[Joint House and Senate Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
S. Hrg. 109-596
THE ECONOMIC OUTLOOK
=======================================================================
HEARING
before the
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
__________
APRIL 27, 2006
__________
Printed for the use of the Joint Economic Committee
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JOINT ECONOMIC COMMITTEE
[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]
HOUSE OF REPRESENTATIVES SENATE
Jim Saxton, New Jersey, Chairman Robert F. Bennett, Utah, Vice
Paul Ryan, Wisconsin Chairman
Phil English, Pennsylvania Sam Brownback, Kansas
Ron Paul, Texas John Sununu, New Hampshire
Kevin Brady, Texas Jim Demint, South Carolina
Thaddeus G. McCotter, Michigan Jeff Sessions, Alabama
Carolyn B. Maloney, New York John Cornyn, Texas
Maurice D. Hinchey, New York Jack Reed, Rhode Island
Loretta Sanchez, California Edward M. Kennedy, Massachusetts
Elijah E. Cummings, Maryland Paul S. Sarbanes, Maryland
Jeff Bingaman, New Mexico
Christopher J. Frenze, Executive Director
Chad Stone, Minority Staff Director
C O N T E N T S
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Opening Statement of Members
Hon. Jim Saxton, Chairman, a U.S. Representative from New Jersey. 1
Hon. Jack Reed, Ranking Minority, a U.S. Senator from Rhode
Island......................................................... 6
Witnesses
Statement of Hon. Ben Bernanke, Chairman, Board of Governors of
the Federal Reserve System..................................... 2
Submissions for the Record
Prepared Statement of Representative Jim Saxton, Chairman........ 35
Prepared Statement of Senator Robert Bennett, Vice Chairman...... 35
Prepared Statement Senator Jack Reed, Ranking Minority........... 36
Prepared Statement of Hon. Ben Bernanke, Chairman, Board of
Governors of the Federal Reserve System........................ 37
Chart entitled ``Inflation,'' submitted by Chairman Jim Saxton... 41
Letter from Chairman Jim Saxton to Chairman Ben Bernanke with
written questions for the record............................... 42
Response from Chairman Ben Bernanke to written questions
submitted by Chairman Jim Saxton............................... 44
Letter submitted by Senator John Sununu from Chairman Alan
Greenspan to Senator John Sununu, January 3, 2006.............. 47
THE ECONOMIC OUTLOOK
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APRIL 27, 2006
Congress of the United States,
Joint Economic Committee,
Washington, DC.
The Committee met at 10:02 a.m., in room 216 of the Hart
Senate Office Building, the Honorable Jim Saxton (Chairman of
the Committee) presiding.
Representatives present: Saxton, Ryan, English, Paul,
Brady, Maloney, Hinchey, and Cummings.
Senators present: Bennett, Sununu, Sessions, Reed, and
Sarbanes.
Staff present: Chris Frenze, Robert Keleher, Brian Higgin-
botham, Colleen Healy, Katie Jones, Jeff Schlagenhauf, Jeff
Wrase, Chad Stone, Matt Salomon, and Pamela Wilson.
OPENING STATEMENT OF HON. JIM SAXTON, CHAIRMAN,
A U.S. REPRESENTATIVE FROM NEW JERSEY
Representative Saxton. Good morning. Chairman Bernanke,
it's a pleasure to welcome you here this morning. We appreciate
your appearance today and we look forward to hearing your views
on the economic outlook.
According to the official data, a healthy economic
expansion has been underway for several years. The U.S. economy
advanced 4.2 percent in 2004, and 3.5 percent in 2005.
As I have noted many times, the pickup in economic growth
since the middle of 2003 is mostly due to a rebound in
investment activity, which had been weak prior to that. This
rebound was fostered by a mix of Federal monetary policy and
the 2003 tax legislation and its incentives for investment.
The continued economic expansion has created 5.2 million
payroll jobs since 2003. The unemployment rate, at 4.7 percent,
is below the averages of the 1970s, the 1980s, and the 1990s.
The Federal Reserve and private economists forecast that
business investment and the overall economy will continue to
grow this year.
As the Fed noted in a policy report last February, ``The
U.S. delivered a solid performance in 2005.'' The Fed also
stated that ``the U.S. economy should continue to perform well
in 2006 and 2007.''
Recent data indicate that the economic growth rate for the
first quarter of this year will be quite robust when it is
released tomorrow.
According to a broad array of economic data, the outlook
remains positive. Consumer spending is expected to be solid in
2006; home ownership has reached record highs; household net
worth is also at record levels; the trend in productivity
growth remains strong.
Although oil prices have raised business costs and imposed
hardships on many consumers, these prices have not derailed the
expansion.
Meanwhile, long-term inflation pressures are contained. As
a result, long-term interest rates such as mortgage rates, are
still relatively low, although these rates have edged up in
recent weeks.
According to the Fed's preferred price index, inflation is
well under control.
One point that I would like to mention, however, is that
it's important to examine the price of energy, the causes for
increased prices, the relationship between supply and demand,
the relationship between the pump price of gasoline and oil
companies' profits, and the effect of these items on the
economy as we go forward.
In sum, current economic conditions are strong. While
economic growth is expected to exceed 3 percent this year, the
economic outlook remains positive.
Mr. Chairman, at this point, we would normally hear from
the Ranking Member, Senator Reed, however, he's tied up on the
floor, and so we're going to turn to you now for your
testimony, and then we'll get into questions.
[The prepared statement of Representative Jim Saxton
appears in the Submissions for the Record on page 35.]
STATEMENT OF HON. BEN BERNANKE, CHAIRMAN, BOARD OF GOVERNORS OF
THE FEDERAL RESERVE SYSTEM
Chairman Bernanke. Thank you. Mr. Chairman and Members of
the Committee, I am pleased to appear before the Joint Economic
Committee to offer my views on the outlook for the U.S.
economy, and on some of the major economic challenges that the
Nation faces.
Partly because of last year's devastating hurricanes and
partly because of some temporary or special factors, economic
activity decelerated noticeably late last year. The growth of
the real gross domestic product, or GDP, slowed from an annual
average rate of nearly 4 percent over the first three quarters
of 2005, to less than 2 percent in the fourth quarter.
Since then, however, with some rebound in activity underway
in the Gulf Coast region and continuing expansion in most other
parts of the country, the national economy appears to have
grown briskly. Among the key economic indicators, growth in
non-farm payroll employment picked up in November and December,
and job gains averaged about 200,000 per month between January
and March. Consumer spending and business investment, as
inferred from data on motor vehicle sales, retail sales, and
shipments of capital goods, are also on track to post sizable
first-quarter increases.
In light of these signs of strength, most private sector
forecasters such as those included in the latest Blue Chip
survey, estimate that real GDP grew between 4 and 5 percent at
an annual rate in the first quarter.
If we smooth through the recent quarter-to-quarter
variations, we see that the pace of economic growth has been
strong for the past 3 years, averaging nearly 4 percent at an
annual rate since the middle of 2003.
Much of this growth can be attributed to a substantial
expansion in the productive capacity of the U.S. economy,
which, in turn, is largely the result of impressive gains in
productivity, that is, in output-per-hour-worked.
However, a portion of the recent growth reflects the taking
up of economic slack that had developed during the period of
economic weakness earlier in the decade. Over the past year,
for example, the unemployment rate has fallen nearly one-half
percentage point, the number of people working part-time for
economic reasons, has declined to its lowest level since August
of 2001, and the rate of capacity utilization in the industrial
sector has moved up 1.5 percentage points.
As the utilization rates of labor and capital approach
their maximum sustainable levels, continued growth in output,
if it is to be sustainable and non-inflationary, should be at a
rate consistent with the growth in the productive capacity of
the economy.
Admittedly, determining the rates of capital and labor
utilization consistent with stable long-term growth is fraught
with difficulty, not least because they tend to vary with
economic circumstances.
Nevertheless, to allow the expansion to continue in a
healthy fashion and to avoid the risk of higher inflation,
policymakers must do their best to help to ensure that the
aggregate demand for goods and services does not persistently
exceed the economy's underlying productive capacity.
Based on the information in hand, it seems reasonable to
expect that economic growth will moderate toward a more
sustainable pace as the year progresses. In particular, one
sector that is showing signs of softening is the residential
housing market. Both new and existing home sales have dropped
back, on net, from their peaks of last Summer and early Fall,
and while unusually mild weather gave a lift to new housing
starts earlier this year, the reading for March points to a
slowing in the pace of homebuilding as well.
House prices, which have increased rapidly during the past
several years, appear to be in the process of decelerating,
which will imply slower additions to household wealth, and,
thereby, less impetus to consumer spending.
At this point, the available data on the housing market,
together with ongoing support for housing demand from factors
such as strong job creation and still-low mortgage rates,
suggests that this sector will most likely experience a gradual
cooling, rather than a sharp slowdown. However, significant
uncertainty attends the outlook for housing, and the risk
exists that a slowdown more pronounced than we currently expect
could prove a drag on growth this year and next. The Federal
Reserve will continue monitoring housing markets closely.
More broadly, the prospects for maintaining economic growth
at solid pace in the period ahead, appear good, although growth
rates may well vary, quarter-to-quarter, as the economy
downshifts from the first-quarter spurt.
Productivity growth, job creation, and capital spending are
all strong, and continued expansion on the economies of our
trading partners, seems likely to boost our export sector.
That said, energy prices remain a concern. The nominal
price of crude oil has risen recently to new highs, and
gasoline prices are also up sharply. Rising energy prices pose
a risk to both economic activity and inflation. If energy
prices stabilize this year, even at a high level, their adverse
effects on both growth and inflation should diminish somewhat
over time. However, as the world has little spare oil
production capacity, periodic spikes in oil prices remain a
possibility.
The outlook for inflation is reasonably favorable, but
carries some risks. Increases in energy prices have pushed up
overall consumer price inflation over the past year or so.
However, inflation in core price indexes, which, in the past
has been a better indicator of long-term inflation trends, has
remained roughly stable over the past year.
Among the factors restraining core inflation, are ongoing
gains in productivity, which have helped to hold unit labor
costs in check, and strong domestic and international
competition in product markets, which have restrained the
ability of firms to pass cost increases on to consumers.
The stability of core inflation is also enhanced by the
fact that long-term inflation expectations, as measured by
surveys and by comparing yields on nominal and indexed Treasury
securities, appear to remain well anchored.
Inflation expectations will remain low only so long as the
Federal Reserve demonstrates its commitment to price stability.
As to inflation risks, I have already noted that continuing
growth in aggregate demand in excess of increases in the
economy's underlying productive capacity would likely lead to
increased inflationary pressures. In addition, although pass-
through from energy and commodity price increases to core
inflation has thus far been limited, the risk exists that
strengthening demand for final products could allow firms to
pass on a greater portion of their cost increases in the
future.
With regard to monetary policy, the Federal Open Market
Committee, or FOMC, has raised the Federal Funds rate in
increments of 25 basis points at each of its past 15 meetings,
bringing it to its current level to 4.75 percent.
This sequence of rate increases was necessary to remove the
unusual monetary accommodation put in place in response to the
soft economic conditions earlier in this decade. Future policy
actions will be increasingly dependent on the evolution of the
economic outlook, as reflected in the incoming data.
Specifically, policy will respond to arriving information that
affects the Committee's assessment of the medium-term risk to
its objectives of price stability and maximum sustainable
employment. Focusing on the medium-term forecast horizon is
necessary because of the lags with which monetary policy
affects the economy.
In the statement issued after its March meeting, the FOMC
noted that economic growth had rebounded strongly in the first
quarter, but appeared likely to moderate to a more sustainable
pace. It further noted that a number of factors have
contributed to the stability in core inflation.
However, the Committee also viewed the possibility that
core inflation might rise as a risk to the achievement of its
mandated objectives, and it judged that some further policy
firming may be needed to keep the risk of attainment of both
sustainable economic growth and price stability, roughly in
balance.
In my view, data arriving since the meeting, have not
materially changed that assessment of the risks. To support
continued healthy growth of the economy, vigilance in regards
to inflation, is essential. The FOMC will continue to monitor
the incoming data closely, to assess the prospects for both
growth and inflation. In particular, even if, in the
Committee's judgment, the risks to its objectives are not
entirely balanced, at some point in the future, the Committee
may decide to take no action at one or more meetings, in the
interest of allowing more time to receive information relevant
to the outlook. Of course, a decision to take no action at a
particular meeting does not preclude actions at subsequent
meetings, and the Committee will not hesitate to act when it
determines that doing so is needed to foster the achievement of
the Federal Reserve's mandated objectives.
Mr. Chairman, the remainder of my testimony, which I submit
for the record, discusses two longer-term challenges to the
U.S. economy: The first is the long-run sustainability of the
Federal budget deficit. Given the aging of our population,
we're going to see increasing stress on transfer programs as a
share of GDP, and I argue that Congress needs to make difficult
choices about what share of the GDP is to be devoted to Federal
programs, and to set taxes accordingly to match that share of
GDP.
The second issue that I discuss--and I'm simply
summarizing--is the U.S. current account deficit, which is now
at about 6.5 percent of GDP, and which cannot be sustained
indefinitely at that level.
Recent discussions with the G7 have made the important
point that the U.S. current account deficit is not a U.S.
problem alone, but is a global problem, and one which requires
action and response, not only by the United States, but by our
trading partners, as well. There are a number of steps that
both we and our trading partners can take to improve the
current account situation over a period of time. On our side,
again, improved fiscal balance would be helpful, but, in
addition, other countries need to take action, as well.
In conclusion, Mr. Chairman, the economy is performing
well, and the near-term prospects look good, although, as
always, there are risk to the outlook. Monetary policy will
continue to pursue its objectives of helping the economy to
grow at a strong, sustainable pace, while keeping inflation
firmly under control.
And while many of the fundamental factors that determine
long-term economic growth appear favorable, actions to move the
Federal budget toward a more sustainable position will do a
great deal to help ensure the future prosperity of our economy.
Thank you, and I'd be happy to take any questions you might
have.
[The prepared statement of Hon. Ben Bernanke appears in the
Submissions for the Record on page 37.]
Representative Saxton. Mr. Chairman, normally we would
begin our questions at this point, but let me just ask Senator
Reed, who was tied up on the floor previously, if he has an
opening statement.
OPENING STATEMENT OF HON. JACK REED, RANKING MINORITY, A U.S.
SENATOR FROM RHODE ISLAND
Senator Reed. Well, thank you very much, Chairman Saxton,
and welcome, Chairman Bernanke, and thank you for your
testimony today and for your service.
All eyes are on you as you embark on a very delicate
balance in terms of allowing the economy to grow and employment
to reach its full potential, while you remain mindful of the
risks of inflation.
For some time, the Fed's job has been easier. It had room
to raise interest rates from very low levels, with little risk
of derailing the economic recovery, while inflation and other
lurking economic problems were at bay.
Today, soaring energy prices, record budget and trade
deficits, negative household savings rates, and a disappointing
labor market recovery, all pose tremendous challenges to
setting monetary policy.
The Fed has raised its target for the Federal Funds rate by
25 basis points at each of the last 15 FOMC meetings, and,
according to the minutes of the March meeting, most members of
the FOMC thought that the end of the tightening process was
near. The question on everyone's mind is, are we there yet?
The phrase we are hearing is that interest rate changes
will now be data-driven, so I hope that means, Chairman
Bernanke, that the Fed will look hard at the full range of data
on economic growth, employment, and inflation, to determine the
best course for monetary policy.
GDP is growing, but the typical American worker has been
left out of the economic gains of this recovery. Strong
productivity growth has shown up in the bottom lines of
shareholders, but not in the paychecks of workers.
Too many Americans are being squeezed by stagnant incomes
and rising costs for gasoline, healthcare, and education. It
seems to me that there is still room for real wages to catch up
with productivity, before the Fed needs to worry about
inflationary pressures from the labor market.
However, there are many other downside risks to the economy
on the horizon. You have mentioned some of them.
Energy prices have been pushing up overall inflation for
some time, but last month, we saw an uptick in core inflation,
which might be an early sign that businesses are starting to
pass on their higher energy costs to customers.
Rising oil prices and interest rates, coupled with a
weakening housing sector, could take their toll on consumers
and businesses alike, and slow down the economy.
Your task in setting the right course for monetary policy
is complicated by fiscal policy and international imbalances,
which you discuss in the bulk of your statement, which you put
into the record.
We no longer have the fiscal discipline that we had in the
1990s, which allowed for monetary policy that encouraged
investment and long-term growth. The President's large and
persistent budget deficits have led to an ever-widening trade
deficit that forces us to borrow vast amounts from abroad, and
puts us at risk of a major financial collapse if foreign
lenders suddenly stop accepting our IOUs.
Even assuming we can avoid an international financial
crisis, continued budget and trade deficits will be a drag on
the growth of our standard of living, and leave us ill prepared
to deal with the effects of the retirement of the Baby Boom
generation.
Strong investment financed by our own national saving, not
foreign borrowing, is the foundation for strong, sustained
economic growth and rising living standards.
There is final issue that I'd like to raise, and that is
the growing inequality of income, earnings, and wealth in the
U.S. economy. Your predecessor, Chairman Greenspan, regularly
raised that issue as one of the concerns for our political
economy. It is not good for a democracy to have widening
inequality.
I know you share those concerns. Recently the Federal
Reserve published the results of the 2004 Survey of Consumer
Finances. They show that the growth in median income and wealth
have slowed substantially, and the top 1 percent of families
hold more wealth than the bottom 90 percent of families.
Mr. Chairman, I hope you can concentrate on that issue as
you continue to develop policy, and, I again encourage and
welcome your presentation here today. Thank you, Mr. Chairman.
[The prepared statement of Hon. Jack Reed appears in the
Submissions for the Record on page 36.]
Representative Saxton. Thank you very much, Senator Reed.
Mr. Chairman, let me begin with a question that I think is
central to the subject that we're discussing here, and that is
the Fed's role in managing our Nation's monetary policy.
In both your statement and in Senator Reed's statement, the
subject of inflation was mentioned prominently. As a matter of
fact, the Fed's monetary policy for many years has focused on
price stability and trying to control inflation.
Under such policy, inflation and interest rates are kept
low. As this low inflation persists, the central bank's policy
becomes increasingly credible in the eyes of investors, as well
as in the eyes of savers.
As a consequence, inflationary expectations recede and
interest rates decline. These movements, in turn, encourage
economic growth and lower unemployment, and just better
economic outcomes for everyone.
My question is this: If the United States were to move
toward explicit inflation targeting, would this be largely a
movement for greater transparency, or mostly a significant
change in the substance of Fed monetary policy?
Chairman Bernanke. Thank you, Mr. Chairman. Let me first
address the point on inflation. The Federal Reserve has a
three-part mandate: Price stability; moderate long-term
interest rates; and maximum employment.
Clearly, keeping inflation low and stable addresses
directly the first two of those, in particular, since long-term
interest rates can only be low if investors expect inflation to
remain low. I would argue, in addition, that there's very
strong evidence that low and stable inflation and well-anchored
inflation expectations also contribute mightily to the third
objective, which is strong and stable employment growth.
For example, we have seen since the mid-1980s, what
economists refer to as the great moderation, the fact that
recessions have been somewhat less frequent and milder, that
quarter-to-quarter variation in output and employment has been
lower. Many scholars attribute that to the fact that inflation
in that last 20-year period, has been low and stable.
Therefore, it is very much in the interest of all of the
objectives, including the employment objectives of the Federal
Reserve, to keep inflation low and stable. So, then, the
question is, how to do that?
The Federal Reserve already has established strong
credibility for keeping inflation low and stable, and I
anticipate we will retain that credibility.
I have discussed, and will be discussing with the Federal
Open Market Committee, ways in which we can continue Chairman
Greenspan's movement toward greater transparency and better
communication, to further anchor inflation expectations and
reduce uncertainty in financial markets.
One of the ideas that's been discussed in that context, is
the idea of defining, quantitatively, what the optimal long-
term inflation rate might be. In doing so, the hope would be to
reduce uncertainty and to help anchor inflation expectations
more tightly.
Clearly--and I'd like to emphasize this point--taking this
step would in no way repudiate the employment part of the dual
mandate; to the contrary, it would provide the Fed with a
stronger tool and better ability to meet this very important
objective.
So, to answer your question most directly, I don't see, and
I don't desire, any change in the basic operating procedures of
the Fed, nor in its objectives; rather, I think that we need to
work on our communication, broadly speaking, to make sure that
inflation expectations remain low and stable, as a tool for
meeting all three of the Federal Reserve's mandated objectives.
Representative Saxton. Mr. Chairman, thank you. Some worry
about Fed policy, which has focused on price stability over the
last couple of decades. Recently, under this policy we have
seen a relatively long period of Fed tightening, which resulted
in higher overnight interest rates.
Some would worry that this translates into higher interest
rates in the economy, particularly in long-term interest rates,
and, most recently, that has not happened. As a matter of fact,
we have seen stable long-term interest rates, in spite of the
fact that short-term rates have increased rather significantly.
Why is it that long-term rates have remained stable and
even come down during this period of time, on occasions, when
Fed policy has been to tighten and the net result of that is
short-term rate increases?
Chairman Bernanke. Mr. Chairman, first I'd like to
reiterate the point that increasing short-term rates to control
inflation has the effect actually, in the long run certainly,
of keeping long-term rates lower, rather than higher.
I can only draw the contrast between the 1970s and the
early 1980s when people paid 18 percent for mortgages, vis-a-
vis today where they are paying 6 percent-plus, in an
environment where inflation is low and stable and under
control, and in that respect, meeting our objective of low to
moderate long-term interest rates is best achieved by keeping
inflation low and stable.
With respect to the recent behavior of long-term interest
rates, it's useful to think about the long-term interest rate
as consisting of a series of short-term rates, the rates for
the next few years and then the rates that investors expect to
be maintained further out into the future.
Over the last almost 2 years, as the Fed has been
tightening, the short-term component of that has been rising,
as the policy rate has risen, but the further-out short-term
rates, at the far end of the yield curve, have been declining
and offsetting that effect and leaving the overall 10-year rate
more or less stable.
The declines in the far-out yields, further out in the term
structure, seem to result from both an increase of saving in
the global economy, which has been looking for returns--and
some of that has come to the United States and to other
industrial countries, driving down returns--and also some
reduction in term premiums, reflecting the reduced sense of
risk that investors feel about the general economy, about
inflation, and about the bond market, specifically.
Now, recently, we have seen a turnaround, in that the far-
out short-term rates, the rates that investors expect to be
maintained, 5 or 10 years from now, have risen fairly
significantly, leading to an overall increase in long-term
interest rates.
I think there are basically two reasons for that: First,
there has been some return of the term premium back to more
normal levels, after a period of unusually low levels.
But, second, and, I think, importantly for our economy, it
appears that the world economy is growing this year at a very
healthy pace. We're seeing strength in Japan; we're seeing some
incipient strength in Europe; China continues very strong, as
well as Southeast Asia; emerging markets are doing well, so
general strength in the world economy is providing some
increased upward pressure on long-term interest rates, and
that, I think, explains what's been happening in the last
couple of months.
Representative Saxton. Thank you. Let me just change the
subject for just a moment.
The price of oil has reached a price in excess of $70 a
barrel. Just let me ask quickly before we turn to the next
Member, how does the oil price increase affect your outlook on
the economy? Are you worried or extremely worried? What is your
general outlook on this subject?
Chairman Bernanke. Yes, Mr. Chairman, higher oil prices do
create problems for monetary policy. On the one hand, they
directly affect the cost of living, inflation, on the other
hand, by taking purchasing power away from consumers, they tend
to slow economic activity, and so they do produce a difficult
problem.
For the Federal Reserve, one issue we will be looking at
very carefully is whether the increases in energy prices that
we have already seen and that we may see in the future pass
through into core inflation--that is, whether they go beyond
the energy sector itself and begin to be seen in higher prices
for other goods and services. If that were to happen and if
expectations of inflation were thereby to rise, that would be
very deleterious to the long-term growth of the economy.
By contrast, if inflation expectations remain stable and
core inflation is not infected, so to speak, by high energy
prices, that gives the Fed considerably more leeway to respond
to any changes that may happen in the real economy related to
the higher oil prices.
In particular, we do expect to see a slight slowing in
growth, perhaps a couple of tenths, this year and next
associated with the higher oil prices and their effects on
consumer spending. And we are very aware of that and are paying
attention to those developments.
Representative Saxton. Thank you, Mr. Chairman.
Senator Reed.
Senator Reed. Thank you, Mr. Chairman. Because Senator
Sarbanes has to leave, I would yield him 5 minutes for
questions.
Senator Sarbanes. Thank you very much, Senator Reed. I will
be very brief and I apologize to Chairman Bernanke that I
cannot stay. I have been looking forward to this hearing, but I
have another commitment.
I am drawn to the sentence at the bottom of page 3 of your
statement: ``Of course, inflation expectations will remain low
only so long as the Federal Reserve demonstrates its commitment
to price stability.'' And the question I want to raise to you
is that in order for the Federal Reserve to demonstrate its
commitment to price stability, is it necessary for the Open
Market Committee to raise interest rates 25 basis points every
time they meet?
Chairman Bernanke. No, Senator.
Senator Sarbanes. Well that is fine. All I need is an
answer, just so I----
Chairman Bernanke. If that satisfies----
Senator Sarbanes [continuing]. Just so I know that we are
not on an irreversible treadmill here, since we have seen 15
meetings in a row in which the Open Market Committee has taken
the interest rates up. But it has not built itself in so that
you have to do that at every meeting in order to show that
you're inflation fighters, is that correct?
Chairman Bernanke. Yes, Senator. Our assessment currently
is that the risks to inflation are perhaps the most significant
at the moment and we need to address that. But as I emphasized
in my statement--I make two points: first is that now that we
have taken away most of the extraordinary accommodation that we
had in the system back from 2003, we are much more data-driven,
we need to continually reevaluate our forecasts and think about
the prospects for the economy and make our decisions based on
the information that is coming into our hands.
And second, as I noted in my written testimony, there is
always the possibility that if there is sufficient uncertainty
that we may choose to pause simply to gain more information to
learn better what the true risks are and how the economy is
actually evolving.
Senator Sarbanes. Well, I see that the minutes of your most
recent meeting on March 28th did say, ``Most members thought
that the end of the tightening process was likely to be near
and some expressed concerns about the dangers of tightening too
much, given the lags in the effects of policy.'' I very much
share that concern, and so I welcome that statement and I hope
the Open Market Committee will, in effect, act off of that
statement in the upcoming meetings.
The other point I would like to raise to you is I want to
again urge you, as we did when we held your confirmation
hearing, on the issue of Federal statistics and the importance
of having appropriate and accurate Federal statistics. A number
of us in the Congress--71 Members, 29 Senators and 42 House
Members--have written to the President about the elimination of
the Survey of Income and Program Participation series, and we
urge the Administration to try to find money with which to
continue that particular program.
I think if the Chairman of the Fed would take a keen
interest in Federal statistics, it would be very helpful in
assuring ourselves that we have accurate and reliable data upon
which to make some of these decisions. Major decisions are
being made that have vast economic implications, and yet the
amount of money going into the methodologies is very, very
limited. We were never able to get Chairman Greenspan to agree
to any spending program except Federal statistics. He did on
one occasion say that he thought we ought to do more. So I
would just leave that idea with you. Thank you very much.
And thank you, Senator Reed.
Representative Saxton. Thank you very much, Senator
Sarbanes.
Senator Bennett.
Senator Bennett. Thank you very much, Mr. Chairman.
I would note your comment with respect to rate hikes.
Everybody wants to read into what you are saying to get an
advance understanding of what is going to happen tomorrow. My
own sense is that the economic information tomorrow is going to
be very strong with respect to GDP growth in the first quarter;
you indicated your assumption that that will be the case. My
market watchers say that could be really bad for the market,
because when the GDP numbers come out very strong, that means
the Fed is going to raise interest rates and they are all going
to sell off in anticipation of that.
I recognize that there is no way you or I can anticipate
what you are going to do at the next FOMC meeting but,
following up on Senator Sarbanes, I would just reassure the
people who were concerned about this, Chairman Bernanke has
said that even if in the Committee's judgment the risk to its
objectives are not entirely balanced, at some point in the
future the Committee may decide to take no action at one or
more meetings in the interest of allowing more time to receive
information relevant to the outlook.
That is a very Greenspan-type statement, sufficiently
tipped in both directions, but I take it as a signal that what
you have said to Senator Sarbanes here is correct, that we are
getting to the point where this almost automatic increase is
not going to occur. And Chairman Greenspan made it very clear
in his statements that there was going to be an automatic
increase every single time they met when the rate was 1
percent. And he tried to be as clear as he ever could be that
that was going to happen, and I welcome this statement and I
think in this conversation we have had, we ought to highlight
it one more time, as I have done.
Now, let's talk about the global savings glut. You have
made mention of that, suggesting that one of the explanations
for the persistence of relatively low long-term interest rates
has come from a global savings glut. And as long as we are
looking into crystal balls and trying to predict what is going
to happen, let's get out of the FOMC crystal ball and look
around the world. Do you think there is still a global savings
glut and what is your sense as to how long it is going to
continue? Because that has a great deal to do with the current
account deficit and people investing in the United States and
so on.
Chairman Bernanke. Thank you, Senator. Just to provide a
little bit of background, I have argued in the past that there
is an excess of saving over investment in our trading partners
around the world and that extra saving has come to the United
States, has driven down world real interest rates, and has been
part of the reason for our current account deficit. And I do
believe that is part of the explanation for why the current
account deficit of the United States has risen and part of the
reason why, as I argued earlier, it is really a global issue
and not just a United States issue to deal with this deficit.
In terms of whether the savings glut still exists, there is
a short-term and a long-term answer to that question. Relevant
to my earlier comment, I think we are seeing a bit of a decline
in that glut in that interest rates--global interest rates, not
just those in the United States--long-term rates have risen in
the last couple of months, suggesting some reduction in the
excess of savings over investment outside of the United States,
and I think that is perhaps a small step in the direction
toward the moderation of the savings glut.
Longer-term, though, I think there is still a long way to
go. And, in particular, what is needed is for our trading
partners, including those in southeast Asia, and also oil
producers, emerging markets generally, to rely more heavily on
their own domestic demand as a source of growth rather than on
exports to the United States.
To take one example, I do see some encouragement that the
Chinese are at least talking about these issues, that they have
recognized that it is not in their interest to run their
economy as an export-led economy indefinitely, and that they
are at least discussing some approaches to increase domestic
consumption in order to reduce the amount of saving that they
put into the world capital markets.
So these are steps that are promising. It is still very
early; there is not much to be seen from it yet. But that is
the kind of development that, over a number of years, will help
rebalance the world economy so that the U.S. is not importing
goods and capital at such a high rate and other countries are
growing more from their domestic demand and less from exports.
Senator Bennett. So if I can summarize without putting
words into your mouth, the solution to the current account
deficit given the scenario you have outlined, could very well
come in slowly over time rather than dropping off a cliff, and
we could see this thing resolve itself in the next, say, within
the next decade or so.
Chairman Bernanke. I would not expect it to resolve in a
short period. It is going to take quite a few years for these
balances to readjust internationally.
Senator Bennett. But you do not see it dropping off a
cliff.
Chairman Bernanke. I do not expect any such change.
Senator Bennett. Good. Thank you.
Representative Saxton. Thank you very much, Senator.
We are going to go now to Mrs. Maloney, the gentle lady
from New York.
Representative Maloney. Thank you.
Welcome, Mr. Bernanke, and thank you for your testimony.
Democrats are concerned not only about price stability and
maintaining and controlling inflation, but also jobs, wages,
and continuing to grow our economy. We are very concerned that
in the recovery the economic positive impact has not shown up
in the wages of the average worker and there has been a decline
in the past 2 years, and we hope you will take that into
consideration as you develop monetary policy.
My constituents are very concerned, I would say even
nervous about this continued clip or pace in the increase in
interest rates--it has been raised 15 times since June of 2004,
and there is a feeling that maybe we should step back a few
steps and just assess where we are. And there is a deep concern
about it and I wanted to relay that to you. My question is can
we continue to increase interest rates without having a
negative impact on our economic growth?
Chairman Bernanke. Thank you for the question. Let me just
address a few parts of it, if I might.
On wages, real wages have not grown at the pace we would
like to see. There are a number of reasons: energy prices have
clearly sapped consumer buying power. There has been a spread
between real wages and compensation reflecting increased health
costs, health insurance costs, for example, and, most puzzling,
real wages have not apparently caught up with the productivity
boom that we have seen going on in the economy.
My suspicion is that as the economy continues to strengthen
and labor markets continue to strengthen, we will see further
increases in real wages and that will be very desirable. I
would also add that I do not believe that higher real wages are
inflationary. Higher real wages can be offset by higher
productivity and they can be offset by lower margins between
costs and selling prices. And so I do hope to see higher real
wages going forward.
With respect to the Fed's mission, as I argued before, it
is like the seventies when inflation was out of control and
those were not good times for workers either. I think we all
benefit from price stability. The Fed has a very important
objective in maintaining price stability and credibility that
is going to keep prices at a stable point. And I believe that
doing so supports strong and stable employment growth, and that
is the other part of our mandate, to which we are going to pay
very serious attention.
Representative Maloney. Do you believe we can continue to
raise interest rates without having a negative impact on our
economy?
Chairman Bernanke. I think we will try to raise rates, if
we do, in a way that maximizes the attainment of our
objectives, which are price stability and maximum sustainable
employment growth. Employment growth that is not sustainable
and which leads to----
Representative Maloney. Mr. Chairman, are we not near full
employment now, so----
Chairman Bernanke. But the underlying growth of the
economy, which is being determined by a very robust
productivity increases, is still going to be quite healthy, and
so my anticipation is that for example, in 2006 we are still
going to see growth in the range between 3 and 4 percent, a
very healthy pace of growth, and I believe that would be
consistent with our attempts to keep inflation well anchored.
Representative Maloney. In your testimony you said our
accounts deficit, our trade deficit, was 6-6\1/2\ percent of
GDP and that this was unsustainable and that our world
partners, our global partners, are saying the same thing. Right
now we have very low national savings and also this large trade
deficit. What role does fiscal discipline have in addressing
these problems and, second, what will happen if we do not get
control of the Federal budget? What will happen?
Chairman Bernanke. Well first of all, it is very important
that we get control of the fiscal situation, particularly over
the longer term. As my testimony elaborates, in particular as
our society ages, the share of GDP going to the three major
transfer programs is going to go from about 8 percent of GDP
today to about 16 percent in 2040. And if that were to
transpire as forecast, we would be faced either with
essentially cutting all other types of spending or raising
taxes quite substantially. So there are some very hard choices
to be made if our Federal budget is going to be sustainable
into the next few decades. That is very important, and we need
to be thinking about that soon. The sooner we make these hard
choices, the better the economy will be able to adjust whatever
changes we make.
With respect to the current account, there is a link, a
somewhat weak link, between fiscal and current account
deficits. To the extent that fiscal deficits reduce national
saving, that in turn contributes to the need to borrow abroad,
which a part of what the current account deficit is about.
Unfortunately, most of the research suggests that fiscal
consolidation by the United States on its own will only have
modest impacts on the current account deficit. Every dollar or
so by which the fiscal deficit is reduced by most estimates
would only reduce the current account deficit by 20 or 30 cents
for various reasons that I could get into.
But the implication is that the United States really cannot
solve the current account deficit problem by itself. It is a
global issue. We need the cooperation of our trading partners.
And all together, by taking actions which are in our own
individual interest, we can also help create a better balance
in terms of trade flows as well.
Representative Maloney. My time is up. I did want to ask
what we could do about this growing inequality, but maybe the
next round.
Chairman Bernanke. Sure.
Representative Saxton. We are going to go to Mr. Ryan next,
but I cannot help but talk a little bit here just for a minute
about a real-life experience that I had relative to interest
rates and inflation expectations. In 1965, I graduated from
college and in 1966, I became a real estate salesman. And I
remember for quite a few years whether I went to Bank A, B, or
C, the interest rate on home mortgages was 6 percent. And as we
got to the late 1970s all of a sudden inflation became an
issue. And by the end of the seventies, 1978, 1979, inflation
had reached double digits. And when we went to the bank with
the person who wanted to buy the house, they were told the
interest rate was 18, 19 or 20 percent. And when I asked the
bankers why that was, they said because we don't know what
inflation is going to be next year. Our expectation is that we
don't know, and therefore we have to hedge against even higher
inflation than 10 or 11 percent.
Today's interest rates are back where they were essentially
in 1966, when I was a young guy and a real estate salesman. And
today home mortgage interest rates are at 6 percent because the
expectations of inflation going forward are that inflation is
under control. And I credit the policy of the Fed over the past
couple of decades for bringing us back to 1966 levels of
mortgage interest rates.
I wanted to note that because everyone in the public should
have the opportunity to understand what it is that the Fed has
been successful in doing over these years. And I don't know
whether you would like to comment further on that, but this is
an extremely important element going forward with respect to
economic growth.
Chairman Bernanke. I would just add that it's often
neglected that the third part of our legal mandate is to
maintain low to moderate long-term interest rates and that is,
of course, best achieved by keeping inflation not only low, but
keeping a high degree of confidence among bond traders and the
like that it will stay low.
Representative Saxton. We have a chart over here that shows
the path of inflation during the decades of the 1980s and 1990s
and into 2000. It very clearly shows that during the early
1990s inflation peaked out at a very moderate 4.5 to 5 percent
and today we are down to a rate that appears to be under 2
percent. And so these are what creates the environment in which
long-term rates are set. And so to the extent that we thank you
and your predecessor for helping us to understand this, it has
been a very, very healthy process.
[The chart entitled ``Inflation'' appears in the
Submissions for the Record on page 41.]
Mr. Ryan.
Representative Ryan. Thank you, Chairman. We have belabored
monetary policy so I am going to switch to fiscal policy, but I
want to just make one point. Chairman Bernanke, I am very
pleased and encouraged with what you had to say about inflation
targeting. To the extent that the Fed can institutionalize
expectations and smooth out the investment horizons and remove
further uncertainty by being more transparent with inflation
targeting, I think that is a fantastic contribution you can
bring to the Federal Reserve, so I am very encouraged with your
statements on that.
On fiscal policy, we are in the midst of considering tax
legislation right now as to whether or not to extend the tax
cuts that passed in 2003. Many of us are concerned that large
tax increases at this time, during our economic recovery, would
be a bad idea. I just want to go through a few statistics,
because we have seen people make points to the contrary which
don't necessarily add up.
Since the 2003 tax cuts--first of all, our unemployment
rate was 6.3 percent at that time. Now it is at 4.7 percent.
Since the 2003 tax cuts, we have gained net in the employment
survey 5.2 million new jobs. Our economic growth rate, the 10
quarters preceding the tax cuts was 1.3 percent, the 9 quarters
since then it has been 3.9 percent; so we have seen a
remarkable turnaround I would say due in large part to the
fiscal policy of our country. But now is the time to talk about
whether or not to extend these things. And people have been
talking about revenues.
When we passed it--I serve on the Ways and Means Committee,
and we looked at these revenue projections quite a bit. And we
thought, according to our estimates, that we would increase the
deficit or that we would actually see a reduction in revenues.
And what actually ended up turning out was that our revenue
projections by the Joint Committee on Taxation didn't
materialize; actually revenues increased at these lower tax
rates. Economic revenues from the individual side in 2004 were
up 1.9 percent at the lower tax rates and the corporate income
tax receipts were up 43.7 percent in 1904. In 1905, revenues
were up 14.6 percent on the individual side and 47 percent on
the corporate side.
At this moment, we are debating tax legislation as to
whether or not to extend the 2008 deadline on capital gains and
dividends. And that is where some people are saying the
dividends--the capital gains tax cuts cost us money.
The Joint Committee on Taxation at the time, in 2003, told
us that we would lose $27 billion in revenue in lower receipts
over the years 2004-2005. What actually materialized, the
actual revenues were, realization surged and receipts went up.
The receipts increased by $26 billion. So we went from a
projection of a $27 billion loss over 2004 and 2005 to actually
increasing tax receipts from capital gains at the lower tax
rate by $26 billion over that, so an enormous difference.
The question I basically have is do you agree that the tax
cuts have been helpful to economic growth, and do you see a
benefit in providing predictability to investors on tax rates?
I clearly can tell that you believe there is a benefit to
providing certainty with respect to monetary policy, thus the
discussion on inflation targeting. Do you believe that there is
a benefit to the economy and to investors by providing
certainty on tax rates given the fact that virtually every
corner of the Tax Code is up for grabs in either 2008 or 2010?
Chairman Bernanke. Mr. Ryan, I highly value the nonpartisan
nature of the Federal Reserve, and for that reason I have
decided that I will not be advising on specific individual tax
and spending programs. I will make a couple of comments,
though, which I hope will be useful.
One is that I do agree that fiscal policy, along with
monetary policy, was an important factor in helping to restart
the economic engine in this latest episode, and some of the
statistics you quoted suggest that we did go from a very weak
situation early in 2003 to a much stronger growth path after
that.
The other comment I would make on your issues with respect
to revenues I have addressed in a recent letter, and that
concerns the issue of dynamic versus static scoring. To the
extent that tax cuts, for example, promote economic activity,
the loss in revenues arising from the tax cut will be less than
implied by purely static analysis which holds economic activity
constant.
There is currently an important and interesting debate
going on to the extent to which so-called dynamic scoring
should be used in the Congress. I don't want to come down with
a definite recommendation. One issue is that any dynamic
scoring model requires some assumptions about what theory, what
model, you are going to use to make the assessment, and,
therefore, you are going to have to look at different
alternatives in coming up with an outcome. But I do think it is
worth considering an alternative range of scoring mechanisms to
give Congress a sense of what the possible outcomes would be on
the revenue side from different tax changes.
Representative Saxton. And as to promoting certainty in the
investment markets and in households and businesses to the tax
climate in the future?
Chairman Bernanke. Well again, I don't want to make a
definite recommendation. The specifics of the dividend tax
extension, for example, would involve not only considerations
of efficiency, but also considerations of equity and revenues.
But looking strictly at the efficiency side, clearly more
certainty about the tax code--and I think this applies to any
tax regulation--when people know the tax rules are going to be
stable, they are going to have stronger effects and more
positive effects than if they are worried that they are going
to be changing from year to year.
Representative Saxton. Thank you.
Senator Bennett. Senator Reed.
Senator Reed. Thank you, Mr. Chairman. Thank you for your
testimony today. And just in line with the question about the
effect of tax cuts, the former chairman of the Council of
Economic Advisors, Greg Mankiw, wrote in his macroeconomic
textbook that there is no credible evidence that tax cuts pay
for themselves and that an economists who makes such a claim
is--quote--``a snake oil salesman who is trying to sell a
miracle cure.'' Do you agree with that?
Chairman Bernanke. I don't think that as a general rule tax
cuts pay for themselves. What I have argued instead is that to
the extent the tax cuts produce greater efficiency or greater
growth, they will partially offset the losses in revenues. The
degree to which that offset occurs depends on how well-designed
the tax cut is.
Senator Reed. If you will let me--this goes out of the
realm, I think, of macroeconomics to simple arithmetic. We are
running a huge deficit, so over time if the tax cut doesn't pay
for itself and we cut taxes again, we are not likely to help
the deficit. Is that a fair judgment?
Chairman Bernanke. Well, the issue as always is whether the
deficit should be adjusted on the spending side or on the tax
side, and I have to leave that to Congress, those are very
difficult value judgments.
Senator Reed. Well you are very clear in that statement,
but I can assume that those tough choices that must be made
include choices on the revenue side as well as the spending
side, is that your view?
Chairman Bernanke. I would say that if you are one of those
who supports low taxes that you also have to accept the
implication that spending also has to be controlled in a
commensurate way, whereas if you are in favor of a larger
government, then you have to accept the corollary that taxes
have to be higher. So, I think the specific law I am arguing
for here is the law of arithmetic, which says----
Senator Reed. Well so am I, but right now the arithmetic is
not running favorably in terms of those people who want fiscal
discipline.
Chairman Bernanke. And I am agreeing that people need to be
consistent in their choices.
Senator Reed. Thank you.
One of the issues that Congresswoman Maloney mentioned and
I am concerned about also is this growing inequality.
Your recent survey of consumer finances has some very
disturbing data. According to the statistics, the top 1 percent
of families hold more wealth than the bottom 90 percent of
families combined. And that is accurate, I presume?
Chairman Bernanke. Yes.
Senator Reed. It suggests that in most families wage is the
main source of income. Is that true also?
Chairman Bernanke. Yes.
Senator Reed. These figures on wages are not encouraging.
After accounting for inflation, the median usual weekly
earnings of full-time wage and salary workers fell by 0.9
percent between the end of 2000 and the end of 2004, and the
earnings at the 10th percentile fell by 2.1 percent. But
meanwhile, earnings for the 90th percentile, the upscale
workers, were up 4 percent.
We are seeing a divergence between low-income/moderate-
income Americans, who are losing ground, and very wealthy
Americans, who are gaining ground. And that has not only
economic consequences, it has social and moral consequences in
many respects.
What do we do about this? What policies can we adopt to, as
you indicated in your statement, not only increase wages, but
make sure that those benefits are more equally distributed?
Chairman Bernanke. Senator, first of all, I agree that the
increasing inequality in wages is an important social problem,
first, because we care about our fellow citizens and want to be
sure that they are living in a decent way, but second, from a
political point of view our society is based on opportunity, it
is based on flexibility in labor markets and product markets,
it is based on open and fair trade, and all of those things are
at risk if a growing portion of the population feels they are
not sharing in the benefits from those changes.
So, I am very concerned about rising inequality. It is a
very difficult problem. I think it should be made clear that
the growing inequality in wages which we are seeing is not a
new phenomenon. It has been going on for about 25 years or so.
And indeed a good bit of it occurred in the early 1980s.
There are a number of arguments and analyses about why
these increases are taking place. My own view, and I think that
of most economists, is that the dominant factor is the increase
in the return to skills; the fact that as our society becomes
more technologically oriented, people who have not necessarily
formal education, but other kinds of skills, on-the-job kinds
of training, will get a higher return, get a higher wage.
So, for a given distribution of education, these changes,
this skill-biased technical change, is going to cause the wage
distribution to widen.
In addition, it has been pointed out in some recent
research that there is a phenomenon at the very top, the so-
called ``super stars phenomenon,'' which suggests that, given
the size of our markets and the interconnectedness of our world
economy, those people who have extraordinary skills can command
tremendous premiums for their work.
Consider what a star baseball player receives today versus
20 years ago, the fact that that player can now play before
much larger markets and through an international market; that
affects their wages, as well.
So again, my main explanation for this phenomenon is the
higher return to education, the higher return to skills. What
can we do about it?
Well first of all, the Federal Reserve will do what it can,
which is primarily to try to maintain strong and stable
employment growth, and that is going to keep providing
opportunities for people and give them on-the-job experience
that will allow them to have higher wages.
But more broadly, the only really sustainable response to
this problem is to alleviate the skills deficit. Sometimes that
is taken as a counsel of despair because it takes such a long
time to improve our school system and to bring a whole new
generation through the system, but I would like to point out
that skills can be acquired through a whole variety of programs
and mechanisms, including on-the-job occupational training,
community colleges, technical schools, and all kinds of other
vehicles which would allow people to upgrade their skills
relatively quickly.
In our current labor market, people with skills like
commercial drivers' licenses, or practical nursing degrees, are
at a premium. They have sufficient skills that they are in high
demand. So, I do think that it is feasible within a medium-run
period of time to upgrade our skill base sufficiently to make a
noticeable dent in this inequality.
I agree it is a very difficult problem, and I hope that we
will address it because it does pose issues for our political
economy, as well as for our society.
Senator Reed. Just a final point. Do you believe it should
be the conscious policy, for all the reasons you espoused, of
this Government to raise wages and distribute them more equally
in terms of our economic performance?
Chairman Bernanke. Well, in the current Administration?
Senator Reed. Well, in any Administration.
Chairman Bernanke. Well, administration after
administration have tackled the educational issues. This
Administration has its own program. Others have had others.
There is a significant amount of money being put into job
training programs and there have been suggestions for reform
about how to make that more effective and more efficient.
There has been a lot of support for community colleges.
Your colleague, Senator Dole, for example, has often talked
about the benefits of community colleges.
I make just one additional comment, which is that one area
where we are quite deficient is in financial literacy. Many
people who earn even a moderate income are not able to save and
to build wealth in part because they may not understand enough
about banking and financial markets to allow them to do that.
So, I am very much in favor of activities through the
Congress, the Federal Reserve, and through the financial sector
itself to help train people to understand better how to save,
how to budget, and how to build wealth for themselves and for
their children.
Senator Reed. Thank you.
Thank you, Mr. Chairman.
Senator Bennett. Thank you very much.
Senator Sununu.
Senator Sununu. Thank you.
Chairman Bernanke, a number of economists and regulators,
including members of the Fed, have testified to Congress on a
number of occasions that the business models of Fannie Mae and
Freddie Mac effectively amount to privatized profits coupled
with socialized risk that stems from the implied guarantee
behind their securities.
Your predecessor spoke clearly of the need for Congress to
anchor the companies more firmly in their housing mission--
which we all agree is very important but from which they have
strayed at times--and he noted the danger and the risks that
are presented to our financial system and the economy by Fannie
and Freddie's very large, maybe more fairly put, massive
investment portfolios.
I have a letter from Chairman Greenspan, Chairman Bennett,
that I would like to be included in the record----
Senator Bennett. Without objection.
Senator Sununu. [continuing]. Which addresses the
relationship between these portfolios and the housing mission.
[The letter from Chairman Alan Greenspan to Senator John
Sununu appears in the Submissions for the Record on page 47.]
Senator Sununu. But in short, the research done by Fed
economists has shown that their investment portfolios simply
act as investment vehicles whereby they can arbitrage their low
borrowing rates against higher yields for mortgage-backed
securities. As a result, they earn great profits, but they do
so in a way that does not result in better accessibility for
30-year mortgages, and lower interest rates for consumers.
That is a very profitable arbitrage operation and, as a
result, we should not be surprised that Fannie and Freddie do
not support provisions in our GSE legislation that passed the
Senate Banking Committee that would give a regulator power to
set limits on those portfolios consistent with their mission.
Now in the coming months, as they square away the many
financial and accounting irregularities that have delayed their
issuing of financial statements, OFAO, their current regulator,
will lift its requirement that they put aside additional
capital.
For Fannie Mae, for example, that is going to result in a
release of $5 to $6 billion. When that capital is leveraged by
what is typical for these institutions 30 or 40 times, that
means that they could potentially grow their portfolios
dramatically--$250 billion or more.
This causes me great concern given the very significant
systemic risks that exist, but I think, fortunately for the
taxpayers, the Treasury does have some power to limit the size
of the portfolios, and in particular the statutes governing
Fannie and Freddie state that the corporation is authorized to
issue, upon the approval of the Secretary of the Treasury, and
have outstanding, at any one time, obligations having such
maturities and bearing such rate or rates of interest as may be
determined by the corporation--again, with the approval of the
Secretary of the Treasury.
So obviously the Secretary has the power in statute to
clearly limit the issuance of GSE debt.
My question is that, given the nature of the implied
guarantee, is this power that has been given to the Secretary
in statute an important power to have, given the structure of
these corporations? And under what circumstances should the
power be exercised?
Chairman Bernanke. Thank you, Senator.
I would like first just to comment on the S. 190
legislation on portfolios. There is a misperception, I believe,
that the legislation calls for hard caps, or for specific
numbers, and that is absolutely not the case, as you well know.
What the legislation tries to do is specifically to anchor
the size of the portfolio in the housing mission so that it
serves the mission and not other purposes.
In particular, the portfolio would be allowed to hold
affordable housing mortgages that are not otherwise
securitizable. They would be allowed to hold as much liquidity
as they wished in order to intervene perhaps in the housing
markets during periods of stress, but it would be limited in
securitizable MBS which, beyond a moderate amount for inventory
purposes and the like, is really not a direct or obvious
affordable housing reason for those holdings.
You are correct, as far as I understand, that the Treasury
does have the power to limit the debt issued by the GSEs, and
perhaps some power even over the terms or maturities, as you
suggested.
My preference, in terms of making sure that this is done
right would be to ask the Congress to, or hope the Congress
could, make clear to the regulator what the expectations of the
Congress were and what the powers of the regulator were. That
would be, I think from a political economy point of view, the
right first step.
If we were unable to achieve progress through Congress, I
don't think Treasury should abandon that power. I think it
should consider using it if it believes that the systemic risks
being generated by the portfolios greatly outweigh the benefits
that are mandated by the affordable housing mandate.
Senator Sununu. So in structuring the language in the
legislation--and you have spoken about the legislation I think
in past hearings--one, to reiterate, you would not recommend a
hard cap, and we have no such hard cap in the legislation; are
certainly comfortable with maintaining portfolios in the kinds
of securities that you describe; and feel that the portfolio
should be consistent with the housing mission, as everything
that they do should be consistent with their mission as
chartered by Congress.
One, is that a fair representation of the key elements that
we consider in the legislation?
And is there anything else that you think would be
important to maintaining an appropriate level of flexibility?
Chairman Bernanke. No, I think that is a fair
characterization and I agree with that characterization. I
would just add that the S. 190 bill also has some important
provisions relating to capital and receivership which are part
of making the GSE regulator more like a bank regulator with
adequate supervisory powers.
Senator Sununu. Thank you.
Thank you, Mr. Chairman.
Senator Bennett. Thank you.
Mr. Hinchey.
Representative Hinchey. Thank you, Senator.
Thank you very much. Mr. Chairman. Thank you for your
testimony here today and for your service. I very much
appreciated listening to you. It has been very instructive.
We have heard a lot about the positive aspects of the
economy, including things like low interest rates, and it may
have been mentioned also that the productivity rate is now I
think more than 3 percent. There are a lot of positive aspects
to that.
But there are also a conflux of circumstances that need to
be addressed, I think, as well. We live in a demand economy. I
think every successful entrepreneur, at least since Henry Ford,
has understood that. But we are not doing much to deal with
that end of our economy.
As you pointed out just a few moments ago, for the last 25
years or so the median household income of American families
has been stagnant or declining during that period of time. But
it has dramatically dropped in the last few years.
In the last few years, that median household income has
gone down by almost 4 percent.
So we are facing a number of circumstances that we are not
really addressing. Rising income inequality has been mentioned
on a number of occasions here. We also have very low and
declining personal savings rates. We have a huge and growing
debt. And the current account deficit, which you talked about a
moment ago, is also placing a heavy burden on our economy.
These rising imbalances are seemingly at the moment
peculiar to America. You have no other industrial country that
has this conflux of circumstances in the way that we do. And it
seems to me that they are essentially impracticable and
unsustainable.
So I just would like to hear your opinion on what we ought
to be doing to deal with these circumstances on the demand
side. We have this huge tax cut, the benefits of which have
flown to people who are already very secure, and these benefits
have made them even more so.
The primary beneficiaries of that tax cut are the richest 1
percent and those just a few percentage points below that
group. But it has little or no effect, obviously, based upon
these statistics, on the average working family.
What should we be doing to deal with those economic
circumstances?
Chairman Bernanke. Thank you, Congressman. The United
States is unique in some respects and not in others. We do have
an unusually large current account deficit. There are some
smaller countries with large deficits, Japan and Germany have
surpluses, and I have discussed some of the ways in which we
can address that particular problem.
On the long-term issues of the fiscal deficit, one of the
main drivers there is the aging of the population. In that
regard, we are perhaps no worse off than some of the other
major industrial countries which are aging quickly. Even China,
surprisingly, because of their one-child policy, will become as
old as the United States by the middle of this century.
So the aging and the demographic transition and the
implications that that has for fiscal policy is a broader
issue, a difficult one, but one that we share with others.
I have already addressed to some extent the inequality
issue. We are not the most unequal country in the world by any
means, but this trend is a disturbing one and it has I think
unfortunate consequences for our political economy.
I am not quite sure what you mean by ``demand policies.'' I
think that if you mean fiscal and monetary policies to bring
the economy to full employment, I think we have worked hard on
that and the economy is approaching a sustainable growth path
consistent with maximum sustainable employment.
But I do think that if we are going to address wages, and
in particular inequality in wages, we have to to do that I
would say on the supply side. That is, by addressing the skills
gaps that exist among different groups of people in our
society.
Senator Reed. Well if that is the case, then we are going
in the opposite direction because we are cutting back on
education and training, and we are cutting back on various ways
in which we can enhance the skill sets of our personnel. We are
doing that in the context of the Federal budget.
We are also seeing a decline in pensions as we move away
from defined benefit to defined contribution benefit pension
programs. These are going to reduce the economic circumstances
of people who are working today and those who are about to
retire.
So I think the point is that while the emphasis of this
particular Government, this Congress and this Administration,
has been on tax cuts and enormous amounts of spending, it is
not in ways that are going to enhance the economy.
We are not doing anything, for example, to increase the
amount of goods that we produce that are marketable both here
in America and around the world. In fact, the amount of goods
that we produce that fall into both of those categories is
declining, and that of course is a major contributor to the
current account deficit that we are experiencing.
So are there not other things that we could be doing, and
should be doing, to deal with those aspects of this economy?
And although you mentioned that there are other countries
that have similar circumstances discretely in one or two of
those categories, I do not think there is any other country in
the industrial world--no other advanced country--that is
confronting this confluence of circumstances. And I do not know
how this economy is going to continue to prosper unless we
begin to deal with those circumstances which are unique in the
industrial world.
Chairman Bernanke. A point on which I am very much in
agreement is that in thinking about the budget, it is not
enough just to say what is the total amount that we are
spending; it is really how well are we spending it?
The programs we are spending it on, are they effective? Are
they delivering results? So I would urge Congress to look very
hard at the mix of programs that you authorize to make sure
that they are producing returns for the dollar.
So in particular looking at education, are there ways to
increase accountability? To increase flexibility? To allow
schools to do a better job?
With regard to job training programs: We spend on the order
of $15 to $20 billion a year on job training programs. Is that
money being well used? I think it is enormously important for
us to review those programs on a regular basis to make sure
that the benefits are flowing to the people who need them and
not just being lost in the bureaucracy.
Senator Reed. Thank you.
Senator Bennett. Mr. English.
Representative English. Thank you, Mr. Chairman.
Mr. Chairman, your testimony here has been actually a
source of not only interest to me today but also a source of
great encouragement. But I would like to pursue a couple of the
specific issues that you have brought up in your testimony.
I first of all found it refreshing that you focused as
heavily in your printed remarks as you did on the challenge of
the U.S. current account deficit.
On that point, you specifically mentioned that you think it
is appropriate for some of our trading partners to pursue
exchange rate flexibility.
In your view, given that China now has massive currency
reserves, is China in a position to move seamlessly toward a
position of exchange rate flexibility to benefit themselves, as
well as presumably to stop dictating for their goods an
artificial price advantage?
Chairman Bernanke. China certainly could and should do more
toward increasing the flexibility of its foreign exchange
regime. A point I think that is worth emphasizing and that we
have tried in our bilateral discussions to make with the
Chinese, and Treasury of course takes the lead on this, is that
increased currency flexibility is in China's interest.
It is a very large country. They need to have an
independent monetary policy. They cannot really run an
independent monetary policy without a flexible exchange rate.
Moreover, their current policies are distorting prices
domestically as well as internationally. And in particular that
means that their economy is becoming devoted toward export
production and not toward the production of domestic goods and
services.
Finally, as an emerging power in the world trading system,
China has an interest in global stability, as do we, and by
reducing its overall trade surplus, by increasing its focus on
domestic demand, and by increasing the flexibility of its
currency, it can help improve global stability.
So for all those reasons, I think they should move further.
There are technical issues that they are trying to address, but
they are quite conservative, let's say, in terms of their
willingness to move further on this issue.
Representative English. And a remark that you made that I
found particularly intriguing had to do with your comment about
the fact that simply reducing the fiscal deficit will have a
limited impact on the reduction of the current account deficit.
You know, I know there has been a great deal of political
rhetoric linking the two deficits together. Could you explore
for us why there is a limited interaction where a reduction in
the budget deficit has only a limited impact on the trade
deficit?
Chairman Bernanke. Yes, I would be glad to.
I would first point out that, just looking around the
world, there is no obvious correlation between trade deficits
and budget deficits.
Japan and Germany have budget deficits which are equal to
or larger than ours and they have large trade surpluses. The
U.S. trade deficit began to expand in the 1990s at a time when
we had a budget surplus. And so there is not an obvious 1 to 1
correlation.
The issue in this case is: If the United States were to
reduce its own deficit, if no other action is taken by any
other country, that would tend to slow down economic activity
by reducing aggregate demand. The Fed, following its mandate
for full employment, would lower interest rates, stimulating
investment spending in the United States.
And so the investment/savings imbalance would not be much
changed if that were the only action being taken. And the
estimates that have been made by not only the Federal Reserve,
but by the OECD and others, are that a dollar reduction in the
U.S. budget deficit only would by itself lead to about a 20 to
30 cent reduction in the current account deficit.
By contrast, if the U.S. budget deficit reduction were
accompanied by increased demand abroad so that the Fed would
not have to respond--that is, exports would take the place so
to speak of Government spending--then you could get a much
bigger pass-through from deficit reduction into current account
deficit reduction.
Representative English. That is an excellent analysis.
Mr. Chairman, I had not planned to bring up this final
point, but in response to some of the strawmen that have been
brought up earlier in previous questions, I wanted to explore
the issue of whether tax cuts can actually promote enough
economic growth to pay for themselves.
I note that in 2003, before the reduced rates of tax on
capital gains were passed, the CBO estimated the total capital
gains liabilities in 2004 and 2005 would be $125 billion.
Following the passage of the new tax rates, CBO revised its
estimates and at that point their estimate for capital gains
tax liabilities in '04 and '05 had fallen to $98 billion, a
drop of $27 billion.
Earlier this year, however, CBO reported on actual capital
gains liabilities in '04 and '05. Rather than falling by the
projected $27 billion, they actually rose by $26 billion to a
total of $151 billion.
Mr. Chairman, I recognize that many factors influence
capital gains realizations, including the strength of the
economy, but as many experts have speculated the lower rates
clearly are partially responsible for improving the economic
outlook and rising stock prices.
You know, accordingly, can we look at these actual revenue
numbers and not conclude that, at least at some level, these
tax rate reductions have actually produced added revenue for
the Treasury?
And, accordingly, slapping on a tax increase because it is
a tax increase, that some on the other side have suggested in
this area, might actually generate--might actually not generate
the revenue that we need in order to deal with the deficit?
Chairman Bernanke. As you point out, Congressman, this is a
complex issue. There are a lot of factors affecting both the
increase in the stock market and realizations. And one of the
issues here is the question whether or not some realization is
taking place today which otherwise might have taken place in
the future.
And so in that sense the increase in tax revenue is
reflecting a one-time gain as opposed to a permanent gain. So
that is one of the issues that you would have to address in
analyzing the revenue effect.
But I go back to what I said before, which is that well-
designed tax cuts which stimulate economic activity will at
least partially offset the revenue losses by stimulating the
tax base.
Representative English. Thank you, Mr. Chairman.
And thank you, Mr. Chairman.
Senator Bennett. Thank you.
Mr. Paul.
Representative Paul. Thank you, Mr. Chairman. I would ask
for unanimous consent to submit some written questions, if I
don't get through this.
Senator Bennett. Without objection.
Representative Paul. Thank you, and welcome. Mr. Chairman.
I have a question dealing with inflation targeting, but I
wanted to make a few assumptions first and have you comment on
these assumptions, as well.
You state that inflation is under reasonable control at the
moment. I have a lot of constituents that would disagree with
you, and would disagree with the chart because if you look at
energy and medicine and education and taxes, there's a lot of
price inflation out there that they are concerned about.
I think there is a discrepancy in who suffers the most from
higher prices. Sometimes the wealthy suffer less than the poor
and the middle class because of the way they spend their money.
So, one index is not a perfect answer to how people respond to
inflation.
One assumption I would have, I think it was Milton Friedman
who said that inflation is first and foremost a monetary
phenomenon, and I sort of ascribe to that. And many other
economists, you know--there's a consensus among many economists
that would go along with that.
Another assumption that I would make is that the role of
the Fed in dealing with the money supply has to do with
increasing or decreasing the money supply, and yet we mostly
talk about interest rates, we're raising interest rates or
we're lowering interest rates. But my assumption is that we're
manipulating increases or decreases in the money supply in
order to secondarily affect interest rates.
Assuming that we did not have an Open Market Committee and
they ceased purchasing securities, my assumption would be that
interest rates would go a lot higher, but we don't know exactly
how high. So the Fed's job, generally speaking, is to keep
interest rates lower than the market and that the point is
there's only one way they can do that and that is increasing
the money supply so, therefore, the money supply is the most
direct measurement that we need to look at to find out what to
anticipate with price increases, also recognizing that
productivity obviously influences that.
Traditionally we've always measured our dollar in terms of
gold. The dollar was worth $20--gold was worth $20 an ounce
when the Fed came into existence. Today that dollar, pre-Fed
dollar is worth 4 cents. We've had tremendous depreciation and
devaluation and a lot higher prices since then.
We had major events throughout history that were monetary
events. During the Roosevelt era, gold going from $20 to $35,
and this was considered a devaluation. And then twice under
Nixon, an 8 percent devaluation and then a 10 percent
devaluation. And then of course when gold was put into the
marketplace we had again a lot of devaluation. Gold settled
down after that, around $250 an ounce, and that's what the
price of gold was in the early--in 2001. Since that time, gold
has gone from $250 up to $630, plus or minus. That represents
more than a 60 percent devaluation of the currency.
Now in your job in looking at inflation and targeting
inflation and looking at prices, how important is this? We do
know that central banks around the world--and our central bank
is still very much aware of the fact that gold is an important
monetary element, it is not like we've thrown it away or sold
it. We hold more gold than anybody else. So it is a monetary
issue.
But how do you look at this price? Does this concern you?
Is it meaningless? What if gold would go to a thousand dollars
an ounce, how would that affect your thinking about what to do
with interest rates and the money supply?
Chairman Bernanke. Thank you, Congressman. You raise a lot
of interesting questions there. I can address a few of them.
It's true that we look at core inflation, which leaves out,
for example, energy and food and the question, as you know, is
whether that really is representative of the consumer basket
that the average person is facing. The answer is no. And we are
interested in maintaining stability of overall inflation.
Our focus on core inflation is mostly a technical thing,
because generally speaking energy and food prices are more
volatile and tend to stabilize more quickly than other parts of
the inflation basket. That hasn't been true lately, as you
know, and we really need to pay attention I think to the
overall inflation rate as well as the core inflation rate.
You're also quite correct that our interest rate policy is
closely linked to our control of the money supply, and during
periods like the recent one where interest rates have been
rising, you also expect to see slower money growth and that in
fact has been generally the case, and those two things do go
together.
I don't think it's really the case that we keep the
interest rate lower than the market. If we were doing that,
then financial conditions would be excessively easy and we
would probably see more inflation. In fact, although we're
obviously not perfect at controlling inflation, not only the
Fed, but other central banks around the world have done a much
better job in the last few decades at targeting and managing
inflation and that at least is positive.
You raise the question of gold, and if your question is do
I look at the gold price, it's on my screen, I look at it every
day. I think there is information in gold prices, as there is
in other commodity prices. But there are also other indicators
of inflation. For example, there is the spread between indexed
and nominal bonds--the so-called break even inflation
compensation, which suggests that inflation expectations are
relatively well controlled.
So the puzzle is why are gold prices rising so fast? There
is probably some fear of inflation; there certainly is some
speculation about commodity price increases in general, which
is being driven by world economic growth. But clearly a factor
in the gold price has got to be global geopolitical uncertainty
and the view of some investors that, given what's going on in
the world today, that gold is a safe haven investment and for
that reason they purchase it.
So to summarize in trying to forecast inflation, I strongly
believe that you need to look at lots of different things. The
commodity and gold prices and oil prices, energy prices, are
all part of the matrix of things that a good central banker has
to pay attention to. But no single variable I think is going to
be adequate for judging the inflation situation.
Representative Paul. Thank you.
Senator Bennett. Mr. Brady.
Representative Brady. Thank you, Chairman Bennett.
Mr. Chairman, I'm Kevin Brady, a five-term Member from the
Texas area, east Texas and part of the Houston region.
International trade is a big job creator for our State and
obviously helps stretch families' budgets by giving them lower
prices and more choices when they shop. As a Nation we are a
fairly open market. How important is it economically that we
continue to pursue more open markets overseas, more trade
agreements that lower those barriers and continue to offer more
consumer choices here at home? How important is it that we
continue to follow that policy?
Chairman Bernanke. Congressman, it's extremely important,
and for more reasons than the textbook will tell you, I think.
The textbook tells us about comparative advantage, the idea
that some countries can produce some things cheaper than others
and therefore it pays them to trade to take advantage of that.
And that's certainly going on in the world today, we're getting
specialization across different countries.
But I think also that an open trading system increases
competition, it increases the flow of ideas, increases the flow
of capital, and makes the world overall a more dynamic and
effective economic environment. And so I think it's a terrible
mistake to try to shut out the world, to embrace economic
isolationism and, even though it's not always popular,
economists and I hope Congress will try to keep trade open.
There is an issue which is an important one, not to be
neglected, that while trade provides broad benefits to our
society and to our economy, there are sometimes people who are
made worse off by trade, workers who lose their jobs because a
certain factory goes overseas or because the competition from
imports is reducing their market. We need to pay attention to
that concern.
But rather than attempting to freeze their jobs in place by
preventing any change in the economy, we're much better off
allowing the change to take place, but helping people retrain
or otherwise provide for themselves so that they can join the
global economy rather than be isolated by it. So I certainly
agree with your proposition with the proviso that we need to
pay attention to those who are adversely affected by trade as
well as those who benefit.
Representative Brady. I agree. People oftentimes look at
the trade deficit and proclaim it a failure of our trade
policy, but your testimony, written testimony, makes the point
it's much more complex than just how much we buy and how much
we sell. America is a key investment target overseas. But, it
is also our failure to save as a Nation is--a factor we can
control as a solution on current accounts and the trade
deficit. Is it your view that our best solution or approach is
increase our savings and increase our sales abroad, which also
requires other countries to boost their spending and lower
their barriers? Is that the solution to how we approach this
problem? It's not to stop free trade, it is to increase our
savings and our sales.
Chairman Bernanke. Absolutely. And I think one of the
reasons to be concerned about the current account deficit is
that it may promote protectionist impulses which would be very
counterproductive to our economy.
Representative Brady. Mr. Chairman, let me finish with this
thought. I was not going to ask this question, but in the last
week we've seen a spate of ideas on how to deal with current
energy prices, from a windfall profits tax to today where I
read about $100 rebates and gas tax holidays. I won't ask you
if these are political gimmicks, but I will ask you are these
substantive? Do these substantively, positively impact the
fundamental drivers of our energy prices?
Chairman Bernanke. Congressman, unfortunately the high
prices we're seeing are due to a multitude of factors, but
they're driven primarily by supply and demand conditions in the
world today. We have substantial economic growth which
generates increased demand, and supply has been very insecure
for a variety of reasons. And unfortunately there's nothing
really that can be done that's going to affect energy prices or
gasoline prices in the very short run. This situation has been
building up for a long time.
And what we need to do is think about whether there are
actions we can take that, over a number of years, will put us
on a more secure footing and allow for either increased supply
or reduced demand that will help keep prices down.
Unfortunately, after many years of not really doing as much as
we should on the energy front, this situation has arisen and I
don't see any way to make a marked impact on it in the very
short run.
Representative Brady. Does a windfall profits tax increase
production or in any way lower our gas prices?
Chairman Bernanke. I don't think it would. Profits taxes
have the adverse effect of removing one of the major incentives
of our market system. If people think that their profits are
going to be taxed away, that reduces their incentive to engage
in certain activities.
So I would like to let the market system work as much as
possible to generate new supplies, both of oil but also of
alternatives, and for the prices, as painful as they may be, to
help generate more conservation and alternative uses of energy
on the demand side.
Representative Brady. Thank you, Chairman. Thank you,
Chairman Bennett.
Senator Bennett. Thank you, Mr. Chairman. This has been a
most illuminating morning.
Representative Hinchey. Mr. Chairman, are you concluding?
Senator Bennett. Did you want a second round?
Representative Hinchey. If you don't mind. It's not quite
20 of.
Senator Bennett. All right. Well, in that case, I'll use my
prerogative to comment and then yield to you.
I'm on my way tonight to Brussels, where I will be
addressing, with some other Members of both the House and the
Senate, economic issues with members of the European Union. As
your testimony makes clear, the United States would not trade
its place economically with any other country in the world. If
you look at the level of unemployment, if you look at the level
of deficit computed as a percentage of GDP--rather than in
total dollars--and if you look at the aging populations and the
demographic projections in other developed countries of the
world, and every other country would like to be where we are,
which is not to say we don't have serious problems.
But I think we should put it in that perspective, and
that's going to be, I think, some of the conversations we will
have in Brussels.
With your predecessor, Chairman Greenspan and I used to
have a kabuki dance that we went through every time he appeared
before this Committee, and I had not planned to do it here, but
it keeps coming up. I would always ask him, stroking my chin in
a thoughtful fashion, as if it has just occurred to me, Mr.
Chairman, what is the ideal capital gains rate?
And he would stroke his chin and say, Senator, the ideal
capital gains rate is zero. And I would say, thank you, and,
you know, we would do that every time he came, because capital
gains means if there's a capital gains tax rate, it locks the
capital to the degree that the rate is high, in its current
investment.
And it may well be that the entrepreneur or the venture
capitalist who has built, by his investment, Business A, now
wants to sell Business A to the pension fund that's perfectly
happy with the mature investment, and move that venture capital
to Business B, that creates an opportunity for more
entrepreneurial activity, and, thereby, more wealth.
But there is a barrier to making that movement from a
mature business to an entrepreneurial activity, in the form of
a tax. As we lower that tax barrier from 28 percent to 20
percent, we see more capital flowing over the wall, if you
will.
And when we lowered it again to 15 percent, we saw more
capital flowing over the wall, and I would like to see the
barrier disappear altogether, because the two things that are
essential to create wealth, are accumulated capital and risk-
taking.
And if the accumulated capital is held in one place where
the risk-taking--it can't join with the risk-taking in another
place, the economy, as a whole, doesn't get the benefit of the
growth.
Now, that's my non-professional economic analysis, and
having done that dance with Chairman Greenspan, I now give you
an opportunity to comment on it one way or the other, and
disagree with your predecessor, if you will, but let's at least
discuss that, because I think that is the major issue with
respect to capital gains.
It has to do with the movement of capital to the place
where it can produce within the economy, ultimately the most
wealth.
And I would add this comment: When we asked Chairman
Greenspan, during the great expansion of the late 1990s, who is
benefiting the most, even though the statistics were showing
the great growth at the top, he very instantly said, the people
who benefited the most from this booming economy, is the bottom
quintile, because they have jobs.
And the difference in lifestyle for Bill Gates, by this
growth, is really nothing, but the difference in lifestyle by
people who can't get jobs who now can, because there's a
booming economy, is night and day.
So, regardless of the statistics, the people who benefit
the most from a growing economy and the creation of wealth are
the people at the bottom. And that's what we all need to be
concerned about, so I'd be interested in your responses.
Chairman Bernanke. Well, Senator, I think most public
finance economists would agree that, on an efficiency basis,
the zero tax rate on capital gains is the optimal one. You can
see that, for example, in the President's Tax Panel, which
tried to push our system toward a consumption-based tax; that
is, one which exempts from taxation returns to savings,
including dividends and capital gains, the idea being that by
exempting savings from taxation, you create more rapid capital
accumulation and that does generate broader economic growth.
So, as a theoretical matter, I think that's correct. Again,
I want to be very careful not to make an unambiguous
recommendation, and I would just point out that people may
differ about the equity implications in terms of who benefits
the most from a cut in capital gains taxes, and that to the
extent that there are revenue effects--and we just had some
discussion about how big they might be and whether they are
temporary or permanent--issues of the deficit and funding and
government spending, would also arise.
So, the final policy decision is a complex one, but I think
that purely from an efficiency perspective, it's a fairly broad
view among public finance economists, that capital income
should be taxed at a low rate.
Senator Bennett. Thank you.
Mr. Hinchey.
Representative Hinchey. Thank you very much, Mr. Chairman,
and, thank you, Mr. Chairman. I have a number--actually, I
think, a large number of constituents who take the position
that the optimum tax rate on wages should be zero percent.
That's a slightly different point of view, from a different
perspective.
I want to----
Senator Bennett. I'll be happy to join them----
(Laughter.)
Senator Bennett [continuing]. If we find another way to
finance the government. I don't think wages is the most
efficient way to do it.
Representative Hinchey. Let's talk, Mr. Chairman, let's
talk.
I very much appreciate your solid and straight answers to
the questions that were delivered today, including the one
about the payback on tax cuts. Your predecessor said something
very similar in testimony before the House Budget Committee. He
said: ``It's very rare and few economists believe that you can
cut taxes and you will get an equal amount of revenues. When
you cut taxes, you gain some revenue back. We don't know
exactly what this amount is, but it's not small, but it's also
not 70 percent or anything like that.''
And we have similar statements from the Congressional
Budget Office and the Congressional Research Service. The one
that I liked the best was the one from the former Chairman of
the Council of Economic Advisors, Greg Mankiw, who wrote in his
macroeconomic textbook, and he says and I quote, ``There is no
credible evidence that tax cuts pay for themselves and an
economist who makes such a claim, is a snake oil salesman who
is trying to sell a miracle cure.''
So we have some interesting points of view on this
particular issue.
I wanted to just ask you about the dollar. We have a
national debt now which is about $8.33 trillion. Congress just
raised the debt ceiling a couple of weeks ago--3 weeks ago, to
just below $9 trillion.
Projections are now that within the next 5 years, that the
national debt is going to exceed $11 trillion, based upon the
circumstances that are prevailing currently. This year, we're
anticipating a budget deficit of $379 billion.
The circumstances here have got to be putting enormous
pressure on the value of the dollar. We've seen the value of
the dollar decline recently, and I'm wondering what you would
say about the potential for the strength of the dollar, given
these economic circumstances of huge growing debt and these
huge annual budget deficits that are fueling that growing debt,
and the current accounts deficit, which--I'm not sure what that
number is, but I think it's something in excess of, what--what
is the current accounts deficit?
Chairman Bernanke. Eight hundred billion dollars.
Representative Hinchey. Eight hundred billion, yes, a
little over $800 billion.
What does this mean for the value of the dollar? Is the
value of the dollar going to go down?
We have the situation and an interesting report from the
IMF. They report that the internal purchasing parody of the
Chinese currency is more than five times its external value.
Given the outcome of the recent visit of the President of
China, there doesn't seem to be any indication that those
circumstances are likely to change.
What do we have to anticipate with regard to the pressure
on the value of our dollar?
Chairman Bernanke. Well, Congressman, I just wanted to say
a word about the Federal debt, which you mentioned, first of
all. There are different ways of measuring it, and you get
somewhat different answers.
The debt limit includes a lot of debt with the government,
like the Social Security Trust Fund, for example, and if you
look at the debt held by the public, including the Federal
Reserve, you find that it's something on the order of 40
percent of GDP, which is lower than a number of other
industrial countries.
From that perspective our current deficit last year was 2.6
percent of GDP, so in a short-term sense, we are in a
comparable situation with other industrial countries.
I think we have a much larger problem, if you take an
unfunded liability approach and say, well, what is it that we
really owe to our senior citizens, based on the promises we've
made in Social Security and Medicare, and there you get a much
larger number, so that that's an issue.
I don't think the Federal debt has a great deal to do with
the dollar. The usual arguments have to do with the current
account deficit and the dollar, and here, I'd like to, I guess,
make a clarification.
There was some media report that the discussions of the G7
over the weekend, had discussed some kind of depreciation of
the dollar or managed depreciation of the dollar as part of the
strategy for addressing the U.S. current account.
That is not correct. The G7 supports a market-determined
dollar, not a managed dollar.
In terms of making forecasts, as I think Chairman Greenspan
often said in this context, you can forecast the dollar and
half the time, you're going to be right.
The experience is that forecasting the dollar is very
difficult, and we want to just leave it to market forces to
determine where the dollar is going to be.
Representative Hinchey. Thank you.
Senator Bennett. Thank you very much, Mr. Chairman. We
appreciate your being here, and look forward to continued
meetings with you, with the JEC.
This Committee was created by the Humphrey-Hawkins Act, as
Senator Humphrey wanted to increase the connection between the
Fed and the Congress, and established these regular reports.
We know you have other things to do, but we're grateful for
your willingness to come spend the morning with us on the Hill.
The hearing is adjourned.
Chairman Bernanke. Thank you, Senator.
(Whereupon, at 11:55 a.m., the hearing was adjourned.)
Submissions for the Record
=======================================================================
Prepared Statement of Representative Jim Saxton, Chairman
Chairman Bernanke, it is my pleasure to welcome you this morning
before the Joint Economic Committee (JEC). We appreciate your testimony
on the economic outlook.
According to the official data, a healthy economic expansion has
been underway for several years. The U.S. economy advanced 4.2 percent
in 2004, and 3.5 percent in 2005. As I have noted many times, the pick-
up in economic growth since the middle of 2003 is mostly due to a
rebound in investment activity, which had been weak. This rebound was
fostered by a mix of Fed monetary policy and the 2003 tax legislation
and its incentives for investment.
The continued economic expansion has created 5.2 million payroll
jobs since August of 2003. The unemployment rate, at 4.7 percent, is
below its average levels of the 1970s, 1980s, and 1990s. Federal
Reserve and private economists forecast that business investment and
the overall economy will continue to grow this year.
As the Fed noted in a policy report last February, ``the U.S.
delivered a solid performance in 2005.'' The Fed also stated that the
``U.S. economy should continue to perform well in 2006 and 2007.''
Recent data indicate that the economic growth rate for the first
quarter of this year will be quite robust when it is released tomorrow.
According to a broad array of economic data, the outlook remains
positive. Consumer spending is expected to be solid in 2006.
Homeownership has reached record highs. Household net worth is also at
a record level. The trend in productivity growth remains strong.
Although high oil prices have raised business costs and imposed
hardship on many consumers, these prices have not derailed the
expansion.
Meanwhile, long-term inflation pressures are contained. As a
result, long-term interest rates, such as mortgage rates, are still
relatively low, although these rates have edged up in recent weeks.
According to the Fed's preferred price index, inflation is well under
control.
In sum, current economic conditions are strong. With economic
growth expected to exceed 3 percent this year, the economic outlook
remains positive.
__________
Prepared Statement of Senator Robert Bennett, Vice Chairman
It is a pleasure to welcome the Honorable Ben Bernanke, Chairman of
the Board of Governors of Federal Reserve System, before the Committee
this morning. We view your testimony on the economic outlook as a
continuation of the longstanding productive exchange between the
Federal Reserve and the Joint Economic Committee.
A wide range of economic data confirms that the U.S. economic
expansion remains on a solid foundation. Growth in the inflation-
adjusted, or ``real,'' gross domestic product increased 3.5% during
2005, on the heels of over-4% growth in 2004. Real GDP has now been
growing for 17 consecutive quarters. Most private forecasters believe
that growth for the first quarter of this year will be a sizeable
acceleration from the temporary lull in the final quarter of 2005 and
growth is then expected to return to more trend-like, yet still
healthy, rates through the remainder of the year.
The unemployment rate has fallen to 4.7 percent, the lowest level
in five years and stands below the averages of the 1960s, 1970s, 1980s,
and 1990s. In 31 consecutive months of job creation, payroll employment
in the Nation has expanded by over 5.1 million new jobs. Last year
alone, 2 million new jobs were added to business payrolls.
While long-term interest rates, including mortgage rates, have
edged up recently, they remain low by historical standards and
financial conditions of households and businesses seem to be in
reasonably good shape. Activity in housing markets has recently been
showing signs of cooling, but levels of activity remain strong.
Although headline consumer price inflation has been boosted by
another round of increased energy prices, so-called ``core'' consumer
price inflation remains relatively steady and measures of inflation
expectations remain stable.
Nevertheless, last year was the third consecutive year of rising
and volatile energy prices, and we all feel how energy price increases
have cut into households' purchasing power and the profitability of
non-energy producing businesses. The economy has remained resilient in
the face of escalating energy prices, but further increases pose a risk
to future growth and inflation.
As I mentioned, the economic expansion remains on a solid
foundation. And I believe that one important ingredient that helped
generate the robust economic growth over the past few years is the
enactment of pro-growth tax relief in 2003.
We look forward to your review of recent economic developments and
your outlook for the U.S. economy.
Welcome, again, Chairman Bernanke.
__________
Prepared Statement of Senator Jack Reed, Ranking Minority
Thank you, Chairman Saxton. I want to welcome Chairman Bernanke and
thank him for testifying here today.
All eyes are on you, Chairman Bernanke, as you embark on a tricky
high-wire act in which you allow the economy to grow and employment to
reach its full potential, while you remain mindful of the risks of
inflation. For some time, the Fed's job had been easier--it had room to
raise interest rates from very low levels with little risk of derailing
the economic recovery, while inflation and other lurking economic
problems were at bay. Today, soaring energy prices, record budget and
trade deficits, a negative household saving rate, and a disappointing
labor market recovery all pose tremendous challenges to setting
monetary policy.
The Fed has raised its target for the federal funds rate by 25
basis points at each of the last 15 FOMC meetings. According to the
minutes of the March meeting, most members of the FOMC thought that the
end of the tightening process was near. The question on everyone's mind
is: are we there yet? The phrase we are hearing is that interest rate
changes will now be ``data driven.'' So I hope that means, Chairman
Bernanke, that the Fed will look hard at the full range of data on
economic growth, employment, and inflation to determine the best course
for monetary policy.
GDP is growing, but the typical American worker has been left out
of the economic gains of this recovery. Strong productivity growth has
shown up in the bottom lines of shareholders but not in the paychecks
of workers. Too many Americans are being squeezed by stagnant incomes
and rising costs for gasoline, health care, and education. It seems to
me that there is still room for real wages to catch up with
productivity before the Fed needs to worry about inflationary pressures
from the labor market.
However, there are many other downside risks to the economy on the
horizon. Energy prices have been pushing up overall inflation for some
time. But last month, we saw an uptick in core inflation, which might
be an early sign that businesses are starting to pass on their higher
energy costs to customers. Rising oil prices and interest rates coupled
with a weakening housing sector could take their toll on consumers and
businesses alike and slow down the economy too much.
Your task in setting the right course for monetary policy is
complicated by fiscal policy and international imbalances. We no longer
have the fiscal discipline that we had in the 1990s, which allowed for
a monetary policy that encouraged investment and long-term growth. The
President's large and persistent budget deficits have led to an ever-
widening trade deficit that forces us to borrow vast amounts from
abroad and puts us at risk of a major financial collapse if foreign
lenders suddenly stop accepting our IOU's.
Even assuming we can avoid an international financial crisis,
continued budget and trade deficits will be a drag on the growth of our
standard of living and leave us ill-prepared to deal with the effects
of the retirement of the baby-boom generation. Strong investment
financed by our own national saving--not foreign borrowing--is the
foundation for strong and sustained economic growth and rising living
standards.
One final issue that I would like to raise is the growing
inequality of income, earnings, and wealth in the U.S. economy. Your
predecessor, Chairman Greenspan, regularly raised that issue as one of
concern for our political economy--it is not good for democracy to have
widening inequality. I know you share these concerns. Recently, the
Federal Reserve published the results from the 2004 Survey of Consumer
Finances. They show that growth in median income and wealth have slowed
substantially and the top 1 percent of families hold more wealth than
the bottom 90 percent of families.
In this environment, it is hard to understand why the
Administration is continuing to pursue policies that add to the budget
deficit by providing tax breaks to those who are already well-off,
including the permanent elimination of the estate tax. Meanwhile, they
continue to propose budgets that cut programs for those who are
struggling to make ends meet. Mr. Chairman, I know you don't want to
get into the specifics of particular policies, but I hope you can offer
us some insights about the kinds of policies that are likely to be
effective in addressing the real challenges we face in this economy and
offering real opportunities for growth that provides widespread
benefits to the American people.
I look forward to your testimony on the economic outlook and to a
discussion of these issues.
__________
Prepared Statement of Hon. Ben Bernanke, Chairman, Board of Governors
of the Federal Reserve System
Mr. Chairman and members of the Committee, I am pleased to appear
before the Joint Economic Committee to offer my views on the outlook
for the U.S. economy and on some of the major economic challenges that
the Nation faces.
Partly because of last year's devastating hurricanes, and partly
because of some temporary or special factors, economic activity
decelerated noticeably late last year. The growth of the real gross
domestic product (GDP) slowed from an average annual rate of nearly 4
percent over the first three quarters of 2005 to less than 2 percent in
the fourth quarter. Since then, however, with some rebound in activity
under way in the Gulf Coast region and continuing expansion in most
other parts of the country, the national economy appears to have grown
briskly. Among the key economic indicators, growth in nonfarm payroll
employment picked up in November and December, and job gains averaged
about 200,000 per month between January and March. Consumer spending
and business investment, as inferred from data on motor vehicle sales,
retail sales, and shipments of capital goods, are also on track to post
sizable first-quarter increases. In light of these signs of strength,
most private-sector forecasters, such as those included in the latest
Blue Chip survey, estimate that real GDP grew between 4 and 5 percent
at an annual rate in the first quarter.
If we smooth through the recent quarter-to-quarter variations, we
see that the pace of economic growth has been strong for the past 3
years, averaging nearly 4 percent at an annual rate since the middle of
2003. Much of this growth can be attributed to a substantial expansion
in the productive capacity of the U.S. economy, which in turn is
largely the result of impressive gains in productivity--that is, in
output per hour worked. However, a portion of the recent growth
reflects the taking up of economic slack that had developed during the
period of economic weakness earlier in the decade. Over the past year,
for example, the unemployment rate has fallen nearly \1/2\ percentage
point, the number of people working part time for economic reasons has
declined to its lowest level since August 2001, and the rate of
capacity tilization in the industrial sector has moved up 1\1/2\
percentage points. As the utilization rates of labor and capital
approach their maximum sustainable levels, continued growth in output--
if it is to be sustainable and non-inflationary--should be at a rate
consistent with the growth in the productive capacity of the economy.
Admittedly, determining the rates of capital and labor utilization
consistent with stable long-term growth is fraught with difficulty, not
least because they tend to vary with economic circumstances.
Nevertheless, to allow the expansion to continue in a healthy fashion
and to avoid the risk of higher inflation, policymakers must do their
best to help to ensure that the aggregate demand for goods and services
does not persistently exceed the economy's underlying productive
capacity.
Based on the information in hand, it seems reasonable to expect
that economic growth will moderate toward a more sustainable pace as
the year progresses. In particular, one sector that is showing signs of
softening is the residential housing market. Both new and existing home
sales have dropped back, on net, from their peaks of last summer and
early fall. And, while unusually mild weather gave a lift to new
housing starts earlier this year, the reading for March points to a
slowing in the pace of homebuilding as well. House prices, which have
increased rapidly during the past several years, appear to be in the
process of decelerating, which will imply slower additions to household
wealth and, thereby, less impetus to consumer spending. At this point,
the available data on the housing market, together with ongoing support
for housing demand from factors such as strong job creation and still-
low mortgage rates, suggest that this sector will most likely
experience a gradual cooling rather than a sharp slowdown. However,
significant uncertainty attends the outlook for housing, and the risk
exists that a slowdown more pronounced than we currently expect could
prove a drag on growth this year and next. The Federal Reserve will
continue to monitor housing markets closely.
More broadly, the prospects for maintaining economic growth at a
solid pace in the period ahead appear good, although growth rates may
well vary quarter to quarter as the economy downshifts from the first-
quarter spurt. Productivity growth, job creation, and capitalspending
are all strong, and continued expansion in the economies of our trading
partners seems likely to boost our export sector. That said, energy
prices remain a concern: The nominal price of crude oil has risen
recently to new highs, and gasoline prices are also up sharply. Rising
energy prices pose risks to both economic activity and inflation. If
energy prices stabilize this year, even at a high level, their adverse
effects on both growth and inflation should diminish somewhat over
time. However, as the world has little spare oil production capacity,
periodic spikes in oil prices remain a possibility.
The outlook for inflation is reasonably favorable but carries some
risks. Increases in energy prices have pushed up overall consumer price
inflation over the past year or so. However, inflation in core price
indexes, which in the past has been a better indicator of longerterm
inflation trends, has remained roughly stable over the past year. Among
the factors restraining core inflation are ongoing gains in
productivity, which have helped to hold unit labor costs in check, and
strong domestic and international competition in product markets, which
have restrained the ability of firms to pass cost increases on to
consumers. The stability of core inflation is also enhanced by the fact
that long-term inflation expectations--as measured by surveys and by
comparing yields on nominal and indexed Treasury securities--appear to
remain well-anchored. Of course, inflation expectations will remain low
only so long as the Federal Reserve demonstrates its commitment to
price stability. As to inflation risks, I have already noted that
continuing growth in aggregate demand in excess of increases in the
economy's underlying productive capacity would likely lead to increased
inflationary pressures. In addition, although pass-through from energy
and commodity price increases to core inflation has thus far been
limited, the risk exists that strengthening demand for final products
could allow firms to pass on a greater portion of their cost increases
in the future.
With regard to monetary policy, the Federal Open Market Committee
(FOMC) has raised the Federal funds rate, in increments of 25 basis
points, at each of its past fifteen meetings, bringing its current
level to 4.75 percent. This sequence of rate increases was necessary to
remove the unusual monetary accommodation put in place in response to
the soft economic conditions earlier in this decade. Future policy
actions will be increasingly dependent on the evolution of the economic
outlook, as reflected in the incoming data. specifically, policy will
respond to arriving information that affects the Committee's assessment
of the medium-term risks to its objectives of price stability and
maximum sustainable employment. Focusing on the medium-term forecast
horizon is necessary because of the lags with which monetary policy
affects the economy.
In the statement issued after its March meeting, the FOMC noted
that economic growth had rebounded strongly in the first quarter but
appeared likely to moderate to a more sustainable pace. It further
noted that a number of factors have contributed to the stability in
core inflation. However, the Committee also viewed the possibility that
core inflation might rise as a risk to the achievement of its mandated
objectives, and it judged that some further policy firming may be
needed to keep the risks to the attainment of both sustainable economic
growth and price stability roughly in balance. In my view, data
arriving since the meeting have not materially changed that assessment
of the risks. To support continued healthy growth of the economy,
vigilance in regard to inflation is essential.
The FOMC will continue to monitor the incoming data closely to
assess the prospects for both growth and inflation. In particular, even
if in the Committee's judgment the risks to its objectives are not
entirely balanced, at some point in the future the Committee may decide
to take no action at one or more meetings in the interest of allowing
more time to receive information relevant to the outlook. Of course, a
decision to take no action at a particular meeting does not preclude
actions at subsequent meetings, and the Committee will not hesitate to
act when it determines that doing so is needed to foster the
achievement of the Federal Reserve's mandated objectives.
Although recent economic developments have been positive, the
Nation still faces some significant longer-term economic challenges.
One such challenge is putting the Federal budget on a trajectory that
will be sustainable as our society ages. Under current law, Federal
spending for retirement and health programs will grow substantially in
coming decades--both as a share of overall Federal spending and
relative to the size of the economy--especially if health costs
continue to climb rapidly. Slower growth of the workforce may also
reduce growth in economic activity and thus in tax revenues.
The broad dimensions of the problem are well-known. In fiscal year
2005, Federal outlays for Social Security, Medicare, and Medicaid
totaled about 8 percent of GDP. According to the projections of the
Congressional Budget Office (CBO), by the year 2020 that share will
increase by more than 3 percentage points of GDP, an amount about equal
in size to the current Federal deficit. By 2040, according to the CBO,
the share of GDP devoted to those three programs (excluding
contributions by the states) will double from current levels, to about
16 percent of GDP. Were these projections to materialize, the Congress
would find itself in the position of having to eliminate essentially
all other non-interest spending, raising Federal taxes to levels well
above their long-term average of about 18 percent of GDP, or choosing
some combination of the two. Absent such actions, we would see widening
and eventually unsustainable budget deficits, which would impede
capital accumulation, slow economic growth, threaten financial
stability, and put a heavy burden of debt on our children and
grandchildren.
The resolution of the nation's long-run fiscal challenge will
require hard choices. Fundamentally, the decision confronting the
Congress and the American people is how large a share of the nation's
economic resources should be devoted to Federal Government programs,
including transfer programs like Social Security, Medicare, and
Medicaid. In making that decision, the full range of benefits and costs
associated with each program should be taken into account. Crucially,
however, whatever size of government is chosen, tax rates will
ultimately have to be set at a level sufficient to achieve a reasonable
balance of spending and revenues in the long run. Members of the
Congress who want to extend tax cuts and keep tax rates low must accept
that low rates will be sustainable over time only if outlays can be
held down sufficiently to avoid large deficits. Likewise, members who
favor a more expansive role of the government must balance the benefits
of government programs with the burden imposed by the additional taxes
needed to pay for them, a burden that includes not only the resources
transferred from the private sector but also the reductions in the
efficiency and growth potential of the economy associated with higher
tax rates.
Another important challenge is the large and widening deficit in
the U.S. current account. This deficit has increased from a little more
than $100 billion in 1995 to roughly $800 billion last year, or 6\1/2\
percent of nominal GDP. The causes of this deficit are complex and
include both domestic and international factors. Fundamentally, the
current account deficit reflects the fact that capital investment in
the United States, including residential construction, substantially
exceeds U.S. national saving. The opposite situation exists abroad, in
that the saving of our trading partners exceeds their own capital
investment. The excess of domestic investment over domestic saving in
the United States, which by definition is the same as the current
account deficit, must be financed by net inflows of funds from
investors abroad. To date, the United States has had little difficulty
in financing its current account deficit, as foreign savers have found
U.S. investments attractive and foreign official institutions have
added to their stocks of dollar-denominated international reserves.
However, the cumulative effect of years of current account deficits
have caused the United States to switch from being an international
creditor to an international debtor, with a net foreign debt position
of more than $3 trillion, roughly 25 percent of a year's GDP. This
trend cannot continue forever, as it would imply an evergrowing
interest burden owed to foreign creditors. Moreover, as foreign
holdings of U.S. assets increase, at some point foreigners may become
less willing to add these assets to their portfolios. While it is
likely that current account imbalances will be resolved gradually over
time, there is a small risk of a sudden shift in sentiment that could
lead to disruptive changes in the value of the dollar and in other
asset prices.
Actions both here and abroad would contribute to a gradual
reduction in the U.S. current account deficit and in its mirror image,
the current account surpluses of our trading partners. To reduce its
dependence on foreign capital, the United States should take action to
increase its national saving rate. The most direct way to accomplish
this objective would be by putting Federal government finances on a
more sustainable path. Our trading partners can help to mitigate the
global imbalance by relying less on exports as a source of growth, and
instead boosting domestic spending relative to their production. In
this regard, some policymakers in developing Asia, including China,
appear to have recognized the importance of giving domestic demand a
greater role in their development strategies and are seeking to
increase domestic spending through fiscal measures, financial reforms,
and other initiatives. Such actions should be encouraged. For these
countries, allowing greater flexibility in exchange rates would be an
important additional step toward helping to restore greater balance
both in global capital flows and in their own economies. Structural
reforms to enhance growth in our industrial trading partners could also
be helpful. Each of these actions would be in the long-term interests
of the countries involved, regardless of their effects on external
imbalances. On the other hand, raising barriers to trade or flows of
capital is not a constructive approach for addressing the current
account deficit because such barriers would have significant
deleterious effects on both the U.S. and global economies.
In conclusion, Mr. Chairman, the economy has been performing well
and the near-term prospects look good, although as always there are
risks to the outlook. Monetary policy will continue to pursue its
objectives of helping the economy to grow at a strong, sustainable pace
while seeking to keep inflation firmly under control. And, while many
of the fundamental factors that determine longer-term economic growth
appear favorable, actions to move the Federal budget toward a more
sustainable position would do a great deal to help ensure the future
prosperity of our country.
[GRAPHIC] [TIFF OMITTED] T9738.004
[GRAPHIC] [TIFF OMITTED] T9738.005
Written Questions Submitted by Hon. Jim Saxton to Hon. Ben Bernanke
Question 1. Your testimony regarding the stance of monetary policy
indicated that the Fed is not locked into a rigid, predetermined
schedule of increases in the federal funds rate. Rather, future
decisions will be data dependent, i.e., made on the basis of the most
recent economic and financial information available. Your statement did
not rule out any future increases in the federal funds rate. Is this a
fair summary of the point you were making?
Question 2. As you know, there are a number of reasons why
inflation targeting allows for a good deal of operational flexibility.
Yet critics of inflation targeting often contend that adopting this
procedure removes much of monetary policymaker's discretionary powers
and flexibility.
This criticism appears questionable given the host of adjustments
and exceptions used in inflation targeting. For example, numerical
bands rather than point estimates are usually used as policy targets by
those countries successfully implementing inflation targeting.
Similarly, multi-year targets are often employed. The inflation indices
normally used are adjusted for volatile components as well as for other
factors. In practice, countries adopting inflation targeting have all
used a flexible approach in implementing monetary policy. Doesn't this
suggest that inflation targeting is quite flexible?
Question 3. What is the role of asset prices in a monetary policy
focused on price stability? Should the central bank respond to asset
price ``bubbles'' or disturbances such as a bubble in the stock market
or a bubble in the real estate market? Or should it ignore such
movements in asset prices?
Are there ``moral hazard'' problems associated with highly
predictable central bank attempts to respond to asset price bubbles?
Question 4. Federal Reserve officials often refer to the PCE
(personal consumption expenditure) deflator in addressing measures of
price changes. What are the advantages of the PCE deflator over the
CPI? Does the CPI overstate inflation to some extent?
What does the core PCE deflator currently tell us about the degree
to which inflationary forces are being contained at present?
[GRAPHIC] [TIFF OMITTED] T9738.006
Response from Chairman Ben Bernanke to Written Questions Submitted by
Chairman Jim Saxton
Chairman Bernanke subsequently submitted the following in response
to written questions received from Chairman Saxton in connection with
the Joint Economic Committee hearing on April 27, 2006:
Question 1. Your testimony regarding the stance of monetary policy
indicated that the Fed is not locked into a rigid, predetermined
schedule of increases in the Federal funds rate. Rather, future
decisions will be data dependent, i.e., made on the basis of the most
recent economic and financial information available. Your statement did
not rule out any future increases in the Federal funds rate. Is this a
fair summary of the point you were making?
Answer. Yes. As conveyed in my testimony, monetary policy must be
forward looking and depend on the Federal Reserve's best assessment of
the economic outlook as inferred from economic and financial
information. Indeed, the Federal Open Market Committee was quite
explicit on this point in the statement issued after its meeting on May
10. The statement explained that ``the Committee judges that some
further policy firming may yet be needed to address inflation risks but
emphasizes that the extent and timing of any such firming will depend
importantly on the evolution of the economic outlook as implied by
incoming information.''
Question 2. As you know, there are a number of reasons why
inflation targeting allows for a good deal of operational flexibility.
Yet critics of inflation targeting often contend that adopting this
procedure removes much of monetary policymaker's discretionary powers
and flexibility.
This criticism appears questionable given the host of adjustments
and exceptions used in inflation targeting. For example, numerical
bands rather than point estimates are usually used as policy targets by
those countries successfully implementing inflation targeting.
Similarly, multi-year targets are often employed. The inflation indices
normally used are adjusted for volatile components as well as for other
factors. In practice, countries adopting inflation targeting have all
used a flexible approach in implementing monetary policy. Doesn't this
suggest that inflation targeting is quite flexible?
Answer. By definition, an inflation targeting framework focuses on
keeping inflation low and stable, and on clearly communicating to the
public both the objectives of monetary policy and the strategy for
achieving those objectives. The key advantage of such a framework is
that it can help anchor inflation expectations more firmly and
therefore promote greater stability in both inflation outcomes and
resource utilization. As you point out, however, inflation targeting
frameworks can be quite flexible. For example, in practice, all
inflation-targeting central banks pay important attention in their
policy decisionmaking not only to inflation but also to output and
employment. Objectives generally are set for some date in the future,
in recognition of the fact that monetary policy affects the economy
only with a considerable lag. Some inflation-targeting central banks
set multi-year targets, while others set policy so as to keep their
inflation projection at a certain horizon close to its target; yet
others aim to keep inflation close to its target on average over the
business cycle. Specifying the inflation objective as a band may help
convey the reality that inflation cannot be controlled perfectly at
every instant, though a band may also increase the challenges around
the communication of objectives and strategies to the public. These are
a few of the key design features that can be used to build flexibility
into the overall policy framework.
Question 3. What is the role of asset prices in a monetary policy
focused on price stability? Should the central bank respond to asset
price ``bubbles'' or disturbances such as a bubble in the stock market
or a bubble in the real estate market? Or should it ignore such
movements in asset prices?
Are there ``moral hazard'' problems associated with highly
predictable central bank attempts to respond to asset price bubbles?
Answer. In setting monetary policy to achieve price stability, a
central bank should take account of all factors influencing the
economic outlook. Accordingly, a central bank cannot ignore movements
in stock prices, home values, and other asset prices, but should
respond to them only to the extent that they have implications for
future output and inflation. Some observers have argued that a central
bank should respond more aggressively to asset-price booms thought to
have an important speculative component. In so doing, so the argument
goes, a central bank can limit the future expansion of the bubble,
thereby mitigating the fallout from its eventual bursting. However, the
validity of this argument rests on several conditions for which there
is little or no empirical evidence, including the presumptions that the
central bank is better able than the market to identify speculative
bubbles and that it can successfully ``deflate'' such bubbles without
harming the broader economy. Given our limited knowledge of the forces
driving speculative bubbles, the more prudent approach is to respond
only as the overall outlook for output and inflation merits. Such a
limited approach should also mitigate potential moral hazard problems
that might arise were a central bank to, in effect, take responsibility
for the appropriateness of asset prices.
Question 4. Federal Reserve officials often refer to the PCE
(personal consumption expenditures) deflator in addressing measures of
price changes. What are the advantages of the PCE deflator over the
CPI? Does the CPI overstate inflation to some extent?
What does the core PCE deflator currently tell us about the degree
to which inflationary forces are being contained at present?
Answer. While the PCE price index generally moves roughly in line
with the CPI--and indeed is derived largely from CPI source data--it
does have some advantages relative to the CPI as a measure of
inflation. The PCE chain-type index is constructed from a formula that
reflects the changing composition of spending and thereby avoids some
of the upward bias associated with the fixed-weight nature of the CPI.
In addition, there is some evidence that the PCE weights are measured
more accurately than the CPI weights. The PCE price measure also has
some disadvantages relative to the CPI; most important, its broader
scope necessitates the inclusion of some prices that are not derived
from market transactions and so may add some noise to the overall index
as a proxy for the cost of living.
Most analysts believe that changes in the CPI overstate changes in
the cost of living to some extent. In 1996, the Senate Advisory
Commission to Study the CPI (The Boskin Commission) assessed the bias
in CPI inflation as centering on 1.1 percentage points per year, with a
range of 0.8 to 1.6 percentage points per year. This result was similar
to the findings of other analysts. Since the time of these studies, the
BLS has made several improvements to the CPI that have, on balance,
served to reduce that bias. In part for this reason, more recent
estimates of bias in CPI inflation have generally been a little smaller
than estimated by the Boskin Commission. For example, a recent study by
Federal Reserve economists judged the bias in CPI inflation currently
to center around 0.9 percentage point per year. The PCE price index
likely is also biased upward, though probably by less than the CPI in
light of the PCE measure's advantages cited above.
Although increases in energy prices have pushed up overall consumer
price inflation over the past couple of years, core inflation has been
more stable. The core PCE price index increased 2 percent over the
twelve months to March of this year, about the same as the increase
over the preceding twelve months. Similarly, the core CPI has increased
21 percent over each of the past 2 years. The stability of core
inflation, even as many firms have faced substantial cost increases for
energy products, has been enhanced by the fact that long-term inflation
expectations appear to remain well contained. Of course, inflation
expectations will remain low only so long as the Federal Reserve
demonstrates its commitment to price stability.
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