue, given the gap that exists between short- and long-term
rates, and then tieing in the question of what is going on
internationally economically, add to it, if you will, some of
the projections that we are getting. The CBO's numbers indicate
a budget deficit substantially different from what the
President indicated only a few weeks ago. They are talking now
about $121 billion versus $80. And a cumulative deficit over
the next 10 years, excluding Social Security, of $1.8 trillion.
I wonder if you might shed some light on to what extent that
ought to be a concern in terms of those of us here as policy-
setters. That is number one.
And then jumping to the issue--and I am not going to ask
you to comment on specific bills because that is not a fair
question for you. But pension reform, obviously in light of
Enron, is going to be a major subject of debate. Another
committee on which I serve may markup a bill as early as next
week. Senator Corzine and Senator Boxer have offered ideas in
this area.
We are going to do some things in this area and I think you
have raised the issue of unintended consequences of some
actions. I wonder if you might comment here. I do not know if
you are familiar with the bill that Senator Kennedy has
proposed dealing with employer contributions, defined
contribution, defined benefit plans, and so forth.
But rather than getting it out in the details of a bill, I
would like to hear you comment on pension issues, the numbers
have come back down now, but they reached a high I think of 44
percent of all stock was being held by employees in the firms
in which they worked. That number seems to have dropped back to
around 34 percent, the latest numbers.
Give us some flavor and feel for that issue, if you will,
because all of us want to do the right thing up here. We
realize that this is a critically important issue. I, for one,
have supported over the years the employee stock option plans
not just because of its ability to generate wealth among those
who work for companies, but also because of the productivity
issues associated with these stocks, the kind of value.
So, I want to be careful as I vote up here on these
questions. I want to avoid the kind of Enron situation where
people were absolutely taken to the cleaners by what happened.
But simultaneously, I do not want to do something up here
that has the unintended consequences of hurting people who
legitimately are using these vehicles as a way of increasing
their wealth and having other economic benefits. So those two
questions.
Chairman Greenspan. Senator, it is my impression that if
the stock of Enron had not collapsed effectively to zero, this
issue would not be on the table.
Senator Dodd. I suspect it might not have been, certainly.
Chairman Greenspan. Yes. If Dynergy, for example, had
successfully merged with Enron, my impression is that the story
of Enron would have been really quite different, not that there
would not have been very significant losses, but the starkness
of the evaporation would not have been evident in that respect.
I agree with you. I think that the employee stock options
plans have been a very positive force in this country in the
sense of ownership and, indeed, because there is a positive
equity premium in our economy, meaning that the rate of return
on stocks is chronically in excess over a rolling 20 year
period of say, bonds or debt instruments, that it is useful for
pensions, which have at least 20 years to run, to make sure
that they have adequate common stock coverage.
I think the problem that may be an unintended consequence
here is that corporations have been fairly generous in stock
matching. And what I am concerned about is that you may reduce
the share of the particular company stock within a 401(k), but
it may be because that number went down and the rest did not go
up. In other words, you can very readily create disincentives
for corporate management in giving stock under ESOP plans
because the incentive for them to do so has effectively been
removed. It is not clear to me that that is offset by increased
compensation and, hence, it is not clear to me that the
employee necessarily benefits.
So all I am really suggesting is that, whatever the bills
of Senator Kennedy and Senator Corzine provide--and you had an
earlier version and then you backed, as I recall, Senator
Kennedy's position--I just merely request that you try to
evaluate as closely as you can what the impact of ESOP issuance
would be under these various different provisions that would
appear in any bill that would reform the pension system.
Senator Dodd. Can you comment on the long-term rate issue,
the gap, and the questions of the intervention on domestic
fiscal policy?
Chairman Greenspan. There is always a tendency for the so-
called term structure of interest rates to be positive, meaning
short-term rates are lower than long-term.
Senator Dodd. Yes.
Chairman Greenspan. Not all the time. Obviously, under
inflationary speculative periods, you will often get short-term
rates going higher than long-term rates.
But, in general, I do not think there is something terribly
significant here in the sense that a very dramatic decline in
long-term interest rates occurred in the second half of the
year 2000, and that a goodly part of the expected decline in
rates that occurred then was in anticipation of an easing of
monetary policy.
And so, it is certainly the case, as many have argued, that
short-term rates went down appreciably in the year 2001, but
long-term rates did not. They went down some, but not a great
deal.
I think the problem in part is the timeframe in which we
were looking at that process. If we extended it back into July
of 2000, it looks a good deal different. You do get a
measurable decline in long-term rates, as well as short-term
rates.
Senator Dodd. Thank you, Mr. Chairman. Thank you.
Chairman Sarbanes. Senator Allard.
Senator Allard. Chairman Greenspan, you noted in your
testimony the economic importance of deregulation over the past
25 years. You went on to further state as an example, where
deregulation worked in a positive manner was in the area of
energy, as well as financial markets. Are there other areas out
there where you think deregulation had a positive impact on the
economy?
Chairman Greenspan. I do, Senator. As I indicated in my
prepared remarks, I think that despite the fact that it is not
terribly evident that deregulation has helped the profitability
of airlines, there is no question that it has created a very
much broader market and created the capability of American
citizens to travel far more cheaply than they had in earlier
periods. And the ability to create a very significant cargo
freight system has I think facilitated the movement of goods of
high economic value. Trucking, obviously, has been, in my
judgment, a significantly improved system with the deregulation
that has occurred there. There are all sorts of other smaller
areas where it is questionable how much impact there has been.
I would suspect that in certain areas of deregulation, you
are going to find that it does not work, or it does not work as
well. But, overall, the net effect of the last 20 years has
been, as best I can see, a positive force.
Senator Allard. Considering what our economy is doing right
now, do you think it is an appropriate time now to consider
reducing capital gains rates even further?
Chairman Greenspan. Well, Senator, I always have been in
favor of doing that, but on long-term structural grounds. I do
not think the capital gains tax, as I have indicated many times
before this Committee, is a particularly effective tool for
capital accumulation and economic growth. It has other
characteristics. I think, clearly, many people argue it has
positive social impact and that is an argument which I think
you have to put on the table because not everything is
economics.
But from an economic point of view, I would prefer that we
displace the whole capital gains tax with some other form of
revenue which has a less negative impact on capital
accumulation, which I perceive to be a crucial issue in long-
term economic growth.
Senator Allard. In my State of Colorado, with the
international trade agreements, particularly NAFTA and GATT, we
have experienced a greater growth in exports of any State in
the country.
So, we have a lot of people that watch the exports and the
value of the dollar. Our value of the dollar in comparison to
other economies, there are two variables there about what is
happening. Two big variables--one is what is happening in the
United States, and also, what is happening worldwide in other
countries and how we are trading with them. Is there anything
that could be done to change that value of the dollar that
would encourage further exports.
Chairman Greenspan. Senator, remember that the cause of the
strength of the dollar is largely the presumed perception on
the part of foreign investors that the rate of return in the
United States is higher than in their home countries. And so,
they are moving capital increasingly into the United States and
that is pressing the exchange rate higher.
I guess we could dissuade foreigners from investing here. I
am not sure that that is to our advantage. We do have the
obverse of this huge flow of funds into the economy, which is
our current account deficit, which increasingly widens, and the
trade deficit, which is the major part of that. And that
implies that--which is, of course, the other side of the
capital flowing in--that there are ever increasing claims on
the American economy by foreign investors. And that cannot go
on indefinitely without some difficulty, history tells us.
So, I have argued many times in the past that the current
account deficit, meaning the capital surplus, cannot continue
to increase. But it is the capital surplus which is driving the
exchange rate at this particular point. This process will end
at some point, but I have been forecasting this for 5 years,
and I guess I will be forecasting it for another five.
[Laughter.]
Senator Allard. Thank you, Mr. Chairman.
Chairman Sarbanes. Senator Akaka.
Senator Akaka. Thank you very much, Mr. Chairman.
Chairman Sarbanes, on March 5, President Bush announced
temporary tariffs on selected steel imports. I would like to
know your comments on the economic consequences of this action.
Chairman Greenspan. Well, Senator, as I have indicated
before this Committee on numerous occasions, I am a very strong
proponent of free trade because I believe a free international
trading system has been a major contributor to the economic
wealth created in this country.
I believe we benefit more than anybody from an open trading
system and we have, indeed, created a significant level of
living in this country in large part because of our ability to
expand and get the division of labor on a worldwide basis.
I understand the obvious problems that are involved in the
transition as you invariably move capital from less productive
areas of an economy into the cutting-edge technologies. And it
is difficult to maintain the process. There are lots of
casualties, both in capital and in people, that are a
consequence of these types of transitions, and that it is
appropriate to try to meet them, to a certain extent.
I understand the difficulties that any President has in
trying to come to grips with our trade laws and conditions such
as exist in our steel industry. I happen not to agree with the
particular judgment, but I recognize that it is a very tough
judgment that the President had to make, and I am glad that I
was not in a position where I had to make that judgment.
Senator Akaka. Chairman Greenspan, the confidence that
investors have in the equity markets, I think there is no
question, has been shaken because of the collapse of Enron and
the accounting irregularities that have been found in the
financial statements of other public companies.
You mentioned about the earthquakes. And when I use the
word shaken, I wondered at what part of the scale are we at.
There is a concern about how badly confidence in our
country has been shaken, to the point that there are proposals
before this Committee addressing investor protection and also
ways to improve accounting systems. So my question to you is,
what actions do you recommend to restore investor confidence?
Chairman Greenspan. Senator, I think one of the things
about the Enron episode is that it is probably improved
corporate governance to quite a significant degree.
The one thing I think everybody became aware of immediately
subsequent to the collapse of Enron is that investors started
to put a price-earnings premium on those companies which they
perceived to be free of spin in the sense of trying to game
their earnings numbers to make it look as though they are doing
better than they actually are. And what that has done is
removed a very considerable amount of incentives to do that
because if you are going to be penalized for doing it, you are
going to do it less.
And indeed, I think a considerable amount of changes that
need to happen--and I do not deny that there are significant
problems in corporate governance--have probably already
happened.
I do think that numbers of issues with respect to
accounting and the structure of accounting and the issue of
independent directors and a variety of issues that have come
forth, they will be addressed and I think we are going to find
out at the end of the day that, even though Enron was a great
tragedy for a number of people, especially the employees who
worked there, it probably has created a positive set of forces
to improve corporate governance.
I think at the end of the day, we are going to find that it
was a net plus to our economy, with the obvious caveat that
that is not the way those thousands of employees of Enron could
conceivably visualize this very tragic incident.
Senator Akaka. This next question is more parochial for me.
The financial condition of Japan has significant influence on
the economy of Hawaii. Some economists predict that the gross
domestic product of Japan will decline during fiscal year 2002.
And if you care to answer this, what is your economic forecast
for Japan?
Chairman Greenspan. Well, the Federal Reserve's forecast is
not significantly different from what conventional forecasts
are, either of the Ministry of Finance or the Bank of Japan or
private forecasters. We are all struggling with the fact that
Japan is in a deflationary environment, that prices continue to
ease inexorably. And projecting what has been going on, it
continues to be just a continuous erosion.
I would suspect, however, that if we turn around, and I
hope that the early data that we are seeing now are suggestive
of that, it is quite likely to be helpful to Japan, and helpful
to Southeast Asia, especially Japan. But we have never really
had to confront something of the type of problem which Japan
has been struggling with for the last 10 years. So that we are
not quite confident about how to forecast that.
Senator Akaka. Thank you.
Thank you, Mr. Chairman.
Chairman Sarbanes. Senator Miller.
STATEMENT OF SENATOR ZELL MILLER
Senator Miller. Thank you, Mr. Chairman. I have an opening
statement that I would like to request be made part of the
record.
Chairman Sarbanes. It will be included in full in the
record.
Senator Miller. Mr. Chairman, thank you so much for being
with us. You are always very patient in answering our
questions. I will be brief. I have a couple of questions.
First, I would like to associate myself with Senators Gramm
and Crapo on the derivatives question. I know you have already
spoken at length about it, but one thing I would be interested
in is if you had any thoughts on the impact of derivatives on
energy prices during the California energy crisis.
My other question, if I may go ahead and just ask you both,
has to do with something that could affect my home State of
Georgia in a dramatic way. As you well know, agri-business is
the backbone of the Georgia economy. It is a $60 billion
business. One out of six jobs come from agri-business. Our
farmers right now are facing a very uncertain future. They have
skyrocketing production costs. They have low commodity prices.
And as they get ready to get into their spring planting, many
banks, I am told, are balking at issuing loans to these farmers
until we have a new farm bill. It is causing a lot of
instability, I am told.
My question is this. All my information is just anecdotal.
I am wondering if you, Mr. Chairman, have seen any reticence
out there from banks about making agricultural loans.
Chairman Greenspan. The evidence that we have is that loans
coming from so-called agricultural banks, which are those with
a significant part of agricultural loans in their assets, have
not been basically holding back until, as you point out,
possibly recently because of the seeming stalemate between the
House and the Senate on the farm bill.
But we do not see any material or significant
unavailability of credit, either through the commercial banks
or the farm credit system. And one of the reasons obviously is
that, not speaking about Georgia but generally speaking,
Government payments have been at significantly higher levels
and have basically supported levels of net farm income, and the
real estate values, farm values, the land values, have been
doing reasonably well.
The underlying income and collateral of the farm community
has been such as to, as best I can judge, maintain the flow of
credit.
I am not aware of banks balking, but I can understand why
it could create some hesitancy on the part of some lenders. But
we do not see that.
Senator Miller. Thank you.
Chairman Greenspan. With respect to the California electric
energy issue, you do not need to advert to derivatives to get a
judgment as to why prices did what they did.
My recollection is that, 10 years ago or so, the sort of
capacity buffer that the California electric power system had
was the typical 15 percent for summer peak loads, which is what
generally a regulated industry had because you effectively
guaranteed a rate of return on capacity which was not being
used. But that 15 percent kept prices down.
As the years went on and demand went up in California,
especially from Silicon Valley, where electric power demands
are very high, but no new capacity, no new plants, as you know,
came on stream, that 15 percent gradually dissolved because
there is no way to have inventories of electricity. Our battery
systems are just inadequate for that. So, you get into a
situation where the demand load, if it is running up against a
limited capacity--and the demand tends to be price inelastic,
as economists like to say, can produce some huge price spikes
because there is no way to store electric power. And indeed,
that is exactly what happened.
Then the authorities in California raised the retail prices
of power and demand came off, as you might expect, fairly
abruptly. And then, the actual load factors fell further in
California, in part, remembering that one of the reasons was
that the weather was favorable toward less electric power use
through the summer of 2001.
But prices have come all the way down. Excess capacity
exists. There has been, in fact, some delays in some of the
capital expansion projects that were there.
You do not need derivatives to explain what happened to
prices. It is conceivable that there may have been price
manipulation. There may have been a number of things. But I do
not think that you need to advert to that, as I said earlier,
to explain what happened. It is a question of fact. The
authorities, to inhibit price manipulation, are following the
statutes that we currently have and I do not see any particular
need, as I indicated to Senator Crapo, of any major change in
the underlying Commodity Exchange Act.
Senator Miller. Thank you.
Chairman Sarbanes. Good. Mr. Chairman, I have one subject
that I want to cover very quickly, and we may do another round.
I see Senator Corzine is still with us. I want to discuss the
unemployment insurance benefits for a moment.
In every recession over the past 30 years, we have extended
unemployment insurance benefits. That has not yet been done in
this economic downturn, and it is in part because and I do not
want to draw you into this issue--but there is a very sharp
conflict in the Congress.
Our colleagues particularly on the other side of the aisle,
on the House side, are insistent that they will not extend
unemployment insurance benefits unless there is a large tax cut
again for what many of us regard as being for people who do not
need a tax cut.
It looks like they may now be relenting on that, or we
certainly hope so. But in any event, I have regarded it as
something of an outrage that extending the unemployment
insurance benefits would be linked to a tax cut, rather than to
get that to help the needy.
But leaving that to one side, I think you have testified
previously, you are supportive of extending unemployment
insurance benefits. Is that correct?
Chairman Greenspan. That is correct, Mr. Chairman. I think
that our unemployment insurance system is actually a reasonably
well constructed one in recent years. The 26 week length of
total insurance, which is pretty much general throughout the 50
States, is not a bad limit because you do not want, as other
countries have, to use the unemployment system to induce people
to leave the workforce.
But the premise of that is that, after 26 weeks, you should
be able to get a job. When we are in a recession, that may not
actually be the case. And therefore, the logic of having 26
weeks as a discipline issue in a market system is lost.
So, I argued at the House hearing that extension, temporary
extension of unemployment insurance during periods of
significant decline in labor demand, seems to be a most
reasonable approach to the pattern. And I think the way we have
done it is a fairly sensible approach to the whole concept of
unemployment insurance.
Chairman Sarbanes. I might note that in the downturn in the
early 1990's, actually when the previous President Bush was in
office, that in the end, we extended it for an additional 33
weeks. We really ran it up to 59 weeks because we had
difficulty coming out of that downturn. But as you point out,
it then reverted back to 26 weeks as we moved into a more
stable and growth economy.
I want to ask two questions on what you said on the
construct of it because I am beginning to think that maybe we
need to examine that a little bit.
One is that, on average, only 46 percent of the unemployed
qualify for unemployment insurance. So, we have a significant
part of the workers who lose jobs who do not qualify for
unemployment insurance because we require them to have worked a
certain length of time and so forth. This gets complicated when
you get more and more people working part-time. That is a
significant component. And part-time often means 30 to 35 hours
a week. They are relatively shy of full-time.
Also, you get workers coming into the workforce, like
Welfare To Work, where we are trying to move people into work,
and then they lose the job. And where does that leave us? Is it
worth examining the coverage of the unemployment insurance
program? I do not have an answer in mind. I am just beginning
to think that we probably need to look at that. Let me ask the
other dimension of that question.
Unemployment insurance benefits now average about $230 a
week. In Northern Virginia, for example, the maximum
unemployment insurance benefit is $1,160 per month. The rent
for a typical two-bedroom apartment is $907 per month.
So, again, that raises the question whether we need to
examine the level of the payments in terms of accomplishing our
purposes.
Now, I know both of these raise questions because you do
not want to turn it into some kind of semi-permanent way of
life. But are those two issues worth taking a look at?
Chairman Greenspan. It is very difficult for me to answer.
And the reason I say that is, it gets down to what the economic
effects in the labor market would be were you to introduce
them.
I do not know the answer to that. All I can say is that it
has been my experience that the system has worked remarkably
well. But implicit in it is that unemployment insurance is not
freely available, and that it induces a flexibility in the
workforce which has us down to an unemployment rate of under 4
percent. And I think that is a highly desirable issue.
It is always easy to find selected people within the pool
of unemployed who are not getting benefits and find reasons why
they should be. If you do that, I think you end up with a much
higher level than you would like for purposes of macroeconomic
stability and that is a judgment which I think the Congress has
to make. I do not think economists can help materially in that.
Chairman Sarbanes. I would just observe, the trend lines
show that the percent of unemployed having access to
unemployment insurance has been trending down from where it
used to be.
Chairman Greenspan. I think that is correct, yes.
Chairman Sarbanes. I also think the amount of income
replaced by the unemployment insurance has also been trending
down. So, at an earlier time, the system was in effect more
comprehensive.
Chairman Greenspan. I think that is correct, Mr. Chairman.
The system was significantly more comprehensive. But, in my
judgment, less effective in its purpose to maintain as a safety
valve which does not undercut the basic viability of the labor
market.
Chairman Sarbanes. Senator Corzine, did you want to wind
this up here?
Senator Corzine. Yes. Thank you, Mr. Chairman. I will be a
quick second.
Mr. Chairman, in no way does the question I am going to ask
change the view that I concurred with Senator Gramm and others
at the start on the job that you have done in the leadership of
the Federal Reserve. But I am really mystified a little bit
about the response to the question with regard to the CFTC Act
and the exemption of over-the-counter derivative activities and
derivative entities outside regulatory oversight, if not
regulatory regimes. It seems inconsistent to me relative to the
needs of consumer protection or antimanipulation or price
transparency in a market that has secondary implications, if
not direct implications, on consumers.
There is a serious issue about whether price manipulation
actually ends up backing into causes of consumer losses in
California. I think that is the question that Senator Miller
was referencing.
It is for certain that it has had implications on
investors, at least the overall Enron issue, yet to be
determined, as I think you outlined. Whether the derivatives
were a driver or not certainly has not been revealed by the
information we have today. But that does not necessarily mean
that it is not a part of it.
I think back into relatively recent history on nonregulated
entities having impact into financial markets that then have
secondary implications, whether it is long-term capital, go
into some of the commodity trading problems that came with
Sumotomo Corp.
I go back into history, Lombard Wahl and Drysdale and a
whole series of things where no oversight ended up having
significant impacts into other areas.
And I think I recall another time and another place that
the Federal Reserve--I do not know your own position on this--
thought that the Government securities market might need some
oversight so that it does not have to be ham-handed regulation.
And certainly believe in counterparty surveillance, so that
people would have a sense of responsibility about how they are
operating. I think we do that with banks and securities firms.
And this idea that there is no oversight of a potentially
significant market does not seem to gibe with the kinds of
initiatives that I have seen out of the Federal Reserve Board
or yourself in some instances. I would love for you to comment
on that because it is inconsistent, at least in my eyesight.
Chairman Greenspan. No. Fair question. First of all, the
CFTC clearly has supervision over regulated markets in energy
and elsewhere. They also have authority under existing statute
to act against price manipulation in the over-the-counter
markets. And indeed, had Enron been involved in price
manipulation, there is authority as of today for the CFTC to be
looking at that.
Senator Corzine. If there is not an ongoing oversight,
though, then it is only a response to an event.
Chairman Greenspan. No. What I am trying to say is that the
CFTC has legal authority. In other words, the question is, do
you need additional legislation?
Senator Corzine. Right.
Chairman Greenspan. And the answer is, they already have
it. It is there.
What the only issue here really gets down to is the
question of consumer protection, per se, in which, as I recall,
when we addressed this issue in the President's Working Group,
which led to the Commodity Futures Modernization Act of 2000,
that when we discussed that issue at considerable length, the
notion was essentially when you are dealing with small
investors, do you want protection? The answer was yes. And that
is what the statute does.
The question, however, of over-the-counter derivatives
being overseen by regulation runs into two problems, at least
from the discussions that we had at the Working Group. One,
that the whole derivatives area was and still is in the process
of evolving. And as you well know, when you stick a regulatory
structure on top of an evolving market, you freeze it. Two, the
effective advantages that one can get are particularly
questionable.
The only issue that is involved here reflects the question
as to whether there is oversight on the nature of the contract
itself.
I remember when I was on the J.P. Morgan board and you were
at Goldman Sachs, there was a huge amount of credit that moved
between J.P. Morgan and Goldman and there was not any
Government official overlooking whether the creditworthiness of
the institutions was there or not. I would venture to say,
looking at it from the point of view of what bank regulators
can do, we do not have the capacity to look at counterparties
at the level that it is possible for individual institutions
such as Morgan or Goldman. And that, in our judgment, it was
not, as we said at the time, the most effective means of
regulation that you can have in those markets.
Senator Corzine. You would not suggest that the
relationship between Morgan and Goldman and credit extension
between the two is not supervised either by the Federal Reserve
System and/or by the SEC? There are limits.
Chairman Greenspan. What I am saying is that there is no
way that the Federal Reserve, which, as you know, supervises
Morgan, has better judgments on a loan to Goldman than the
people at the bank would have.
Senator Corzine. I am certainly not suggesting that. But
there are supervisory oversights--
Chairman Greenspan. There are. And indeed, you have to ask
whether they are positive or negative to the system.
I have no doubt that we could put every sort of regulation
on derivatives and over-the-counter derivatives and force them
into specific molds. I will tell you, as you would agree
probably more so than I, that you will dry up that market. And
if, indeed, we had seen significant problems in the over-the-
counter market, I think that that is where we would be at this
stage.
But what is really quite remarkable about the evolution of
that market is that when problems of risk emerged, you know, we
went to collateralization of derivatives, and the default rates
are unimaginably low. There is this large legal issue as to
whether certain transactions with Enron were a debt or a
derivative--so the surety bonds are under dispute--but if you
eliminate that, it is very hard to find defaults. And it was
our view that in the over-the-counter energy area, it was
desirable to allow that market to evolve.
We think it has. The collapse of Enron did not demonstrably
impact on the prices of natural gas or electric power or any of
the elements that they were significantly involved as the major
player in.
Senator Corzine. Well, though, it is not just the impacts
that occur in the market, the immediate market. It has other
implications for other activities when there is a financial
dislocation with a particular market entity, Long-Term Capital
or any other.
Chairman Greenspan. Let me just say this. Long-Term
Capital, as you may recall, was not taking hedging positions.
They took principled positions. They happened to use
derivatives as the vehicle to make some of those bets. They
turned out to be dubious, to say the least. But I would
scarcely argue that derivatives were a factor. They could just
as readily have done it by plain vanilla stocks, bonds,
leverage, any other thing they could have done.
It is the case that derivatives are a very powerful tool.
And if misused, they can create problems. LTCM was a problem.
But I think we have to distinguish between the instruments and
the actions. What I think was involved in LTCM and in Enron
was, as I put in my prepared remarks, just plain, old-fashioned
excess of debt. The derivatives were a vehicle in enabling that
debt to be accumulated. But they could have done it in 20 other
different ways. They would not have done it as efficiently or
as quickly. I will grant you that.
And if it does turn out, Senator, that these types of over-
the-counter derivative activities which are not now regulated,
do impinge on consumers, I think that would be appropriately
revisited.
What we said was that it was inappropriate at that time,
meaning the year 2000, to effectively be locking in regulation
until we saw a particular need for it. And at least those of us
who were involved in it, did not see it then. I must say that I
have not yet seen evidence to suggest that that is the case
now.
But I grant you, it may turn out that way. If it does, I
think it would be most appropriate to take legislative action
to address that subject. However, at the moment, I have not
seen anything that suggests the need for it.
Chairman Sarbanes. Senator Carper.
Senator Carper. Thank you, Mr. Chairman.
Chairman Greenspan, shortly after you completed your
statement and the questioning began, I had to slip out to
preside in the Senate where we are debating today, again, the
comprehensive energy bill that is before the Senate.
I telegraphed you earlier in my opening statement that I
would like to visit with you just briefly before we conclude,
some energy-related issues. If you could do that with me, I
would be grateful.
As we debate the energy legislation before the Senate, we
do so at a time when our oil imports are approaching 60 percent
of that which we consume, where our trade deficit, I believe
for last year, reached $300 billion. And we know that not all
of that is oil, but a significant piece of that trade deficit
is.
I learned this week that apparently, there is some talk of
a cartel being formed similar to OPEC that might deal with
another commodity, and that is natural gas. There was some talk
of that occurring around the world.
Against that backdrop, and the debate on energy, I wanted
to ask, if you could, just to share a word or two with the
implications for our economy going forward, on our failure to
adopt a comprehensive energy policy that does two things. One,
produces more energy; and two, conserves more energy.
Chairman Greenspan. Senator, it is fairly apparent from all
of the data that we have seen over the decades that there is a
fairly close relationship between energy consumption and GDP.
Indeed, we must be certain that even though the ratio of energy
per constant dollar GDP has been falling over the years as we
have gone to increasing efficiencies of various different
forms, the longer-term outlook for energy is a crucial element
in any view of where this economy is going over the next 10,
15, 20 years.
The problems that I see we have crucial difficulties with
are more natural gas than oil because oil we can import. And
one must presume that we have been able to do that to date and
hopefully, we will be able to do it in the future.
Natural gas is a much more difficult issue in the sense
that we have chosen natural gas as the preferred fuel for
emissions reasons and there is, as you know, on the drawing
board, a very significant number of gas-fired electric power
plants to effectively meet the problems that we saw, not only
in California, but also in many other areas of the country.
The difficulty is that natural gas is essentially a
domestic and Canadian source of supply. That is, my
recollection is we import about a sixth of our gas from Canada
and we produce the rest of it essentially here by drilling.
And what we have found is that as the technology improves,
increasingly the reservoirs that we get from drilling dissipate
far more rapidly than they have in the past, which means that,
if, for example, which is relative to the case, that we lose 50
percent of a new reservoir a year, then, clearly, you need
gross additions to gas production to just maintain a net
growth.
We expended a huge amount of effort in drilling in the last
couple of years and only increased net marketed gas by a very
small percent. And if you project out into the future, and if
you take a look at the potential demands for natural gas, it is
going to create a problem because we cannot drill fast enough
to do it, which leads to the conclusion that we either get it
from Canada, which is already beginning to run into capacity
problems itself, or liquefied natural gas imports.
It is very likely that that is where an increasing
proportion of our gas is going to come from. But we have been
hesitant to put in the terminals that are required to import
gas from Indonesia or from Qatar. And the reason is that there
are environmental concerns about the issue of liquefied natural
gas, which is a very tricky commodity to handle at cryogenic
temperatures. So, we are going to have to build a number of
areas which can bring the gas in and we have not really
addressed that issue, and I think that is where a long-term
program is required.
Second, we obviously are going to need to take a real close
look at our electric grids, which are really deteriorating. And
indeed, I noticed the Supreme Court, was it yesterday or the
day before, unanimously voted to grant authority to FERC to
require that individual utilities open up their electric power
to feed into the grid, at least as I read it. That is helpful,
but you need a grid that is not deteriorating to handle those
particular qualities.
So, I think that if you start to look at all the various
different things, including coal, there is still a very big
problem that we are importing an ever-increasing proportion of
our oil, which creates some national security problems as well.
It is going to be important, as far as I can judge, that we
indeed take a very close look at the long-term outlook and the
supply of energy and then take a close look at what our
alternate sources of conservation are.
Fuel cells have a huge potential, but they are considerably
far out in the future. They are not something that is going to
be a major factor. And as somebody said the other day, every
time we seem to be getting a fusion breakthrough, it is
commercially available 50 years out.
It reminds me of shale oil. As you may recall back in the
1970's, the cost of shale oil was always something like $6 a
barrel more than crude oil, no matter what the price of crude
oil was, which made no sense whatever. It just sort of
indicated to you that we tend to look at these newer forms of
energy supply and they seem to be less available than we would
like.
I think the issue of conservation, the issue of sources of
production, our import strategy, our environmental strategy,
are all part of an integrated strategy which the Congress has
to address in total.
Senator Carper. Thank you. Thank you, Mr. Chairman.
Chairman Sarbanes. Mr. Chairman, thank you very much for
appearing before the Committee. As always, we very much
appreciate your testimony. And again, we wish you a happy
birthday.
Chairman Greenspan. Thank you very much, Mr. Chairman.
Chairman Sarbanes. The hearing stands adjourned.
[Whereupon, at 12:35 p.m., the hearing was adjourned.]
[Prepared statements and additional material supplied for
the record follow:]
PREPARED STATEMENT OF SENATOR PAUL S. SARBANES
I am pleased to welcome Chairman Greenspan before the Committee on
Banking, Housing, and Urban Affairs this morning to testify on the
Federal Reserve's Semi-Annual Monetary Policy Report to Congress.
Legislation enacted in the last Congress requires the Federal
Reserve not only to submit a report to Congress twice a year on the
conduct of monetary policy, but also requires the Chairman of the
Federal Reserve to testify before the Congress on the report. Prior to
the enactment of that legislation, the Fed Chairman testified before
Congress on the report as a matter of custom, but was not actually
required to do so by statute. Senator Phil Gramm and I worked together
with the Fed on that legislation, which provides that the Fed Chairman
testifies first before the House in February in even numbered years and
first before the Senate in odd numbered years. The House thus had the
benefit of Chairman Greenspan's testimony last week. The Senate has the
benefit of a week to review the testimony presented before the House.
Chairman Greenspan's testimony last week and this morning presents
a positive, but cautious outlook for the U.S. economy. He speaks about
a ``subdued recovery,'' which he views as remarkable in light of the
severe shock experienced by the economy as a result of the terrorist
attack on September 11.
According to his testimony, the central tendency of the forecasts
of the Federal Open Market Committee prepared for the Monetary Policy
Report to Congress was for real GDP to rise 2\1/2\ to 3 percent during
2002. Unemployment was expected to rise to 6 to 6\1/4\ percent, and
inflation as measured by the price index for personal consumption
expenditures was expected to increase only 1\1/2\ percent. Chairman
Greenspan pointed out that despite the forecast of a resumption of
economic growth, the FOMC at its meeting on January 30 saw the risks as
continuing to be weighted toward conditions that may generate economic
weakness in the foreseeable future.
Since Chairman Greenspan testified last Wednesday, the Commerce
Department released a report which revised upward U.S. economic growth
in the fourth quarter of last year from 0.2 percent to 1.4 percent. In
addition, the Institute for Supply Management (ISM), formerly known as
the National Association of Purchasing Management, released its index
of manufacturing activity which showed a larger than expected rise and
gave the first sign of growth in manufacturing in 18 months. The
Federal Government also reported that consumer spending and income
growth increased in January, and that construction activity expanded.
These reports have led to increased optimism that a recovery is taking
hold. Chairman Greenspan slightly modified his testimony from last week
to reflect those reports. The Banking Committee will be very interested
to hear Chairman Greenspan's views on them this morning.
I would like to make just a few of observations. First, I believe
the Federal Reserve's caution about the outlook for U.S. economic
recovery is well placed. Sustained consumer demand has been the
foundation of the improved outlook for of the economy. However, both
the University of Michigan's Consumer Sentiment Index and the
Conference Board's Index of Consumer Confidence declined last month.
Consumers reported that they are increasingly worried about
unemployment and future income prospects. Those worries are grounded in
the current weakness of labor markets, and they will only be
exacerbated by the projected increases in unemployment.
In addition, most observers agree that the key to the strength of a
recovery will be significant growth in capital spending, and there is
great uncertainty as to whether that will occur. According to the
Commerce Department, business fixed investment in the fourth quarter of
last year declined at an 11 percent annual rate, even as the overall
economy grew at a 1.4 percent rate.
Finally, even as the economy recovers, unemployment is expected to
continue to rise, as the FOMC forecasts. Over the last year, according
to the Bureau of Labor Statistics, the number of people unemployed for
more than 14 weeks has nearly doubled (from 1,357,000 to 2,547,000).
Those unemployed for more than 26 weeks, the cutoff for unemployment
insurance, has also nearly doubled (from 648,000 to 1,127,000). This
affects consumer sentiment. In my view it also makes a compelling case
for the temporary 13 week extension of unemployment benefits, as passed
by the Senate, for those who are looking for work but cannot find it.
The extension should not be tied to the enactment of the extreme tax
cut proposal put forward in the House.
The Federal Reserve is prudent to emphasize the uncertainties still
present in the economic outlook. With inflation contained the Fed can
afford to adopt a wait and see attitude, and certainly not move
precipitously to raise interest rates. I look forward to hearing
Chairman Greenspan's testimony this morning.
PREPARED STATEMENT OF SENATOR TIM JOHNSON
Chairman Greenspan, thank you for coming to today's hearing to
discuss the Federal Reserve's monetary policy and the state of the U.S.
economy. I would also like to recognize your staff for preparing such a
comprehensive written report on these issues.
I sense a cautious optimism in your written testimony that reflects
well on the resilience of the U.S. economy, especially in the wake of
September 11. Further, I want to thank you, Chairman Greenspan, for the
Federal Reserve's diligent management of U.S. monetary policy in
helping to make the recent economic downturn, I hope, relatively
shallow and brief.
While most Americans can look forward to continued prosperity
during 2002, I would like to draw your attention to a segment of the
population that will not share in this prosperity: the approximately
2.7 million Native American and Native Hawaiian people living in the
United States.
Consider the following statistics. According to U.S. Department of
Commerce's census data, unemployment rates on Indian Lands in the
continental United States ranging up to 80 percent compared to 5.6
percent for the United States as a whole. Census data also show that
the poverty rate for Native Americans during the late 1990's was 26
percent, compared to the national average of 12 percent. In fact,
overall, Native American household income is only three-quarters of the
national average.
This disparity is particularly evident in my home State of South
Dakota where Native Americans represent over 8 percent of the State's
population. While the overall State economy is relatively strong with a
low 3.1 percent unemployment rate, the Native American population
continues to suffer. South Dakota counties with Indian Reservations are
ranked by the U.S. Census Bureau as among the most impoverished in the
United States.
This past Tuesday's Wall Street Journal carried an article by
Jonathan Eig that focuses, in part, on the toll of poverty for the
Oglala Sioux living on the Pine Ridge Indian Reservation. The article
notes that:
Nearly half the tribe's population is destitute. The
unemployment rate is about 75 percent. There is no bank, no
motel, no movie theater. Restaurants open and close down before
anyone notices. . .. The community has the shortest life
expectancy of anywhere in the Western Hemisphere outside Haiti:
48 years old for men and 52 for women.
In light of this unacceptable economic disparity, it is important
to address this issue in a comprehensive manner. Therefore, as I
announced at the National Congress of American Indians 2 weeks ago, I
am moving forward with a Financial Institutions Subcommittee hearing on
developing capital resources for Native Americans. At the hearing, we
will consider issues such as:
mechanisms for providing small business capital;
means for fostering the growth of Native American-owned
financial intermediaries;
incentives for financial institutions to provide services on
Indian Lands;
ways to encourage personal savings; and
vehicles for improving financial literacy.
The goal of these discussions will be to assess the state of
affairs of Native American capital formation and to develop strategies
for addressing the barriers that keep the first Americans out of the
financial mainstream.
I thank you, Chairman Greenspan, for your extensive and thoughtful
written testimony, and for the Federal Reserve's efforts to keep the
U.S. economy on track. However, in closing, I would encourage you to
consider the economic problems facing Native Americans. I believe we
all, including the Federal Reserve Board and Federal Reserve Banks,
have a responsibility to address these issues, and I look forward to
working with you on this matter.
----------
PREPARED STATEMENT OF SENATOR WAYNE ALLARD
Mr. Chairman, I would like to thank you for holding this hearing
today and I want to welcome Federal Reserve Board Chairman Greenspan. I
always look forward to the opportunity to hear from you, Chairman
Greenspan, regarding monetary policy and other economic issues.
The Federal Reserve's quick and aggressive efforts to counteract
the effects of our Nation's weakened economy during 2001 should be
applauded. The resiliency of our economy through the September 11
attacks was remarkable and it seems that the economy today is slowly
gaining strength, which we can attribute to prudent monetary and fiscal
policy.
Consumer spending remained high in recent months, particularly in
the Housing and Automotive Sectors. This strong consumption, along with
other factors, helped bring about a more stable economy. Chairman
Greenspan, I look forward to hearing from you what else can be done to
continue strengthening our economy.
Thank you, again, Mr. Chairman, for holding this hearing and
Chairman Greenspan, I look forward to your report.
----------
PREPARED STATEMENT OF SENATOR CHRISTOPHER J. DODD
It is always a pleasure to see you, Chairman Greenspan. I
appreciate your coming before the Committee today to deliver the
Monetary Policy Report to Congress.
The last time Chairman Greenspan reported on the Nation's monetary
policy before this Committee was last summer. During that time we were
wondering if our economy was heading toward a significant downturn.
Soon after, the events of September 11 occurred, and it was announced
that we were officially in a recession, and actually have been since
March 2001. Never would we have predicted that so much would have
occurred in the last 5 months. I would like to commend you for doing a
great job in taking aggressive action to counter the effects of the
shock suffered by the economy after September 11.
It has been a difficult year for our Nation. We have seen the
unemployment rate climb to rates higher than we have seen in almost a
decade. In 2001, the real GDP grew only 1.2 percent, inflation as
measured by the Consumer Price Index rose 1.6 percent in 2001.
Interesting enough, while unemployment rates climbed in 2001, consumer
spending remained steady throughout. During the last 2 months, we have
seen somewhat of a small rebound. The unemployment rate has decreased
during the last 2 months, and hopefully, we will continue to see a
decline.
Just yesterday, the Fed's Beige Book reported that a majority of
Federal Reserve districts reported some signs of improvement in
economic conditions in January and early February. The Beige Book also
reported that the increase in retail sales during the last 2 months is
an indication that the U.S. economy is recovering from the recession,
but that the recovery will be a slow and weaker one than the average
post-recession recovery. While a recovery is good news, there are many
challenges that loom ahead. Challenges that must be confronted if we
are going to build a strong economy that will afford every hard working
American an opportunity to build a sound and secure future.
I look forward to hearing from the Chairman and my colleagues this
morning. I especially look forward to hearing the Chairman's thoughts
on the diminished surplus, the duration of the recession, and his
predictions on future unemployment rates.
Again, thank you Mr. Chairman for your time before this Committee.
----------
PREPARED STATEMENT OF SENATOR DANIEL K. AKAKA
Thank you, Mr. Chairman. As we all know, in November 2001, the
National Bureau of Economic Research declared that the U.S. economy has
been in recession since March 2001, ending the longest expansion in
U.S. history and beginning the first downturn in a decade.
Chairman Greenspan and the Federal Reserve Board of Governors have
been confronted with a recession very different than those in the past.
Previous recessions were a result of a decline in consumer spending
which led to a reduction in production and capital investment. The
current recession has resulted from a decline in production and capital
investment while consumer spending has remained strong. The Federal
Reserve sharply reduced the Federal funds rate in 2001 to encourage
economic growth.
There have been some encouraging economic indicators that show the
early signs of a recovery. Examples of these include the growth of the
gross domestic product in the fourth quarter by 1.4 percent and the
significant increases in the consumer confidence index since November.
In addition, durable goods orders rose in January by 2.6 percent.
However, not all economic data has been positive. Unemployment
remains much higher than it was a year ago. Corporate profits remain
weak and new home sales reached an 18 month low in January.
Chairman Greenspan, I thank you for appearing today. I look forward
to hearing your thoughts on the state of the economy.
----------
PREPARED STATEMENT OF SENATOR ZELL MILLER
Mr. Chairman, it is a pleasure to have you before the Committee
today. My State of Georgia has been through some troubled economic
times over the past few months, just as the rest of the United States
has as well. In Georgia, manufacturing activity has been weak and we
have seen job cuts in several industries.
Tourism has been especially hard hit after September 11. Hotel
occupancy is still below normal and we are seeing continued price
discounting for hotel rooms and rental cars. Our Georgia travel
industry is vigorously promoting travel and tourism in our State both
domestically and internationally.
Additionally, agriculture has been a big concern in Georgia. Our
farmers are hurting and they are facing an uncertain future. They are
struggling with skyrocketing production costs and low-commodity prices.
They are desperately seeking the stability a farm bill will offer them.
However, because it is taking longer to get a farm bill than
anticipated, many bankers are balking at issuing loans to farmers. The
bankers want a guarantee that there will be a new farm bill this
season, or at the very least a disaster relief package. Our farmers
cannot operate without loans. Their livelihood depends on getting that
bank loan each season, so we have left them in limbo, anxiously
awaiting our next move.
And finally, many of my small businesses are reporting fairly steep
increases in their property and liability and workman's compensation
insurance premiums. Ed Northup with Burger King in Albany, Georgia,
reports that his workman's comp premiums increased 50 percent from
$28,400 in 2001 to $43,366 in 2002, and his property and liability
premiums increased 26 percent from $26,264 in 2001 to $33,213 in 2002.
These increases may reflect post September 11 needs for a terrorism re-
insurance bill.
When my time comes for questions. I look forward to asking you
about many of these concerns.
----------
PREPARED STATEMENT OF ALAN GREENSPAN
Chairman, Board of Governors of the Federal Reserve System
March 7, 2002
Since July, when I last reported to the Committee on the conduct of
monetary policy, the U.S. economy has gone through a period of
considerable strain, with output contracting for a time and
unemployment rising. We in the Federal Reserve System acted vigorously
to adjust monetary policy in an endeavor both to limit the extent of
the downturn and to hasten its completion. Despite the disruptions
engendered by the terrorist attacks of September 11, the typical
dynamics of the business cycle have reemerged and are prompting a
firming in economic activity. The recent evidence increasingly suggests
that an economic expansion is already well under way, although an array
of influences unique to this business cycle seems likely to moderate
its speed.
At the time of our last report, the economy was weakening. Many
firms were responding to the realization that significant overcapacity
had developed. The demand for capital goods had dropped sharply, and
inventories were uncomfortably high in many industries. In response,
businesses slashed production, and the resulting declines in incomes
amplified the cyclical downturn. Real gross domestic product did not
grow in the second quarter and contracted in the third.
A coincident deceleration in activity among the world economies was
evident over the past year, owing, at least in part, to the
retrenchment in the high-technology sector and the global reach of the
capital markets in which the firms in that sector are valued and
funded. However, before the terrorist attacks, it was far from obvious
that this concurrent weakness was becoming self-reinforcing. Indeed,
immediately prior to September 11, some sectors exhibited tentative
signs of stabilization, contributing to a hope that the worst of the
previous cumulative weakness in world economic activity was nearing an
end.
That hope was decisively dashed by the tragic events of early
September. Adding to the intense forces weighing on asset prices and
economic activity before September 11 were new sources of uncertainty
that began to press down on global demand for goods and services.
Economies almost everywhere weakened further, a cause for increasing
uneasiness. The simultaneous further slowing in activity raised
concerns that a self-reinforcing cycle of contraction, fed by
perceptions of greater economic risk, could develop. Such an event,
though rare, would not be unprecedented in business-cycle history.
If ever a situation existed in which the fabric of business and
consumer confidence, both here and abroad, was vulnerable to being
torn, the shock of September 11 was surely it. In addition to the
horrific loss of life, enormous uncertainties had accompanied the
unfolding events and their implications for the economy. Indeed, for a
period of weeks, U.S. economic activity did drop dramatically in
response to that shock.
In the immediate aftermath of the strikes, the Federal Reserve
engaged in aggressive action to counter the effects of the shock on
payment systems and financial markets. We provided a huge volume of
reserves through open market operations, the discount window, and other
means to facilitate the functioning of the financial system. We worked
closely with many market participants, industry groups, and other
Government officials on a broad range of financial infrastructure
problems that needed to be resolved quickly and in the common interest.
Still, market functioning was impaired for a time. The substantial
damage to trading, settlement, and communications facilities forced
many market participants to their backup sites. Owing in part to
careful and thorough contingency planning, many firms, markets, and
exchanges were able to resume business within a few hours or days of
the attacks. Nonetheless, the episode did reveal threats to, and
vulnerabilities of, the operations of financial institutions that had
not been previously considered and illustrated the significant
interdependence of the modern financial infrastructure. Institutions
will need to continue to work diligently toward ensuring that their
backup capabilities are adequate. We at the Federal Reserve have been
reexamining intensively our own contingency capabilities to ensure that
our central banking functions can be performed in the most pressing of
emergency circumstances.
In the weeks following the attacks, along with the drops in
activity and confidence, equity prices fell markedly, and lenders
became more cautious, boosting risk premiums, especially on credits
already considered to be weak. In response, the Federal Reserve reduced
short-term interest rates considerably further. Longer-term yields,
including mortgage rates, fell to extraordinarily low levels. The
monetary stimulus that we provided was visible not only in interest
rates but also in a rapid growth of liquidity over the final months of
the year, as gauged by the broad monetary aggregates. As the fourth
quarter progressed, business and consumer confidence recovered, no
doubt buoyed by successes in the war on terrorism. The
improved sentiment seemed to buffer the decline in economic activity.
Indeed, in the past several months, increasing signs have emerged
that some of the forces that have been restraining the economy over the
past year are starting to diminish and that activity is beginning to
firm. The appearance of these signs, in circumstances in which the
level of the real Federal funds rate was at a very low level, led the
Federal Open Market Committee to keep policy unchanged at its meeting
in late January, although it retained its assessment that risks were
tilted toward economic weakness.
One key consideration in the assessment that the economy is moving
through a turning point is the behavior of inventories. Stocks in many
industries have been drawn down to levels at which firms will soon need
to taper off their rate of liquidation, if they have not already done
so. Any slowing in the rate of inventory liquidation will induce a rise
in industrial production if demand for those products is stable or is
falling only moderately. That rise in production will, other things
being equal, increase household income and spending. The runoff of
inventories, even apart from the large reduction in motor vehicle
stocks, remained sizable in the fourth quarter. Hence, with production
running well below sales, the lift to income and spending from the
inevitable cessation of inventory liquidation could be significant.
But that impetus to the growth of activity will be short-lived
unless sustained
increases in final demand kick in before the positive effects of the
swing from inventory liquidation dissipate. We have seen encouraging
signs in recent days that underlying trends in final demand are
strengthening, although the dimensions of the pickup remain uncertain.
Most recoveries in the post-World War II period received a boost
from a rebound in demand for consumer durables and housing from
recession-depressed levels in addition to an abatement of inventory
liquidation. Through much of last year's slowdown, however, spending by
the household sector held up well and proved to be a major stabilizing
force. As a consequence, although household spending should continue to
trend up, the potential for significant acceleration in activity in
this sector is likely to be more limited than in past cycles.
In fact, there are a number of cross currents in the outlook for
household spending. In recent months, low mortgage interest rates and
favorable weather have provided considerable support to homebuilding.
Moreover, attractive mortgage rates have bolstered the sales of
existing homes and the extraction of capital gains embedded in home
equity that those sales engender. Low rates have also encouraged
households to take on larger mortgages when refinancing their homes.
Drawing on home equity in this manner is a significant source of
funding for consumption and home modernization. The pace of such
extractions likely dropped along with the decline in refinancing
activity that followed the backup in mortgage rates that began in early
November. But mortgage rates remain at low levels and should continue
to underpin activity in this sector.
Consumer spending received a considerable lift from the sales of
new motor vehicles, which were remarkably strong in October and
November owing to major
financing incentives. Sales have receded somewhat, but they have
remained surprisingly resilient. Other consumer spending appears to
have advanced at a solid pace in recent months.
The substantial declines in the prices of natural gas, fuel oil,
and gasoline have clearly provided some support to real disposable
income and spending. To have a more persistent effect on the ongoing
growth of total personal consumption expenditures, energy prices would
need to decline further. Futures prices do not suggest that such an
outcome is in the offing, though the forecast record of these markets
is less than impressive.
Changes in household financial positions in recent years are
probably damping consumer spending, at least to a degree. Overall
household wealth relative to income has dropped from a peak multiple of
about 6.3 at the end of 1999 to around 5.3 currently. Moreover, the
aggregate household debt service burden, defined as the ratio of
households' required debt payments to their disposable personal income,
rose considerably in recent years, returning last year to its previous
cyclical peak of the mid-1980's.
However, neither wealth nor the burden of debt is distributed
evenly across households. Hence, the spending effects of changes in
these influences also will not be evenly distributed. For example,
increased debt burdens appear disproportionately attributable to
higher-income households. Calculations by staff at the Federal Reserve
suggest that the ratio of household liabilities to annual income for
the top fifth of all households ranked by income, who accounted for 44
percent of total after-tax household income last year, rose from about
1.10 at the end of 1998 to 1.20 at the end of the third quarter of
2001. The increase for the lower four-fifths was only about half as
large. Although high-income households should not experience much
strain in meeting their obligations, others might. Indeed, repayment
difficulties have already increased, particularly in the subprime
markets for consumer loans and mortgages. Delinquency rates may well
worsen as a delayed result of the strains on household finances over
the past 2 years. Large erosions, however, do not seem likely, and the
overall levels of debt and repayment delinquencies do not, as of now,
appear to pose a major impediment to a moderate expansion of
consumption spending going forward.
Although the macroeconomic effects of debt burdens may be limited,
we have already seen significant spending restraint among the top fifth
of income earners, presumably owing to the drop in equity prices. The
effect of the stock market on other households' spending has been less
evident. Moderate-income households have a much larger proportion of
their assets in homes, and the continuing rise in the value of houses
has provided greater support for their net worth. Reflecting these
differences in portfolio composition, the net worth of the top fifth of
income earners has dropped far more than it did for the bottom 80
percent.
As a consequence, excluding capital gains and losses from the
calculation, as is the convention in our national income accounts,
personal saving for the upper fifth, which had been negative during
1999 and 2000, turned positive in 2001. By contrast, the average saving
rate for the lower four-fifths of households, by income, was generally
positive during the second half of the 1990's and has fluctuated in a
narrow range in the past 2 years. Accordingly, most of the change in
consumption expenditures that resulted from the bull stock market, and
its demise, reflected shifts in spending by upper-income households.
The restraining effects from the net decline in wealth during the past
2 years presumably have not, as yet, fully played out and could exert
some further damping effect on the overall growth of household spending
relative to that of income.
Perhaps most central to the outlook for consumer spending will be
developments in the labor market. The pace of layoffs quickened last
fall, especially after September 11, and the unemployment rate rose
sharply. However, layoffs diminished noticeably in January, and the
reported unemployment rate declined--though adjusting for seasonal
influences was difficult last month. Moreover, initial claims for
unemployment insurance have decreased markedly, on balance, providing
further evidence of an improvement in labor market conditions. Even if
the economy is on the road to recovery, the unemployment rate, in
typical cyclical fashion, may resume its increase for a time, and a
soft labor market could put something of a damper on consumer spending.
However, the extent of such restraint will depend on how much of
any rise in unemployment is the result of weakened demand for goods and
services and how much reflects strengthened productivity. In the latter
case, average real incomes of workers could rise, at least partially
offsetting losses of purchasing power that stem from diminished levels
of employment. Indeed, preliminary data suggest that productivity has
held up very well of late, and history suggests that any depressing
effect of rapid productivity growth on employment is only temporary.
The dynamics of inventory investment and the balance of factors
influencing consumer demand will have important consequences for the
economic outlook in coming months. But the broad contours of the
present cycle have been, and will continue to be, driven by the
evolution of corporate profits and capital investment.
The retrenchment in capital spending over the past year and a half
was central to the sharp slowing we experienced in overall activity.
The steep rise in high-tech spending that occurred in the early post-
Y2K months was clearly not sustainable. The demand for many of the
newer technologies was growing rapidly, but capacity was expanding even
faster, and that imbalance exerted significant downward pressure on
prices and the profits of producers of high-tech goods and services.
New orders for equipment and software hesitated in the middle of 2000
and then fell abruptly as firms reevaluated their capital investment
programs. Uncertainty about economic prospects boosted risk premiums
significantly, and this rise, in turn, propelled required, or hurdle,
rates of return to markedly elevated levels. In most cases, businesses
required that new investments pay off much more rapidly than they had
previously. For much of last year, the resulting decline in investment
outlays was fierce and unrelenting. Although the weakness was most
pronounced in the technology area, reductions in capital outlays were
broad-based.
These cutbacks in capital spending interacted with, and were
reinforced by, falling profits and equity prices. Indeed, a striking
feature of the current cyclical episode relative to many earlier ones
has been the virtual absence of pricing power across much of American
business, as increasing globalization and deregulation have enhanced
competition. In this low-inflation environment, firms have perceived
very little ability to pass cost increases on to customers. To be sure,
growth in hourly labor compensation has moderated in response to slowed
inflation and deteriorating economic conditions. A significant falloff
in stock-option realizations and in other forms of compensation related
to company performance has likely been a factor. But over most of the
past year, even those smaller hourly compensation increases outstripped
gains in output per hour, precipitating a marked decline in profit
margins.
Business managers, with little opportunity to raise prices, have
moved aggressively to stabilize cashflows by trimming workforces. These
efforts have limited any rise in unit costs, attenuated the pressure on
profit margins, and ultimately helped to preserve the vast majority of
private-sector jobs. To the extent that businesses are successful in
stabilizing and eventually boosting profits and cashflow, capital
spending should begin to recover more noticeably.
Part of the reduction in pricing power observed in this cycle
should be reversed as firming demand enables firms to take back large
price discounts. Though such an adjustment would tend to elevate price
levels, underlying inflationary cost pressures should remain contained.
Output per hour is not likely to accelerate this year as much as in a
typical recovery because businesses have not delayed, as they have in
past recessions, shedding workers at the first indications of weakened
demand. But slack in labor markets and further increases in
productivity should hold labor costs in check and result in rising
profit margins even with inflation remaining low.
Improved profit margins and more assured prospects for rising final
demand would likely be accompanied by a decline in risk premiums from
their current elevated levels toward a more normal range. With real
rates of return on high-tech equipment still attractive, that should
provide an additional spur to new investment. Reports from businesses
around the country suggest that the exploitation of available
networking and other information technologies was only partially
completed when the cyclical retrenchment of the past year began. Many
business managers are still of the view, according to a recent survey
of purchasing managers, that less than half of currently available new,
and presumably profitable, supply chain technologies have been put into
use.
Recent evidence suggests that a recovery in at least some forms of
high-tech investment could already be under way. Production of
semiconductors, which in the past has been a leading indicator of
computer production, turned up last fall. Expenditures on computers
rose at a double-digit annual rate in real terms last quarter. But
investment expenditures in the communications sector, where the amount
of overcapacity was substantial, as yet show few signs of turning up,
and business investment in some other sectors, such as aircraft, hit by
the drop in air travel, will presumably remain weak this year.
On balance, the recovery in overall spending on business fixed
investment is likely to be only gradual; in particular, its growth will
doubtless be less frenetic than in 1999 and early 2000--a period during
which outlays were boosted by the dislocations of Y2K and the
extraordinarily low cost of equity capital available to many firms.
Nonetheless, if the recent more favorable economic developments gather
momentum, uncertainties will diminish, risk premiums will fall, and the
pace of capital investment embodying new technologies will increase.
Even a subdued recovery would constitute a truly remarkable
performance for the American economy in the face of so severe a decline
in equity asset values and an unprecedented blow from terrorists to the
foundations of our market systems. For, if the tentative indications
that the contraction phase of this business cycle has drawn to a close
are ultimately confirmed, we will have experienced a significantly
milder downturn than the long history of business cycles would have led
us to expect. Crucially, the imbalances that triggered the downturn and
that could have prolonged this difficult period did not fester. The
obvious questions are what has changed in our economy in recent decades
to provide such resilience and whether such changes will persist into
the future.
Doubtless, the substantial improvement in the access of business
decisionmakers to real-time information has played a key role. Thirty
years ago, the timeliness of available information varied across
companies and industries, often resulting in
differences in the speed and magnitude of their responses to changing
business conditions. In contrast to the situation that prevails today,
businesses did not have real-time data systems that enabled
decisionmakers in different enterprises to work from essentially the
same set of information. In those earlier years, imbalances were
inadvertently allowed to build to such an extent that their inevitable
correction engendered significant economic stress. That process of
correction and the accompanying economic and financial disruptions led
to deep and prolonged recessions. Today, businesses have large
quantities of data available virtually in real time. As a consequence,
they address and resolve economic imbalances far more rapidly than in
the past.
The apparent increased flexibility of the American economy arguably
also reflects the extent of deregulation over the past quarter century.
Certainly, if the energy sector were still in the tight regulatory
fetters of the 1970's, our flexibility today would be markedly less.
That the collapse of Enron barely registered in the relatively recently
developed markets for natural gas and electric power was encouraging.
Although the terrorist attacks hit air travel especially hard over the
past few months, deregulation of that industry has demonstrably
increased the quantity and flexibility, if not the profitability, of
air travel over the past 20 years. Trucking and rail deregulation has
added flexibility to the movement of goods across our Nation.
Both deregulation and innovation in the financial sector have been
especially important in enhancing overall economic resilience. New
financial products--including derivatives, assetbacked securities,
collateralized loan obligations, and collateralized mortgage
obligations, among others--have enabled risk to be dispersed more
effectively to those willing to, and presumably capable of, bearing it.
Shocks to the overall economic system are accordingly less likely to
create cascading credit failure. Lenders have the opportunity to be
considerably more diversified, and borrowers are far less dependent on
specific institutions for funds. Financial derivatives, particularly,
have grown at a phenomenal pace over the past 15 years, evidently
fulfilling a need to hedge risks that were not readily deflected in
earlier decades.
Despite the concerns that these complex instruments have induced (an
issue I will address shortly), the record of their performance,
especially over the past couple of stressful years, suggests that on
balance they have contributed to the development of a far more flexible
and efficient financial system--both domestically and internationally--
than we had just 20 or 30 years ago.
As a consequence of increased access to real-time information and,
more arguably, extensive deregulation in financial and product markets
and the unbundling of risk, imbalances are more likely to be readily
contained, and cyclical episodes overall should be less severe than
would be the case otherwise. If this is indeed the case--and it must be
considered speculative until more evidence is gathered--the implied
reduction in volatility, other things equal, would lower risk and
equity premiums.
Other things, however, may not be wholly equal. The very
technologies that appear to be the main cause of our apparent increased
flexibility and resiliency may also be imparting different forms of
vulnerability that could intensify or be intensified by a business
cycle.
From one perspective, the ever-increasing proportion of our GDP
that represents conceptual as distinct from physical value added may
actually have lessened cyclical volatility. In particular, the fact
that concepts cannot be held as inventories means a greater share of
GDP is not subject to a type of dynamics that amplifies cyclical
swings. But an economy in which concepts form an important share of
valuation has its own vulnerabilities.
As the recent events surrounding Enron have highlighted, a firm is
inherently fragile if its value added emanates more from conceptual as
distinct from physical assets. A physical asset, whether an office
building or an automotive assembly plant, has the capability of
producing goods even if the reputation of the managers of such
facilities falls under a cloud. The rapidity of Enron's decline is an
effective illustration of the vulnerability of a firm whose market
value largely rests on capitalized reputation. The physical assets of
such a firm comprise a small proportion of its asset base. Trust and
reputation can vanish overnight. A factory cannot.
The implications of such a loss of confidence for the macroeconomy
depend importantly on how freely the conceptual capital of the fading
firm can be replaced by a competitor or a new entrant into the
industry. Even if entry is relatively free, macroeconomic risks can
emerge if problems at one particular firm tend to make investors and
counterparties uncertain about other firms that they see as potentially
similarly situated. The difficulty of valuing firms that deal primarily
with concepts and the growing size and importance of these firms may
make our economy more susceptible to this type of contagion.
Another, more conventional determinant of stability will be the
economy's degree of leverage--the extent to which debt rather than
equity is financing the level of capital. The proper degree of leverage
in a firm, or in an economy as a whole, is an inherently elusive figure
that almost certainly changes from time to time. Clearly, firms find
some leverage advantageous in enhancing returns on equity, and thus
moderate leverage undoubtedly boosts the capital stock and the level of
output. A sophisticated financial system, with its substantial array of
instruments to unbundle risks, will tend toward a higher degree of
leverage at any given level of underlying economic risk. But, the
greater the degree of leverage in any economy, the greater its
vulnerability to unexpected shortfalls in demand and mistakes.
Indeed, on a historical cost basis, the ratio of debt to net worth
for the nonfinancial corporate business sector did rise, from 71
percent at the end of 1997 to about 81 percent at the end of the third
quarter of last year, though it is still well below its level at the
beginning of the recession in 1990. The ratio of interest payments to
cashflow, one indicator of the consequence of leverage, has slowly
crept up in recent years, reflecting growth in debt. Owing to lower
interest rates, it remains far below its levels of the early 1990's.
Although the fears of business leverage have been mostly confined
to specific sectors in recent years, concerns over potential systemic
problems resulting from the vast expansion of derivatives have
reemerged with the difficulties of Enron. To be sure, firms like Enron,
and Long-Term Capital Management before it, were major players in the
derivatives markets. But their problems were readily traceable to an
old fashioned excess of debt, however acquired, as well as to opaque
accounting of that leverage and lax counterparty scrutiny. Swaps and
other derivatives throughout their short history, including over the
past 18 months, have been remarkably free of default. Of course, there
can be latent problems in any market that expands as rapidly as these
markets have. Regulators and supervisors are particularly sensitive to
this possibility. Derivatives have provided greater flexibility to our
financial system. But their very complexity could leave counterparties
vulnerable to significant risk that they do not currently recognize,
and hence these instruments potentially expose the overall system if
mistakes are large. In that regard, the market's reaction to the
revelations about Enron provides encouragement that the force of market
discipline can be counted on over time to foster much greater
transparency and increased clarity and completeness in the accounting
treatment of derivatives.
How these countervailing forces for stability evolve will surely be
a major determinant of the volatility that our economy will experience
in the years ahead. Monetary policy will have to be particularly
sensitive to the possibility that the resiliency our economy has
exhibited during the past 2 years signals subtle changes in the way our
system functions.
Our most recent experiences underscore this possibility, along with
the persistence of a long list of older, well-tested, economic
verities. Inventories, especially among producers and purchasers of
high-tech products, did run to excess over the past year, as sales
forecasts went badly astray; alas, technology has not allowed us to see
into the future any more clearly than we could previously. But
technology did facilitate the quick recognition of the weakening in
sales and backup of inventories. This enabled producers to respond, as
evidenced by output adjustments that resulted in the extraordinary rate
of inventory liquidation that we experienced late last year.
For the period just ahead, the central tendency of the forecasts of
the members of the Federal Open Market Committee prepared earlier for
our monetary policy report to the Congress was for real GDP to rise
2\1/2\ to 3 percent during 2002. Such a pace for the growth of real
output would be somewhat below the rates of growth typically seen early
in previous expansions. Certain factors, such as the lack of pent-up
demand in the consumer sector, significant levels of excess capacity in
a number of industries, weakness and financial fragility in some key
international trading partners, and persistent caution in financial
markets at home, seem likely to restrain the near-term performance of
the economy.
In line with past experience during the early stages of expansion,
labor market performance was expected initially to lag as firms rely
primarily on overtime and shifts from part-time to full-time work. The
unemployment rate was anticipated to rise somewhat further over 2002,
to the area of 6 to 6\1/4\ percent. FOMC members evidently anticipated
that slack in resource utilization, the lagged effects of past declines
in energy prices, and productivity growth will keep inflation low this
year, with the price index for personal consumption expenditure
increasing 1\1/2\ percent.
Despite its forecast that economic growth is likely to resume at a
moderate pace, as I already noted, the Federal Open Market Committee at
its meeting on January 30 saw the risks nonetheless as continuing to be
weighted mainly toward conditions that may generate economic weakness
in the foreseeable future. In effect, the FOMC indicated that until the
dynamics of sustained expansion are more firmly in place, it remained
concerned about the possibility of weak growth for a time, despite the
very low level of the Federal funds rate.
Although there are ample reasons to be cautious about the economic
outlook, the recuperative powers of the U.S. economy, as I have tried
to emphasize in my presentation, have been remarkable. When I presented
our report on monetary policy to this Committee last summer, few if any
of us could have anticipated events such as those to which our Nation
has subsequently been subjected. The economic consequences of those
events and their aftermath are an integral part of the challenges that
we now collectively face. The U.S. economy has experienced a
substantial shock, and, no doubt, we continue to face risks in the
period ahead. But the response thus far of our citizens to these new
economic challenges provides reason for encouragement.