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[108 Senate Hearings]
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S. Hrg. 108- 281
FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT FOR 2003
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
ON
OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU-
ANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978
__________
JULY 16, 2003
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
RICHARD C. SHELBY, Alabama, Chairman
ROBERT F. BENNETT, Utah PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky EVAN BAYH, Indiana
MIKE CRAPO, Idaho ZELL MILLER, Georgia
JOHN E. SUNUNU, New Hampshire THOMAS R. CARPER, Delaware
ELIZABETH DOLE, North Carolina DEBBIE STABENOW, Michigan
LINCOLN D. CHAFEE, Rhode Island JON S. CORZINE, New Jersey
Kathleen L. Casey, Staff Director and Counsel
Steven B. Harris, Democratic Staff Director and Chief Counsel
Peggy R. Kuhn, Senior Financial Economist
Martin J. Gruenberg, Democratic Senior Counsel
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
(ii)
?
C O N T E N T S
----------
WEDNESDAY, JULY 16, 2003
Page
Opening statement of Chairman Shelby............................. 1
Opening statements, comments, or prepared statements of:
Senator Johnson.............................................. 2
Senator Allard............................................... 3
Senator Sarbanes............................................. 3
Senator Enzi................................................. 5
Prepared statement....................................... 45
Senator Reed................................................. 7
Senator Bennett.............................................. 7
Senator Bayh................................................. 8
Senator Hagel................................................ 8
Senator Chafee............................................... 8
Senator Corzine.............................................. 22
Senator Carper............................................... 25
Senator Crapo................................................ 27
Senator Dodd................................................. 29
Senator Schumer.............................................. 32
WITNESS
Alan Greenspan, Chairman, Board of Governors of the Federal
Reserve System, Washington, DC................................. 8
Prepared statement........................................... 46
Response to written questions of:
Senator Shelby........................................... 50
Senator Sarbanes......................................... 53
Senator Bunning.......................................... 56
Senator Miller........................................... 56
Additional Material Supplied for the Record
Monetary Policy Report to the Congress, July 16, 2003............ 59
Letter to Senator Tim Johnson from Alan Greenspan, dated June 25,
2003........................................................... 89
(iii)
FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT TO CONGRESS FOR 2003
----------
WEDNESDAY, JULY 16, 2003
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:00 a.m. in room SD-538, Dirksen
Senate Office Building, Senator Richard C. Shelby (Chairman of
the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY
Chairman Shelby. The hearing will come to order.
I am very pleased this morning to welcome Chairman
Greenspan before the Committee on Banking, Housing, and Urban
Affairs to testify on the Federal Reserve's Semi-Annual
Monetary Policy Report to the Congress.
This morning, I will keep my remarks brief as we are all
eager to hear from the Chairman on his views on the U.S.
economy and other related issues. We also have the benefit, Mr.
Chairman, of having read about your remarks before the House
yesterday.
At this time I would like to make two observations, both of
which you highlight in your statement or in your more extensive
report.
First, the economy stands on the brink of, we hope, a
strong recovery. The question is how strong will the rebound be
and what further steps can be taken should the recovery falter.
There is little question that we all would like to see the
economy grow faster and to have more jobs created for the
American people. A number of stimulative measures, including
the tax cut enacted in May, have already been taken. We know
from your testimony that the Federal Reserve also stands ready
to take additional action should the economy remain sluggish.
Second, the Congress, I believe, needs to remain focused on
achieving the appropriate fiscal policy. Yesterday, as we all
know, the OMB announced an update of its budget estimates,
revising its estimates of the 2003 deficit upward to $455
billion. The budget forecast has been adversely affected by the
relatively weak economy and by the necessary expenditures to
fight the war on terrorism. Over the longer term, the Congress
needs, I believe, to renew its effort at reforming mandatory
programs and controlling Government spending. We would
certainly welcome, Mr. Chairman, your views of the importance
of that goal.
We are happy to host you and we look forward to your
remarks and an enlightening discussion.
Senator Johnson.
STATEMENT OF SENATOR TIM JOHNSON
Senator Johnson. Thank you, Chairman Shelby, for inviting
Chairman Greenspan before this Committee to present the Second
Monetary Report to Congress for 2003. I hope that we will find
some good news in the report given the recent demoralizing
headlines about an exploding budget deficit, the tax cuts
enacted earlier this year, contrary to Chairman Greenspan's
recommendation that any tax cuts be offset so as to minimize
deficit.
Once again, the Office of Management and Budget has
adjusted its deficit estimates upward. We are now being told
that this year's deficit will reach $455 billion, 50 percent
higher than the Bush Administration forecast just 5 months ago.
In fact, the deficit is $55 billion higher than many economists
projected just last week. This represents a fiscal reversal of
more than $680 billion since 2000 when the Treasury reported a
surplus--a surplus--of $236 billion.
At the same time, the unemployment rate has reached 6.4
percent. More than 9.4 million Americans are looking for work
and cannot find a job. Now, as much as the next person, I will
take a glass-half-full attitude any day, but at a certain
point, one begins to suspect that reports of an imminent
economic recovery are assuming a bit more juice than we really
have.
For example, just one year ago, Chairman Greenspan
predicted that our economy, our GDP, would grow between 3.5 and
4 percent in 2003. Chairman Greenspan has now slashed those
projections to 2.5 to 2.75 percent. A year ago, Chairman
Greenspan predicted the unemployment rate would be
approximately 5.24 to 5.5 percent by the end of 2003. We are
now at 6.4 percent and rising steadily.
Now, I have enormous respect for Chairman Greenspan, and I
know that the depth of the economic malaise has taken us all by
surprise. But I am deeply skeptical of arguments by this
Administration that all economic ills will be cured if we give
massive tax cuts, without offsetting them, to those at the top
of the economic ladder in the hope that the money will somehow
trickle down to working families.
At this point I would also like to make note of a topic on
which Chairman Greenspan and I do see eye to eye, and, Mr.
Chairman, I do have a 10-page letter from Chairman Greenspan
that I would ask unanimous consent that the letter be inserted
into the record in its entirety.
Chairman Shelby. Without objection, it is so ordered.
Senator Johnson. This letter deals with the topic of the
regulation of the industrial loan companies and the importance
that these banks come under consolidated supervision. As many
of you know, I have a longstanding concern about the mixing of
banking and commerce, and I am alarmed that recent attempts to
expand the ILC charter would undercut much of the progress we
have made over the past few years, including closing the so-
called ``unitary thrift loophole'' a few years ago. Of even
greater concern, I believe, is the ability of ILC's, which may
have commercial parent companies, to escape consolidated
supervision by the Federal Reserve.
I would like to quote from Chairman Greenspan's letter
about the critical importance of consolidated supervision:
Consolidated supervision provides the Board with both the
ability to understand the financial strength and risks of the
overall banking organization and the authority to address
significant management, operational, capital, and other
deficiencies within the overall organization before these
deficiencies pose a danger to subsidiary insured banks and the
Federal safety net. As the Treasury Department noted in its
1991 report and recommendations on modernizing the financial
system, umbrella oversight of a financial company that controls
an insured bank, ``is necessary to protect the insured
depository [institution] from affiliate risk. Umbrella
oversight is designed to identify problems in the holding
company or affiliates that are likely to cause difficulties for
the insured bank, and to apply remedial action.''
I would like to note my great respect for FDIC Chairman
Powell, and I do not mean in any way to impugn the supervisory
capacity of his agency. However, ILC's which exist principally
within large affiliated structures should not be regulated
separate and apart from those affiliates. The Bank Holding
Company Act provides a unique set of supervisory powers which
are vitally important where banking and commerce are
intertwined in a way that introduces additional risk to the
system.
Thank you, Mr. Chairman, for holding today's hearing. I
apologize in advance that I will be unable to stay for
questions due to competing and conflicting hearing obligations.
Chairman Shelby. Senator Allard.
COMMENTS OF SENATOR WAYNE ALLARD
Senator Allard. Mr. Chairman, I would also like to thank
you for holding this hearing and join my colleagues in
welcoming Federal Reserve Board Chairman Greenspan to this
hearing. I always look forward to the opportunity to hear from
Chairman Greenspan concerning monetary policy and other
economic issues.
I was pleased to hear Chairman Greenspan's generally
positive comments yesterday. I share his belief that the
economy is headed in a positive direction. But the recovery is
still preliminary, and we need to ensure that we keep the
country headed in the right direction. Now is the time to
address the long-term solvency of Social Security and Medicare
and to put the Government on a plan to eliminate the deficit
and to pay down the national debt.
I would invite my colleagues to join me in voting to hold
down spending excesses on the floor of the Senate. So far,
there have just been a few that have been willing to join me in
that effort. To balance the budget means that we need to hold
down spending as we go through the appropriations process, and
that is what we are beginning to address now on the floor of
the Senate.
By pursuing policies of low taxation, limited Federal
regulation, free trade, and sound monetary policy, the United
States will prosper with wealth and opportunity.
Chairman Greenspan, again, thank you for appearing before
the Banking Committee today, and I look forward to your
testimony.
Chairman Shelby. Senator Sarbanes.
STATEMENT OF SENATOR PAUL S. SARBANES
Senator Sarbanes. Thank you very much, Mr. Chairman. I am
pleased to join with my colleagues in welcoming Chairman
Greenspan to this morning's hearing on the Federal Reserve's
Semi-
Annual Report to Congress on Monetary Policy.
I went over Chairman Greenspan's statement this morning. As
usual, it provided a thoughtful overview of the outlook for the
economy and signaled the Fed's willingness ``to maintain a
highly
accommodative stance of policy for as long as needed to promote
satisfactory economic performance.'' However, I found very
little discussion in the statement of what I consider to be a
significant concern with respect to our economy today, and that
is an exceptionally weak labor market.
Chairman Greenspan's statement mentions that, ``incoming
data on employment and aggregate output remain mixed.'' In the
context of a discussion of productivity, the statement also
says that, ``One consequence of these improvements in
efficiency has been an ability of many businesses to pare
existing workforces and still meet increases in demand. Indeed,
with the growth of real output below that of labor productivity
for much of the period since 2000, aggregate hours and
employment have fallen, and the unemployment rate rose last
month to 6.4 percent of the civilian labor force.''
Now in my perusal of the statement, this is the extent of
the discussion about jobs in our economy. Given what I believe
is the disturbing prospect for employment, particularly at this
stage of a so-called recovery, Mr. Chairman, I would like to
take a moment or two to review in a little more detail the
employment situation.
Since January of this year, the unemployment rate has risen
from 5.7 percent to 6.4 percent, the highest unemployment rate
in over 9 years, since April of 1994; 9.4 million workers are
unemployed, the most unemployed workers since December 1992,
more than 10 years ago. If individuals who have become too
discouraged to look for work were included in the unemployment
rate figure, it would be well over 7 percent.
The economy has lost 394,000 jobs since January, losing
jobs each of the past 5 months. Since February 2001, total jobs
have fallen 2.6 million, and private sector employment has
fallen more than 3.1 million. More than 3 million private
sector jobs have been lost since February 2001, a little over 2
years ago--2 and a half years ago. Last week, the Labor
Department reported that an additional 439,000 workers filed
initial unemployment insurance claims. More than 400,000
workers have been filing initial claims now for 21 consecutive
weeks. The last time we had such an extended streak was in
September 1992--again, more than 10 years ago.
Continuing claims for unemployment insurance are at a 20-
year high of 3.8 million. That is the highest level since
February 1983--more than 20 years ago. There are over 1.1
million Americans who have already exhausted all of their
unemployment insurance benefits still unable to find a job. The
average unemployed worker has been out of work 19.8 weeks. That
is the highest duration average for unemployed workers, 19.8
weeks, since 1948, except for a 7-month period in 1983 and 1984
when unemployment ranged between 8 and 10 percent.
Since GDP reached a low in the third quarter of 2001, the
economy has lost over 2 million jobs. At the same stage of the
early 1990's cycle--when the phrase ``a jobless recovery'' was
coined--the economy had already generated net job gains
totaling 482,000, and job growth had already turned positive on
a sustained basis by the summer of 1992, just a year after the
recession officially ended. In other words, it seems to me we
are in a very difficult situation here, and we really need to
lay this out and then make some judgments about how to move on
it.
Last week, The Washington Post reported that the National
Bureau of Economic Research, the arbiter of when U.S. economic
recessions begin and end, has been unable to declare an end to
the recession that began in March 2001, because payroll
employment has continued to decline long after the economy
resumed growing.
The article noted that employment has never been down so
much this far into a post-recessionary phase. The article
quotes a prominent Wall Street economist as saying, ``The
current situation makes the early 1990's jobless recovery look
like a hiring spree.''
On Monday, The New York Times reported that, ``Teenagers
are facing the worst summer job market in years, with the
percentage of those holding summer jobs at its lowest in 55
years and the unemployment rate at its highest in a decade.''
I take note of all of this because I think there is a
serious prospect that the employment situation may not improve
in the coming months and unemployment may continue to rise. It
is by no means clear that a level of economic growth can be
achieved that will bring about a significant improvement in the
unemployment rate.
Taken together, it seems to me more focused attention on
our employment situation is warranted. Unlike Chairman
Greenspan's statement that he finds the situation mixed, I find
it very negative with respect to the employment situation.
Chairman Greenspan notes in his testimony the achievement
of ``effective price stability--a long-held goal assigned to
the Federal Reserve by the Congress.'' And it is certainly part
of the statutory mandate of the Fed as determined by the
Congress. But I would note another goal assigned by the
Congress not covered in the Chairman's statement and that is
``maximum employment.'' Mr. Chairman, I think it is important
that we focus on this. At a minimum, it seems to me critical
that unemployment insurance should be extended for those long-
term unemployed who have exhausted their benefits.
Thank you very much.
Chairman Shelby. Senator Enzi.
STATEMENT OF SENATOR MICHAEL B. ENZI
Senator Enzi. Thank you, Mr. Chairman.
Everyone always looks with anticipation toward this
presentation. Of course, there is a little more anticipation
when it is the Senate's turn for the first presentation, but we
thank you for all of the insight that you provide.
The U.S. economy is still the greatest economy in the
world, but there are certain issues that we need to address to
ensure that we retain that position. If I had to pick a single
issue that has the greatest impact on the financial affairs of
Wyoming, and the rest of the Nation, I would choose the state
of the Nation's energy development. Every sector of our economy
relies on some form of technology that in turn relies on
electricity and/or fossil fuels to function. And one of the
secrets of the United States has always been low-cost energy.
Our economy is literally driven by our ability to develop and
maintain a steady, constant energy supply.
Wyoming's role is much like the position held by the
colonies during America's first years of European settlement.
We provide the raw materials or, in other words, the feedstock
that makes the rest of the Nation's energy economy function. In
my home county of Campbell County, Wyoming, we would be the
third largest coal-producing country in the world. One-third of
our Nation's coal is produced in this county alone. We also
produce more uranium annually than the rest of the Nation
combined and have the greatest potential for natural gas
development in the entire continental United States. In our
county, we are in the process of building some 50,000 wells for
coal-bed methane, and they just made a discovery that there is
another coal formation below the present one. The top formation
is 60 to 100 feet thick, and under about 60 to 100 feet of
dirt. The other one is a little bit lower, but it is 200 feet
thick and it has considerably more natural gas production than
the other. In short, we have what the rest of the Nation needs
to keep its technology fueled and running.
Unfortunately, most of that energy is stranded in Wyoming
and is inaccessible to other parts of the country that need it.
Our natural gas development is being slowed down by the
inability to get the gas out of State. We are short of
pipelines. We are talking about some pipelines from Alaska. We
need to talk about pipelines to get the gas that has already
been discovered in the lower 48 to where it is needed. Our
electricity runs into bottlenecks where the power lines outside
the State do not have enough capacity to carry what we can
generate, and our coal is being hit with the threat of new
regulations and bureaucratic limitations that could eventually
slow down exploration and development. All of these limitations
are having an effect on the rest of the economy.
I know that Chairman Greenspan has already visited the Hill
on a number of occasions and has testified on this issue. I
look forward to any additional insights he might offer on how
we can bolster the economy by increasing energy stability, and
I hope he could address what future role the energy-producing
States can play in meeting our energy demands.
I know that we have had a craze of trying to go with
natural gas for as many things as possible. The production of
electricity can be very efficiently done with coal, and I know
they were making a decision in Rapid City one year on whether
to use peaking power from natural gas. They discovered that the
peaking power would require as much natural gas and be needed
at the same time as gas to heat Rapid City. It was an
equivalent amount. It took as much electricity as it would take
to heat in winter in Rapid City. So, we are talking about some
large quantities of gas for things that could be substituted by
coal production. We do need to be able to get the electricity
around. And I have mentioned the need for pipelines.
In addition to the importance of natural gas prices on our
Nation's economy, we must also ensure that we have a favorable
business climate to encourage the creation and growth of our
small businesses. And small business has been the backbone for
the country; more than 97 percent of the businesses are small
business. I appreciate any of the concentration that people
have done on improving small business, and I would ask that a
copy of my full statement be made part of the record.
Chairman Shelby. Without objection, it is so ordered.
Senator Reed.
COMMENTS OF SENATOR JACK REED
Senator Reed. Thank you, Mr. Chairman, and welcome,
Chairman Greenspan. You are certainly a respected voice on
these matters, not only here in Washington but also
internationally.
We are in the midst of some of the worst economic news we
have had in a long time, particularly the unemployment numbers.
And the Administration seems to suggest more tax cuts and it
will get better. The Congress has passed more tax cuts, and it
is getting worse. I do not think that is the approach that we
should take.
It is particularly worse when it comes to the increase in
unemployment, and I think Senator Sarbanes' comments are very
precise and detailed about what is happening and the fact that
it seems in most cases to be a lag variable. So even when the
GDP starts improving, we are likely to see further increases in
unemployment. We are reaching a critical juncture. These are
the real lives of our constituents.
And right over the horizon is Social Security and Medicare,
and rather than taking prudent steps today to strengthen those
programs, or at least to reserve resources to do that, we have
effectively funded the tax cuts with Social Security monies and
other monies. I know it is incumbent upon all of us to restrain
spending, but, frankly, in 2003, about 94 percent of the
spending above the baseline was devoted to defense, homeland
security, and other items as a response to September 11, plus
Iraq and Afghanistan. It is very difficult to hold down
spending when we are spending $4 billion a month in Iraq and $1
billion a month in Afghanistan.
Today, we will consider and this week we will vote on a
defense bill that is a significant increase in spending, and,
ironically, none of those funds will include the cost of Iraq.
That will come later, probably in a supplemental. So, we have a
policy that is difficult to rationalize in terms of our fiscal
policy here: Uncontrollable expenses, or at least very-
difficult-to-predict expenses, resulting from our operations in
Iraq, Afghanistan, and homeland security, and continued tax
cuts which leave us, I think, not only with a poorly performing
economy but also in no position to deal with the issues of
Medicare and Social Security.
I look forward to your comments, Mr. Chairman.
Chairman Shelby. Senator Bennett.
COMMENTS OF SENATOR ROBERT F. BENNETT
Senator Bennett. Thank you, Mr. Chairman. I will resist the
temptation to engage in a debate and save that for speeches on
the floor.
I appreciate Chairman Greenspan's being with us today and
look forward to his testimony.
Chairman Shelby. Senator Bayh.
COMMENTS OF SENATOR EVAN BAYH
Senator Bayh. Welcome, Mr. Chairman. I look forward to your
testimony as well. I think my colleagues have covered most of
the relevant terrain.
Chairman Shelby. Senator Hagel.
COMMENTS OF SENATOR CHUCK HAGEL
Senator Hagel. Mr. Chairman, thank you.
I, too, welcome Chairman Greenspan. With all of this good
news floating around today, I look forward to your comments.
Thank you.
Chairman Shelby. Senator Chafee.
COMMENTS OF SENATOR LINCOLN D. CHAFEE
Senator Chafee. Likewise, welcome, Mr. Chairman, and you
have the back-to-back--the House yesterday, the Senate today. I
look forward to your testimony.
Chairman Shelby. Chairman Greenspan, your written testimony
will be made part of the record in its entirety. You proceed as
you wish. Welcome to the Committee again.
STATEMENT OF ALAN GREENSPAN, CHAIRMAN
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Chairman Greenspan. Thank you very much, Mr. Chairman and
Members of the Committee.
When in late April I last reviewed the economic outlook
before the Congress, full-scale military operations in Iraq had
concluded, and there were signs that some of the impediments to
brisker growth in economic activity in the months leading up to
the conflict were beginning to lift. Many, though by no means
all, of the economic uncertainties stemming from the situation
in Iraq had been resolved, and that reduction in uncertainty
had left an imprint on a broad range of indicators.
Stock prices had risen, risk spreads on corporate bonds had
narrowed, oil prices had dropped sharply, and measures of
consumer sentiment appeared to be on the mend. But, as I noted
in April, hard data indicating that these favorable
developments were quickening the pace of spending and
production were not yet in evidence, and it was likely that the
extent of the underlying vigor of the economy would become
apparent only gradually.
In the months since, some of the residual war-related
uncer-
tainties have abated further and financial conditions have
turned decidedly more accommodative, supported, in part, by the
Federal Reserve's commitment to foster sustainable growth and
to guard against a substantial further disinflation. Yields
across a number of maturities and risk classes have posted
declines, which together with improved profits boosted stock
prices and household wealth. If the past is any guide, these
domestic financial developments, apart from the heavy dose of
fiscal stimulus now in train, should bolster economic activity
over coming quarters.
To be sure, industrial production does appear to have
stabilized in recent weeks after months of declines. Consumer
spending has held up reasonably well, and activity in housing
markets continues strong. But incoming data on employment and
aggregate output remain mixed. A pervasive sense of caution
reflecting, in part, the aftermath of corporate governance
scandals appears to have left businesses focused on
strengthening their balance sheets and, to date, reluctant to
ramp up significantly their hiring and spending. Continued
global uncertainties and economic weakness abroad, particularly
among some of our major trading partners, also have extended
the ongoing softness in the demand for U.S. goods and services.
When the Federal Open Market Committee met last month, with
the economy not yet showing convincing signs of a sustained
pickup in growth, and against the backdrop of our concerns
about the implications of a possible substantial decline in
inflation, we elected to ease policy another quarter-point. The
Federal Open Market Committee stands prepared to maintain a
highly accommodative stance of policy for as long as needed to
promote satisfactory economic performance. In the judgment of
the Committee, policy accommodation aimed at raising the growth
of output, boosting the utilization of resources, and warding
off unwelcome disinflation can be maintained for a considerable
period without ultimately stoking inflationary pressures.
The prospects for a resumption of strong economic growth
have been enhanced by steps taken in the private sector over
the past couple of years to restructure and strengthen balance
sheets. These changes, assisted by improved prices in asset
markets, have left households and businesses better positioned
than they were earlier to boost outlays as their wariness about
the economic environment abates.
Nowhere has this process of balance sheet adjustment been
more evident than in the household sector. On the asset side of
the balance sheet, the decline of longer-term interest rates
and diminished perceptions of credit risk in recent months have
provided a substantial lift to the market value of nearly all
major categories of household assets. Most notably,
historically low mortgage interest rates have helped to propel
a solid advance in the value of the owner-occupied housing
stock. And the lowered rate at which investors discount future
business earnings has contributed to the substantial
appreciation in broad equity price indexes this year,
reversing a portion of their previous declines.
On the liability side of the balance sheet, despite the
significant increase in debt encouraged by higher asset values,
lower interest rates have facilitated a restructuring of
existing debt. Households have taken advantage of new lows in
mortgage interest rates to
refinance debt on more favorable terms, to lengthen debt
maturity, and, in many cases, to extract equity from their
homes to pay down other higher-cost debt. Debt service burdens,
accordingly, have
declined.
We expect both equity extraction and lower debt service to
continue to provide support for household spending in the
period ahead, though the strength of this support is likely to
diminish over time.
In addition to balance sheet improvements, the recently
passed tax legislation will provide a considerable lift to
disposable incomes of households in the second half of the
year, even after accounting for some State and local offsets.
Most mainstream economic models predict that such tax-induced
increases in disposable income should produce a prompt and
appreciable pickup in consumer spending. The evolution of
spending over the next few months may provide an important test
of the extent to which this traditional view of
expansionary fiscal policy holds in the current environment.
Much like households, businesses have taken advantage of
low-interest rates to shore up their balance sheets. Most
notably, firms have issued long-term debt and employed the
proceeds to pay down commercial paper, bank loans, and maturing
high-cost debt. The net effect of these trends to date has been
a decline in the ratio of business interest payments to net
cash flow, a significant increase in the average maturity of
liabilities, and a rise in the ratio of current assets to
current liabilities.
With business balance sheets having been strengthened and
with investors notably more receptive to risk, the overall
climate in credit markets has become more hospitable in recent
months. Specifically, improvements in forward-looking measures
of default risk, a decline in actual defaults, and a moderation
in the pace of debt-rating downgrades have prompted a marked
narrowing of credit spreads and credit default swap premiums.
In the past, such reductions in private yields and in the
cost of capital faced by firms have been associated with rising
capital spending. But as yet there is little evidence that the
more accommodative financial environment has materially
improved the willingness of top executives to increase capital
investment. Corporate executives and boards of directors are
seemingly unclear, in the wake of the recent intense focus on
corporate behavior, about how an increase in risk-taking on
their part would be viewed by shareholders and regulators.
As a result, business leaders have been quite circumspect
about embarking on major new investment projects. Moreover,
still-ample capacity in some sectors and lingering uncertainty
about the strength of prospective final sales have added to the
reluctance to expand capital outlays. But should firms begin to
perceive that the pickup in demand is durable, they doubtless
would be more inclined to increase hiring and production,
replenish depleted inventories, and bring new capital online.
These actions in turn would tend to further boost incomes and
output.
The favorable productivity trend of recent years have
continued, which certainly bode well for the future. Output per
hour in the nonfarm business sector increased 2.5 percent over
the year ending in the first quarter. It has been unusual that
firms have been able to achieve consistently strong gains in
productivity when the overall performance of the economy has
been so lackluster. To some extent, companies under pressure to
cut costs in an environment of still-tepid sales growth and an
uncertain economic outlook might be expected to search
aggressively for ways to employ resources more efficiently.
However, one consequence of these improvements in
efficiency has been an ability of many businesses to pare
existing workforces and still meet increases in demand. Indeed,
with the growth of real output below that of labor productivity
for much of the period since 2000, aggregate hours and
employment have fallen, and the unemployment rate rose last
month to 6.4 percent of the civilian labor force.
Inflation developments have been important in shaping the
economic outlook and the stance of policy over the first half
of the year. With the economy operating below its potential for
much of the past 2 years and productivity growth proceeding
apace, measures of core consumer prices have decelerated
noticeably. Allowing for known measurement biases, these
inflation indexes have been in a neighborhood that corresponds
to effective price stability--a long-held goal assigned to the
Federal Reserve by the Congress. But we can pause at this
achievement only for a moment, mindful that we face new
challenges in maintaining price stability, specifically to
prevent inflation from falling too low.
This is one reason the Federal Open Market Committee has
adopted a quite accommodative stance of policy. A very low
inflation rate increases the risk that an adverse shock to the
economy would be more difficult to counter effectively. Indeed,
there is an especially pernicious, albeit remote, scenario in
which inflation turns negative against a backdrop of weak
aggregate demand, engendering a corrosive deflationary spiral.
It is incumbent on a central bank to anticipate such
contingencies, however remote, and the Federal Reserve has been
studying how to provide policy stimulus should our primary tool
of
adjusting the target Federal funds rate no longer be available.
Indeed, the Federal Open Market Committee devoted considerable
attention to this subject at its June meeting, examining
potentially feasible policy alternatives. However, given the
now highly stimulative stance of monetary and fiscal policy and
well-anchored inflation expectations, the Committee concluded
that economic fundamentals are such that situations requiring
special policy actions are most unlikely to arise. Furthermore,
with the target funds rate at 1 percent, substantial further
conventional easings could be
implemented if the Federal Open Market Committee judged such
policy actions warranted. Doubtless, some financial firms would
experience difficulties in such an environment, but these
intermediaries have exhibited considerable flexibility in the
past to changing circumstances. More broadly, as I indicated
earlier, the Federal Open Market Committee stands ready to
maintain a highly accommodative stance of policy for as long as
it takes to achieve a return to satisfactory economic
performance.
Thank you very much. I look forward to your questions.
Chairman Shelby. Thank you, Mr. Chairman.
Mr. Chairman, in response to your remarks yesterday, bond
markets moved the yield on the benchmark 10-year Treasury up to
3.93 percent. Was the market reaction, in your judgment, in
line with what you anticipated would be the case? And if not,
would you take an opportunity to redirect your thoughts or just
tell us what your thoughts are?
Chairman Greenspan. Well, as I indicated yesterday,
remember that just prior to our last meeting, the financial
markets had been split on the evaluation of whether we would
move 25- or 50-basis-points. In the event, of course, we moved
25-basis-points and we concluded as a consequence that when we
announced that, interest rates would rise, as indeed they did.
It is difficult to judge what causes market rates to move.
There are a great number of opinions out there, and I hesitate
to give an opinion because that is basically endeavoring to try
to answer the question why did a large number of market
participants do certain things?
You can draw certain inferences. For example, Treasury rate
yields went up significantly, as, in effect, did high-grade
corporates. But speculative-grade bond yields actually went
down and the exchange rate firmed up. So a number of
commentators have concluded, looking at those data, that the
general view of the economy which we expressed--meaning the
Federal Reserve--was somewhat stronger than they had expected
we would have indicated.
There was also a general judgment that, in a sense, we took
off the table, as I read one commentator stipulating, the
notion that we might use so-called nontraditional means. I was
not aware I took anything off the table at any time, but
apparently that was the view that was taken at the time.
Remember that the Federal Open Market Committee can make a
judgment about policy probably with a 15-minute lead. And our
job is to be prepared to be able to move if we have to in any
particular case. But that requires a good deal of backup
analysis, and that is what we have been doing, and we have been
trying to convey what we are learning along the way to the
American public and the markets.
Chairman Shelby. Mr. Chairman, what is your view on the
spread between short- and long-term rates at the moment?
Chairman Greenspan. The market is obviously responding to
our general view--which has been our policy and will continue
to be our policy, as best I can judge--that we will hold rates
until the economy achieves satisfactory performance, which
means that we tend to anchor the short-term rate structure
because what we are targeting, as you know, is the overnight
rates.
Chairman Shelby. Sure.
Chairman Greenspan. And the longer-term rates reflect three
things: They basically reflect inflationary expectations, the
expectations of real economic growth, and the supply of
securities. And in all of those cases, those markets will move
essentially independently in many respects of what Federal
Reserve policy is.
Chairman Shelby. Mr. Chairman, this morning's data released
on industrial production showed an output gain for
manufacturing. Does this signal a potential rebound for this
sector of the economy which has been lagging?
Chairman Greenspan. It certainly indicates--at least, as I
say in my prepared remarks--that industrial production has
stabilized. But it is stabilized, as best I can judge on the
data we are looking at, with inventories being liquidated,
which effectively is saying that the consumption of industrial
production, is somewhat higher than the production level,
implying that at some point it will rise further. But short of
that, I would just as soon not give you any projection because
we do not have one immediately that is useful.
Chairman Shelby. We respect that.
Senator Sarbanes.
Senator Sarbanes. Thank you, Mr. Chairman.
In this July report, the Fed has downgraded its projection
for GDP growth for 2003 for the second time. Last July, the Fed
forecast GDP growth for 2003, the year we are in, between 3.5
and 4 percent. In February, it lowered that forecast slightly
to between 3.25 and 3.5 percent. And now it estimates growth
between 2.5 and 2.75 percent for 2003.
Regrettably, this pattern is similar to forecasts for the
previous several years. In February 2001, the Fed projected
economic growth of between 2 and 2.5 percent. In July, we were
already in the midst of a recession, and the Fed significantly
lowered its projections to between 1 and 2 percent growth.
Growth in 2001 was barely even positive at 0.3 of a percent.
In February 2002, the Fed projected growth of between 2.5
and 3 percent for 2002, only to revise that projection upward
in July to between 3.5 and 3.75 percent. Growth came in below
projections at 2.4 percent. Those are the three most recent
years.
So far economic growth in the first quarter of this year
was a meager 1.4 percent. The consensus estimate is that the
second quarter will hardly be any better. But now we are
hearing that next year the growth will pick right back up to
between 3.75 and 4.75 percent, according to this report.
It leads me, Mr. Chairman, to ask: Are the models that you
are using at the Fed overly optimistic? Or have we all fallen
into the trap of believing that there is a mythical recovery
which is just around the corner? I mean, in all three of these
years now, the Fed has really been off the mark on its
projections, overly optimistic consistently?
Chairman Greenspan. That is true, and I would suggest to
you that it is not the result of a single model because what
you are quoting is, I would put it this way, the consensus of
the individual forecasts of the members of the Federal Open
Market Committee. That is not the staff forecast as such, which
we produce separately.
But it is certainly the case that we and others--in fact,
the general consensus--have been projecting a recovery sooner
than it has obviously been occurring.
Senator Sarbanes. Well, that would lend some weight to the
view that we have a more serious economic situation on our
hands than is being generally acknowledged or admitted to.
Chairman Greenspan. Oh, there is no question that that is
the case, and indeed, remember that we did have the emergence
of
Afghanistan and especially the Iraqi war, the big surge in oil
prices, and a number of events which we did not forecast.
Senator Sarbanes. Let me ask about the labor market, just
to follow along with this line of thought. The June 25, Federal
Open Market Committee statement said, ``Recent signs point to
labor and product markets that are stabilizing.'' Now this was
a shift from the FOMC meeting on May 6 in which the FOMC found,
``Initial claims for unemployment insurance remained at an
elevated level, suggesting further labor market weakness in
May.'' Indeed, the labor market was quite weak in May, with the
revised data reporting that 70,000 jobs were lost. Initial
claims for unemployment
remained above the 400,000 level throughout May and June.
Since your June report, initial claims have risen to
439,000 for the most recent week. They have been above the
400,000 level for 21 consecutive weeks. The unemployment rate
jumped to 6.4 percent, a 9-year high, and the economy continued
to lose jobs in June for the fifth consecutive month. As I said
earlier, the number of workers who were unemployed for more
than one week has reached a 20-year high of 3.8 million.
Would it not be more accurate now in describing the labor
market to go back to the May formulation, an elevated level
suggesting further labor market weakness rather than the June
formulation, the labor markets are stabilizing?
Chairman Greenspan. Well, Senator, my recollection--and I
would have to look at the data--is that the reason the
statement of stabilization was put in there is that the
employment data historically were revised to, as I would put
it, a more stable pattern. They then were revised again down in
the most recent report. So what we were reflecting were the BLS
payroll data, which, as I recall, had shown signs of stability,
which then was erased in the next month's report.
Senator Sarbanes. Yes, I understand that, and the point I
was trying to get at is, given the additional data that is now
available to us, as you come this morning, wouldn't the May
formulation of a further labor market weakness be more apt to
our current circumstance than the June formulation of a
stabilizing labor market?
Chairman Greenspan. Senator, we will not know until we get
beyond the July initial claims figures, and let me explain to
you what that is.
We have very considerable difficulty during the month of
July, especially in the first 2 weeks of July, in seasonally
adjusting the normal retooling that goes on in the motor
vehicle industry and seasonal shutdowns in a number of
different industries, and they vary. And we have found that the
variants of the seasonals are very large, and so until we get
into August, we will not get a good reading on initial claims
or insured unemployment.
It is conceivable that the formulation you just suggested
may, in fact, turn out to be the correct one. I would like to
wait a couple of weeks before I respond to that in any
definitive manner.
Senator Sarbanes. Thank you, Mr. Chairman.
Chairman Shelby. Senator Allard.
Senator Allard. Chairman Greenspan, we just enacted a tax
cut. Would you say that that tax cut increases the likelihood
that our economy will recover more quickly?
Chairman Greenspan. I have argued in the past that I did
not view fiscal measures as being appropriate for purposes of
short-term fiscal stimulus. I have said that over the years. I
have indicated that in many testimonies here.
The truth of the matter is that more, I suspect, for
fortuitous reasons, the last two tax cuts have turned out to be
timed in a manner which would affect the economy. And I do
believe that the current one, as I indicated in my prepared
remarks, by shifting a very substantial amount of monies to
reduce taxes and increase disposable personal income in the
third quarter has the makings of a fairly prompt impact on
sales.
It is too soon to judge whether that impact is going to be,
as I put it in my prepared remarks, what standardized
conventional models ordinarily suggest would occur. But there
is no question that the quality of the data on sales have been
improving. The retail sales released for the month of May,
which is obviously prior to these data, was obviously above
expectations. And, indeed, chain store sales in recent weeks
have been running above expectations.
Motor vehicle sales seem to be a shade better, but it is
too soon to tell. And the best thing is we will probably find
out the answer to your question of whether the tax cuts really
made a difference I would say probably toward the end of this
quarter.
Senator Allard. Thank you for your response.
As you know, you and I have had a discussion about the
capital gains tax. In some of those hearings where you appeared
before
either this Committee or the Budget Committee, you have
strongly argued for its elimination or reduction. Whenever we
get a fiscal note on a capital gains proposal, or tax reduction
proposal, it has a positive fiscal note; in other words, it
shows increasing revenue to the Federal Government.
So, I was struck by your comment yesterday when you
acknowledged that the tax cuts have a stimulatory effect,
although you noted that you doubted the tax cut paid for
itself. Would you modify that comment, specifically with
regards to capital gains?
Chairman Greenspan. No, not really, Senator. It is
certainly the case that if you cut the capital gains tax, you
are likely to get fairly significant revenue initially. You
probably will get an initial response in revenue raising as the
turnover occurs.
Senator Allard. Right.
Chairman Greenspan. But over the long run, I do not think
the data show that. In other words, you get an initial surge in
revenues followed by a significant decline from the capital
gains tax, and taken over the long run, you would lose revenue,
as best I can judge.
Senator Allard. Chairman Greenspan, this Congress is right
now wrestling with the reauthorization of transportation bills,
highway transportation and mass transit in particular. Members
of Congress are struggling with how they are going to pay for
all these transportation projects. Some have called for an
increase of 2 cents per gallon, while others are calling for an
increase in excess of 12 cents per gallon.
First, I wonder if you might comment on how you think this
tax increase could have an impact on our economy when it is
dedicated to improving the infrastructure of this country. The
second part of the question: In Colorado, we have a unique
situation. We have some of the highest gas taxes in the
country. And, our neighbor, Wyoming, has some of the lowest gas
taxes in the country. Could you talk a little about how those
two extremes may be impacted since they are right next to each
other? I would appreciate it.
Chairman Greenspan. Well, it should be apparent that if you
increase the gasoline tax, consumption of gasoline will go
down. That has two effects. Since a significant part of the
crude oil and, indeed, even gasoline stocks that we consume are
imported, it probably has the effect of reducing consumption of
gasoline, reducing, I should say, aggregate consumption, which
is partially offset from imports. The net effect is probably to
weaken the economy slightly. But I would be doubtful that that
is a big issue, and I think there are far more important other
issues that are involved in gasoline tax, which obviously gets
to questions of conservation, gets to questions of security of
supply, and I would be hesitant to draw the economic impact as
being a crucial issue in the context of the small changes that
we tend to talk about.
I have really nothing to say about the disparity among
States. That has to do with your legislatures, and if you want
to have a meeting at the border to marginalize them, that is a
question for the States.
Senator Allard. Let me rephrase that question. Is there
likely to be a greater economic impact on States that have high
gas taxes as opposed to those who have lower gas taxes?
Chairman Greenspan. Yes.
Senator Allard. I see my time has expired. Thank you.
Chairman Shelby. Senator Reed.
Senator Reed. Thank you very much, Mr. Chairman.
Thank you, Chairman Greenspan.
In this Monetary Report to the Congress, page 12, and I
quote, ``With little change, on balance, in non-Federal
domestic saving over this period, the downswing in Federal
saving''--which I think roughly is the surplus--``showed
through into net national saving, which was equal to less than
1 percent of GDP in the first quarter, compared with the recent
high of 6.5 percent of GDP in 1998. If not reversed over the
longer haul, such low levels of national saving could
eventually impinge on the formation of private capital that
contributed to the improved productivity performance of the
past half-decade.''
Today's headlines from The Washington Post,--White House
Foresees 5-Year Debt Increase Of $1.9 Trillion.--``The Federal
Government will pile up $1.9 trillion in new debt over the next
5 years and will still be running an annual deficit of $225
billion by 2008, long after White House economists assume
current war costs will have subsided and the economy will have
recovered. . . .'' Those are pretty rosy predictions but,
nevertheless, even the White House assumes we will be running
deficits and not surpluses by 2008.
The question is: Where is the long haul? Is it 2005, 2006,
2007, 2008, 2009? When are we going to start seeing this
adverse impact requiring us to do something more than just talk
about it?
Chairman Greenspan. Remember that the statement in that
report is a statement of accounting and arithmetic; that is,
the accounts of savings and investment must balance. Obviously,
if you get an absorption of savings from the private sector by
increased Federal deficits, that will reduce the private
savings available to finance investment.
But as I said yesterday in response to a related question,
that leaves open the question of financing domestic capital
investment by essentially borrowing savings from abroad, as one
possibility, which we have done, obviously, quite extensively.
And then there is a quite important question which gets to the
issue that only roughly half of our productivity increases are
directly attributable to the amount of capital investment that
is employed in the economy. The rest are technological changes,
organizational changes, things which economists call ``multi-
factor productivity.''
There is no question that if you run substantial and
excessive deficits over time, you are draining savings from the
private sector, and other things equal, you do clearly undercut
the growth rate of the economy. That is one of the reasons I
have argued for years about getting the deficit down. So, I
have no question that if we do not come to grips with these
deficit issues, it will make it more difficult for us to
maintain the type of growth rates which, to respond to Senator
Sarbanes' concerns, will bring total employment up and bring
the unemployment rate down.
Senator Reed. As I understand the numbers out of the White
House, though, they are assuming a full-employment economy by
2008 and still deficits. Is that accurate?
Chairman Greenspan. That is certainly economically
consistent. It depends on the nature of the individual
assumptions that are made with respect to a lot of different
variables.
Senator Reed. I still have not heard the long haul, where I
am looking over the horizon. Where should I put my stake down
for the long haul? Certainly that is something that you must
think about. It is one thing, because your models and your
presumptions all have a time base as well as other parameters.
Chairman Greenspan. That is exactly right, Senator. Even
though, as I indicated earlier, we can move on 15 minutes
notice, nonetheless, unless we have a broad overview of the
forces that are driving the economy, not only in the short run
but also in the long run, it is difficult to make judgments as
to what the appropriate posture of monetary policy is unless
you have the full context of both the short term and the long
term.
Senator Sarbanes. Jack, would you yield for a second?
Senator Reed. I would yield to the gentleman.
Senator Sarbanes. Would you run large deficits at full
employment levels? If the economy is at full employment levels,
what is your view with respect to running large deficits in the
Federal budget?
Chairman Greenspan. I would be against it.
Senator Reed. May I ask one more question? That is, the
consumer has been one of the stalwarts in the economy. Getting
back to the taxes, there are at least two issues with the
taxes. One is the size and the other issue is who are the
beneficiaries? It seems to me, and the one phrase I remember
from college economics is that the marginal propensity to
consume is the inverse of proportional income. So that if we
target these tax cuts--I have exhausted all my economic
knowledge, I will admit it.
[Laughter.]
Senator Reed. If we target these tax cuts to the
wealthiest, which seems to be the case, we will not get the
proportional benefit from consumption that we would if we had
targeted these tax cuts to lower-income Americans.
Chairman Greenspan. Senator, I was exposed to the same
economic education that you were as an undergraduate.
Senator Reed. I think it took in your case.
[Laughter.]
Chairman Greenspan. I would merely qualify the conclusion.
What we have found recently is that while indeed the marginal
propensity to consume does fall as incomes rise, that the
extent of the decline is much less than has been our previous
expectation, and what I also would presume to be conventional
wisdom. So, yes, it is true that marginal propensities to spend
fall, but it is not enough to really make a very substantial
difference when you apply it to various different income
distributions.
Senator Reed. Thank you.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Bennett.
Senator Bennett. Thank you very much, Mr. Chairman.
Chairman Greenspan, this is anecdotal from my own
observation, but I want to share it with you and get your
response. One of the areas where I have found that the recent
recession and soft recovery has hit very, very hard is in the
area of venture capital. VC's, as I have discussions with them
about new ideas and new opportunities, say very flatly, ``We
have no money. There is no VC money.'' What little VC money
that has been available has gone not to fund new ventures but
to follow the pattern that you outlined in your statement, to
shore up the balance sheets of the ventures that they funded
during the bubble of the 1990's, so that when we had the froth
and the excitement of the late 1990's, and you could get
venture capital for almost any idea, no matter how hare-brained
it might have been in retrospect, the system washed out all of
the bad investments and the venture capitalists took what money
they did have and went back to the investments that were just
hanging on, but surviving nonetheless, and put money that would
have gone into new ventures and thus created new jobs into
strengthening the balance sheets of the companies that they
had.
The VC's were saying to me, ``We have a liquidity crisis.
We cannot get any money out of the banks. The banks are getting
very, very anxious about making sure that they are not taking
undue risks, much the way they did after the savings and loan
crisis when banks got very, very conservative in their lending
process. We cannot raise very much money from individuals. They
are burned. They are being very, very cautious, and
consequently there is a liquidity crisis in the venture capital
world.''
I think that may have some impact on the unemployment
situation that Senator Sarbanes is so concerned about because
much of our job creation comes from new business creation.
Fortunately, we are not like Europe, and we are not like Japan
where they do not have the VC tradition. So until we get
venture capitalists funding new entrepreneurial activities, we
are probably not going to make as big a dent on the
unemployment number as we would like. The Fortune 500 cannot
solve the unemployment problem. The Fortune 500 has always been
lagging in job creation as opposed to the entrepreneurial side
of the house.
Do you have any data, or if no data, any intuition about
what might be happening in the venture capital world and what
we might be able to look forward to in this uniquely American
phenomenon of a lot of private capital funding brave new
entries into the world?
Chairman Greenspan. Senator, the data that we have show, as
you correctly point out, a moderate to small industry prior to
the mid-1990's, and then with the surge of the stock market
there is this huge increase in venture capital as a spike, and
indeed it has come all the way back down to where it had been.
It is not below, but clearly it was all the way up and all the
way down. My impression is that it depends to a very large
extent not just on the availability of capital without the
ideas, but you need to start to get market values up first, so
that there are presumed opportunities. Remember, that so far as
financing is concerned, as important as venture capital is for
these highly speculative and very imaginative projects, and as
you pointed out, some of them perhaps a little exotic, too
exotically imaginative in the past, far more important is the
fact that there has been a very significant decline in what we
call junk bond yields. Those are high-yielding bonds which are
a large source of financing for capital investment in a number
of lower-grade corporations whose fluctuation in capital
expenditure is quite large. So, yes, I do think if we were to
get increased venture capital going it would be helpful, but I
think if the economy gets going, venture capital will follow
along.
I do not believe that it is a leading indicator at all, and
it is one which really requires opportunities to arise and
individuals looking for various different types of investments
because they presume that other market prices have gone up too
high.
Senator Bennett. Thank you.
Chairman Shelby. Senator Bayh.
Senator Bayh. Thank you, Mr. Chairman. Time permitting, I
have three questions, two of a short-term nature, one of a
longer-term nature.
My first question would be: When do you anticipate a pickup
in capital investment, and how robust would you expect that to
be? Particularly, Mr. Chairman, you mentioned three factors in
your testimony. First, the increased risk aversion by corporate
decisionmakers because of the recent scandals. I will assume
that they will eventually become acclimated to the new rules
and that will abate. Second, you mentioned overcapacity in some
parts of the economy. You did not mention telecom, but some of
those areas I assume we will just have to work their way
through that. In particular, if you could, I would like for you
to address the third point you mentioned, which is when do you
think the pickup in demand will be perceived as being durable,
thereby incenting corporate decisionmakers to increase their
capital investments?
Chairman Greenspan. Senator, if we knew the answer to just
any two of those three questions, I think we would have the
elements of an economic forecast, because that is really where
the major uncertainties are.
The problem in the corporate governance area is one in
which there has been a shock to the corporate sector because
the types of things that occurred were not presumed
contemplatable in an earlier period, and it is going to take a
while for that to wear off. I do not know how long it will
take, but one way of getting some judgments, I would be looking
to see whether mergers and acquisitions begin to pickup. That
would give you a sense that there is lessened concern.
Senator Bayh. There are some tentative signs of that, more
MA activity.
Chairman Greenspan. Well, I have heard the same, but it is
still quite preliminary and not really evident.
Senator Bayh. Could I ask, Chairman--forgive me for
interrupting, but our time is unfortunately limited--if you
might focus on the third factor, when the pickup in demand will
be perceived as being more durable?
Chairman Greenspan. It will depend on two things. One, on
the issue which I was discussing with Senator Reed, what the
propensity to consume out of these very substantial tax cuts
concentrated in a short period of time is, and, two, whether
the increase in demand is perceived by the business community
as not a blip but as something which is more ongoing. I cannot
answer that question with any degree of certainty, but at the
moment most private forecasters have forecast for the third
quarter which I will tell you are higher than ours.
Senator Bayh. Well, that is encouraging.
Chairman Greenspan. I do not know whether that makes it
right. I am just saying it.
[Laughter.]
Senator Bayh. It is always nice to be encouraged, right or
not. It seems to me though that that really lies at the crux of
the issue, that the risk aversion because of the corporate
scandals will eventually subside as decisionmakers acclimate
themselves to the new rules that we have attempted to put in
place and that some of the overcapacity, we will eventually
work our way through that, but really the key here is the
perception of the durability of demand going forward on a
sustainable basis, to the increase in CapEx which has been a
significant missing component of this tentative recovery to
date.
My second question I do not think I am going to get to my
third, which is unfortunate because I wanted to ask you about
the long-term fiscal challenges that we face when the baby
boomer begins to retire. Perhaps that will await another time.
We all care about the deficit here. I know when I go home
people occasionally ask about it, but my perception is that the
public only begins to focus on the deficit when it begins to
bite in real rather than theoretical terms, and public
policymakers tend to only make the difficult decisions that
have to be made once the public has begun to focus because of
real world consequences.
So my question would be, and you mentioned in response to
one of my colleagues' questions, or rather one of my colleagues
may have mentioned the activity in the credit markets
yesterday, and then you mentioned that the more high-yielding
securities actually responded well, I assume because of
perception of a reduced default risk. But the treasuries and
high-grade corporates went the other direction. My question
would be: When do you perceive that the adverse consequences of
the deficit will actually begin to manifest themselves in real
terms? It seems to me that the markets yesterday were at least
sending a near-term signal that the answer may be now. In terms
of the crowding out, they are anticipating both higher private
demand, which was the reason for my first question,
simultaneously with high ongoing deficits, and that we may see
crowding out sooner rather than later.
Chairman Greenspan. I think it is difficult to separate the
issue of increased supply in the short term, and general
notions of broad economic recovery. They are interrelated and
very difficult to separate. We have found that the impact of
deficits on current long-term interest rates are related to
changes in long-term deficit expectations, not generally short-
term issues of deficits and Treasury borrowing. So it is not
clear to me to what extent changes in yields are impacted,
although there is no question that if you put new
securities in the market, prices will tend to adjust. But the
real impact on long-term interest rates which matter are really
driven by long-term expectations of the deficit to the extent
that interest rates are affected by deficits, which as you
know, I am a firm believer they are.
Senator Bayh. My time has expired, Mr. Chairman, which is
too bad, because that led directly to my third question which
was the long term--
Chairman Shelby. Senator, we will have another round.
Senator Bayh. Thank you, Mr. Chairman.
And thank you, Chairman Greenspan.
Chairman Shelby. Senator Hagel.
Senator Hagel. Mr. Chairman, thank you.
Chairman Greenspan, thank you again for appearing before
the Committee. Actually, I would like to pick up where the
Senator from Indiana left off, staying within the universe of
deficits, and I think where the Senator from Indiana was going
with this is in the unfunded entitlement liabilities direction,
or at least that is where I want to go with the question.
First, it has been noted here, and you have responded to
some questions about OMB's numbers that they released yesterday
which appeared in the papers today about a $1.9 trillion
deficit over the next 5 years, and I think we are all familiar
with the numbers that they have projected for this fiscal year
as well, as higher numbers for next year. Staying in that
universe for a moment, there was a piece in the Financial Times
yesterday, and I do not know if you saw it. The headline was
``The Fiscal Overstretch That Will Undermine An Empire.'' As a
matter of fact, one of the authors of this, according to the
story, is a senior economist at the Federal Reserve in
Cleveland. It talks about the unfunded entitlement liabilities
that are out there for this country. And you know the numbers
very well on this, Mr. Chairman. In 8 years, 77 million baby
boomers start collecting Social Security benefits.
What they did in this study is they tried to, as best they
could, develop a model that would tell them what kind of
revenues we could expect within that time frame versus the
commitments that the Government had. What they found was a $44
trillion shortfall in revenues, and a great amount of that was
due to the Medicare-Social Security liabilities that are
unfunded.
Now, in light of that, as you have been following, and you
and I have had some discussions about this previously, both the
House and the Senate have passed a Medicare reform bill, and
the centerpiece of that, as you know, is a prescription drug
plan. I would be interested in your thoughts about the entirety
of this issue because of the kind of obligations that we are
saddling future generations with a prescription drug plan in a
Medicare reform bill, and any other comments you would like to
make in this regard, because I think you just said that large
deficits, in your words, undercut the growth rate of an
economy.
So with all of that, have at it. Thank you.
Chairman Greenspan. Without discussing any particular
programs, I do think that it is possible to get a general
projection of what under the best conditions the revenue flows
in this country would be to the U.S. Treasury. Wholly
independent, the Congress passes legislation with commitments
for the future which do not relate to the available revenues.
It is a very difficult evaluation, and I will grant you that
others will come to different conclusions. In recent years it
has been my impression that the statutes that we have now
currently in place, granted the demographics that will emerge
in the years ahead, will create a level of spending in excess
of our capability to finance it. It is not an issue of raising
taxes
because there comes a point, as everybody agrees, when you
raise taxes, you will lose revenue eventually, so it is not an
open-ended situation.
As a consequence of that I do think that it is crucially
important for us to look at the whole fiscal situation in the
context of whether our laws are internally consistent, whether,
in fact, the structure of obligations we have presented for the
future are indeed capable of being financed in real terms,
because remember, we are talking real resources. Money is
merely an intermediary here. From the types of numbers that I
have been looking at, when we get into the period beyond 2010,
2011, and 2012, we are running into potentially serious
troubles in which the claims on the aggregate GDP, in order to
finance what is required by law for retirees, would require a
significant reduction in the real earnings of the working
people over and above what otherwise would be the case. In
other words, a disproportionate amount of the GDP would have to
be diverted, and it is not clear under those conditions whether
we create a very major problem between generations in that
regard. I think it is readily forecastable now because we may,
as Senator Sarbanes says, have some trouble with our GDP
forecasting. We do not have trouble in forecasting the age
structure of the American population and what the demographics
are going to impose on us as we move toward the movement of
this very large baby boom generation from productive work into
retirement.
Senator Hagel. Thank you.
Chairman Shelby. Senator Corzine.
COMMENTS OF SENATOR JON S. CORZINE
Senator Corzine. Thank you, Mr. Chairman.
I welcome Chairman Greenspan. Let me just follow on there
just for a brief second. I think your arguments today with
regard to structural deficits which we apparently have now in
place due to the set of policies and the need to prepare for
the demographic reality that you suggest, tells us that our
imprudence at the current moment is only going to aggravate the
problems that one could anticipate coming down the pike with
how we deal with these obligations. We certainly put ourselves
on a course where we may be in a position where we have no
choices to deal with that, and we are taking those choices off
the table as we go, and it is very troubling to me.
We have a statement you made to this Committee in February.
We have to be very careful in talking about structural deficits
because there is no self-equilibrating mechanism when
structural deficits are occurring because the rise in
indebtedness increases the amount of interest payments which,
in turn, increases the debt still further, and there is an
acceleration, a pattern, till you reach a certain point of no
return. You put that against the demographic situation, and we
are taking off the table our ability, many of the
options to deal with just the issue we are talking about
suggests.
I had a couple of micro issues. Since we are now seemingly
going to be financing the U.S. Treasury for very significant
amounts of dollars for a very long period in time, regardless
of how you calculate it, including what the Budget Office let
us know yesterday, is it not time that the Treasury reconsider
the issuing of 30-year notes? At the time they ended the 30-
year bond, they argued that we were headed into surplus. I
think that was 2 years ago or 2\1/2\ years ago. And a long bond
was no longer necessary to meet Government financing needs.
They also added at the time that the return to deficit might
necessitate a reintroduction.
I would also ask that, given the debate that we are now
having about discount rates for pension policies, which are so
important for the private sector and others, there is also a
need for clarity with regard to what the yield curve looks
like, using indices that may be an accurate reflection of
longer dated markets for discount rates. It just seems there
are a number of reasons to spread out over a longer period of
time. I remember these arguments being made by the most
eloquent economists in the late 1970's and early 1980's of why
we needed a full-year curve. Is it not time to reconsider that
point of view? I would love to hear how you feel about it
yourself.
And then finally, another micro issue. We see the SEC
talking about easing voting for outside directors and other
issues. Do you have any comments on how that might impact
capital formation? Is that a positive? Is that a negative? And
how would you respond?
Chairman Greenspan. On the 30-year bond I am going to be
interested in hearing the various debates and arguments on both
sides of the issue, which I think will eventually materialize
for exactly the reasons that you raise, Senator. There are pros
and cons to the issue, as you are aware, and I do not want to
anticipate how Treasury will come out, but I would presume we
will be involved, as we have been over the years, in
discussions on this issue as it affects our monetary structure.
While to be sure the ultimate decision has to be with the
Secretary of the Treasury, we do have input and we will
endeavor to review the pros and cons and try to come to a
conclusion ourselves on that issue.
Senator Corzine. Did you have a view about whether it was
constructive or not in the period of time? We had almost 20
years of experience.
Chairman Greenspan. Yes. I thought that if you took the
projections of the surpluses seriously, and remember, we all
were skeptical, but those were nonetheless the best judgments
that people could make at that time, then the issue of taking
the 30-year off the table clearly was a very reasonable one.
Times have changed, Senator. Presumably these issues will be
revisited as part of a broader set of questions of how Treasury
needs to fund itself, or more exactly, how Treasury needs to
fund the debt requirements of the Government.
Senator Corzine. Shareholder issues?
Chairman Greenspan. Actually, I am aware that the SEC was
discussing that yesterday and I have not caught up to what they
have been mentioning on the issue. I am aware that it is in the
papers this morning, but I have not as yet had a chance to see,
and hence to comment on anything that they have said on that
regard.
Senator Corzine. Thank you.
Chairman Shelby. Senator Chafee.
Senator Chafee. Thank you, Mr. Chairman.
Again, welcome, Chairman Greenspan. In your written
testimony you say there is an especially pernicious, albeit
remote scenario, in which inflation turns negative against a
backdrop of weak aggregate demand, engendering a corrosive
deflationary spiral. Can you describe what might be a worst
case scenario of this corrosive deflationary spiral?
Chairman Greenspan. Sounds by itself as a worst case
scenario.
[Laughter.]
It is an issue which economists never even thought about
largely because, as I indicated in my prepared remarks, it was
considered a curiosity, because with fiat money it just seemed
noncredible that you could get too little inflation and that
the capacity of central banks essentially to print money at
will could not overcome any such tendency. That changed with
the evident difficulties that Japan has been having. Even
though there are good arguments, as I point out in my prepared
remarks, to presume that the Japanese case of modest deflation
is idiosyncratic, especially related to their institutions and
specific difficulties that they have. But it still raises
questions as to whether we are prepared as a central bank in
the event that that happens.
It was not an issue that concerned us when the inflation
rate was 5 percent, 3 percent, or even 2 percent, but in the
last 6 to 9 months the rate of inflation has fallen quite
dramatically in this country. It has triggered a fairly
extensive evaluation on our part as to what we would do if we
perceived that that issue was becoming an important one. And as
I indicated, we have spent a good deal of time on examining
types of alternative monetary policies which we believe could
successfully address that problem and fend it off. It is quite
remote, in our view, because we do not see the elements of that
occurring, but if it occurs, it is a very major event. Even
though its probability is very small, the size of the problem,
should it occur, is sufficiently large to have engaged our
attention, and it will continue to engage our attention until
it is very clear that it can be fully taken off the table.
Senator Chafee. And as you war game for this scenario, do
you worry about, as you said, stoking inflationary pressures on
the other end?
Chairman Greenspan. We certainly do, and obviously a
central bank needs to be acutely aware of that, but as I
indicated in my prepared remarks, the impact of a number of
forces from the collapse of the bubble in stock prices and its
downward pressure on asset values for a while, and the issue of
globalization, are all working at this stage to contain
inflationary impulses. But it is obvious that our goal is price
stability, and it is price stability on both sides. We are
engaged in trying to fend off both deflation and inflation, and
hopefully we can maintain the degree of price stability that we
have finally achieved and hopefully do so for a very
considerable period of time.
Senator Chafee. I do not think you mentioned in your
testimony exactly what you would do if we went down that
pernicious path of disinflation?
Chairman Greenspan. Senator, we have discussed what we call
nontraditional means, meaning the focus of central bank policy
in this country has, for a very long period of time, been
restricted to endeavoring to change the overnight rate of
interest without any advertence to how we might impact longer-
term interest rates.
The reason that issue comes up is that with the Federal
funds rate at 1 percent, there is obviously a downside limit to
how far we could engage in further monetary expansion which is
the obvious remedy that a central bank would create to confront
this type of difficult deflationary process. Obviously, with
only 100 basis points left, we have to first conceive what we
would do in the event, which I have indicated we consider is
remote, of needing to go well beyond that, and we have engaged
in a number of different issues, all of which are involved in
expanding the balance sheet of the central bank, which
essentially means that we buy different types of assets and we
do different types of things including moving out on the yield
curve well beyond the issue of overnight funding.
That is an issue which we have been concerned about for a
number of months. We have accordingly, not having focused on it
before because we, as I said, thought it was an academic
curiosity, but I think we have pretty much caught up to speed,
so to speak, and we trust we never have to engage in such
policies, but I think we are in a position to know what to do
and how to do it should that necessity arise.
Senator Chafee. Thank you.
Chairman Shelby. Senator Carper.
STATEMENT OF SENATOR THOMAS R. CARPER
Senator Carper. Thanks, Mr. Chairman.
Welcome, Chairman Greenspan. Good to see you.
Senator Chafee and I have offered legislation, along with
Senators Judd Gregg of New Hampshire and also Lamar Alexander
of Tennessee, that attempts to address the need to clean our
air further with respect to emissions of sulfur dioxide,
nitrogen oxide, mercury, and also CO<INF>2</INF>. We have
sought to find a middle position, if you will, between Clear
Skies over here, the President's proposal, the competing
proposal over here by Senator Jeffords, and we sought to put
something right here in the middle which puts in place caps on
emissions including carbon, but relies on market systems, such
as cut cap and trade. For example, if you are a utility and I
am a farmer, and you have to reduce your emissions, you can use
technology, you can change up your mix of fuels. You can say to
this farmer: I would like for you to put more money in and
expand the number of trees on your land, reforestation, change
the planting patterns on the land, change what I do on our
animal feedlots, that kind of thing, so different ways to
achieve the goal.
It has been estimated over the next I guess 17 years, by
2020, if there is no change in the law at all, just business as
usual, the cost of generating electricity for the producers is
about $95 billion. The cost under the President's Clear Skies
Initiative is about $101 billion. The cost under our proposal
is about $102 billion. So, we are trying to decide whether or
not at a time when we want utilities to be able to create the
electricity, we want them to reduce their sulfur dioxide,
nitrogen oxide, and mercury, if this is also a time to come in
and say, all right, somewhere along the line you are going to
have to face reducing carbon dioxide, and rather than wondering
when that is going to happen, let us just provide some
certainty and to try to do it now. There are some, as I
suggested, marginal costs that are involved in that, about a
billion dollars it looks like by 2020.
I wanted to talk with you a little bit this morning. You
and I have talked about energy costs before, but I want to talk
a little bit this morning about the cost of trying to regulate
carbon dioxide, and the effect that that might have on our
economy, and just your counsel on how we might go about it. I
have a concern. I am a native of West Virginia and I have a lot
of concerns about coal still in my native State. I am not
interested in seeing a lot of change in the fuel mix. I want us
to use coal, but use clean coal. Interestingly enough, under
the President's proposal and in the proposal that we have made,
by 2020 it is estimated about 45 percent of electricity
generation will still come out of coal, in either proposal. And
what has been suggested to us by some analysis done by people
more objective than we are, is we can have some good outcomes
with respect to better health outcomes, less premature deaths
with our approach. Health care savings of about $50 billion
under our approach. And to do so without putting huge burdens
on utilities and on the consumer.
That is kind of laying it out there. I do not know if there
is a question in there or not, but I hope there might be.
[Laughter.]
The thought is, in regulating CO<INF>2</INF> how might we
go about it? Does any of that make any sense? I will not be
offended by what you might say. Senator Chafee might be.
[Laughter.]
Chairman Greenspan. Senator, I think the type of analysis
that you are discussing is probably the most complex type of
statistical analysis which you can bring to bear on Government
policy. First of all, we have a number of different problems
all emerging simultaneously. We have an issue of the new
technologies enabling the wielding of power over very
significant areas, and hence the whole question of the nature
of regulation of the electric power industry by itself is a
very difficult issue, which is all the more difficult because,
as you know, there is no way, with the exception of a minor
situation with hydroelectric facilities, of effectively storing
electric power. And if you do not have inventories in a
product, the tendency for markets to spike in all different
directions with respect to price is very high, as we observed
in California a couple of years ago. I do not think yet we have
come to grips with the question of exactly how to manage our
power industries in a manner in which the efficiencies which
are evident in the newer technologies are brought forth.
Coupled with that is the overall issue of the fuel inputs in
the CO<INF>2</INF> emissions, and then of course, there is the
Kyoto Protocol out there which is also overhanging this whole
question.
The trouble I see is that, because these issues are
extremely complex, we develop very complex models and the
conclusions of a number of these studies may be model specific
as distinct from what economists would say robust, meaning the
same results would come up no matter what models you tend to
use.
So, I am not someone who has been involved in this specific
problem but I have spent a good deal of my life involved in
this type of process. I would essentially suggest, if I may,
that the resolutions of all the related issues be done
simultaneously because you cannot, as far as I can see, make
the judgments with respect to natural gas or coal, or various
different emissions requirements, without having an
understanding simultaneously of what the underlying technology
force is, specifically the new technologies which enable a very
large regional bridge to be created. You have to address them
at the same time, and I think that is going to be very
difficult, and all I suggest to you is that when you get a
number from a specific model which has three digits in it, you
may suggest that only two of them may be accurate, and indeed
it is quite possible that only one is. So it is a very
difficult issue, and I understand where you are coming from and
I wish you well.
Senator Carper. I will take those good wishes and run with
them. Thank you.
Chairman Shelby. Senator Crapo.
COMMENTS OF SENATOR MIKE CRAPO
Senator Crapo. Thank you very much, Mr. Chairman.
Chairman Greenspan, thank you for coming here and
presenting your information about our monetary policy in the
country.
I want to go back to an issue you and I have discussed
several times over the last 2 years, and that is derivatives.
As you well know, we have for the last 2 years faced, on two or
three occasions, efforts to change the manner in which we
regulate derivatives. Under the Commodities Futures
Modernization Act of 2000, the President's Working Group and
others recommended a structure by which we approach the
management of commodities in a number of contexts, and
derivatives were handled in a particular way under that
approach.
By the way, let me interject. I want to thank you, the
Secretary of the Treasury, the Chairman of the Securities and
Exchange Commission, and the Chairman of the Commodities
Futures Trading Commission for being so prompt in responding to
our letter inquiring about this yet once again this year when
the amendment came forward on the energy bill once again to try
to make this change in the way that we regulate derivatives.
The purpose of my bringing it up with you again is that
there are again rumors that we will see another effort to try
to in some way similar to the previous amendments change the
Commodities Futures Modernization Act so that we create a new
regulatory regime for derivatives, and in my opinion, create
some confusion with regard to the regulator in terms of the
introduction of regulation from FERC as well.
The question I have is, has anything changed? Is there a
reason that we should change our approach to the regulation of
derivatives or does the Commodities Futures Modernization Act
still represent a very solid approach to managing this issue?
Chairman Greenspan. I am of the opinion that it was an
excellent Act when it was passed in 2000 as I recall.
Senator Crapo. In 2000, that is right.
Chairman Greenspan. And as far as I can judge, I see
nothing which would alter my view and my appraisal of it.
Senator Crapo. I know you have done this before, but could
you give us your understanding of why derivatives are helpful
in our markets?
Chairman Greenspan. We have a very complex financial system
in which we endeavor to regulate in a manner to enable the
system to be stable and function in a way which contributes to
economic growth, not only in our country but also for the world
at large. What we have found over the years in the marketplace
is that derivatives have been an extraordinarily useful vehicle
to transfer risk from those who should not be taking it to
those who are willing to take it and are capable of doing so.
Prior to the advent of derivatives on a large scale we did
not have that capability, and we often had, for example,
financial institutions like banks taking on undue risk and
running into real serious problems. From 1998 to 2001, we had a
trillion dollar increase in debt in telecommunications
worldwide. A significant part of that debt went into
bankruptcy, and yet no financial institution of any
significance was caught in that, and the reason was that, in
this case, credit derivatives were employed to transfer the
risk from these highly leveraged financial institutions to
other institutions and pension funds, insurance companies,
pension funds largely, which had much more equity and could
absorb the costs of default which they did, but they did not
like it. But they are still around and they are still viable.
The vast increase in the size of the over-the-counter
derivatives markets is the result of the market finding them a
very useful vehicle. And the question is, should these be
regulated, well, indeed for the United States they are
obviously regulated to the extent that banks, being the crucial
creators of these derivatives, are regulated by the banking
agencies, but not beyond that.
The reason why we think it would be a mistake to go beyond
that degree of regulation is that these derivative transactions
are transactions amongst professionals, and the institutions
which are involved have very considerable what we call
counterparty surveillance, where, for example, one major bank
will know far more about its customer, whether it is a bank or
something else, than we could conceivably know as regulators.
In a sense this counter-
party surveillance has become the crucial element which has
created stability in that particular system.
My concern and others' concerns about going in the
direction of an increasing degree of Government regulation is
that we will undercut counterparty surveillance and that the
net effect will not be to enhance the stability of that overall
structure, but undermine it, and it has become such a valuable
tool, in my judgment, in the international financial system
that anything that we can do to enhance its capability of
internal stabilization, which is currently the case, we ought
to do, and I do not believe that many of the measures that have
been offered to introduce increased regulation are indeed
positive in the sense that they would have a positive outcome.
My fear is that their effect would be counterproductive and
that is the reason I wrote the letter, the response to you on
that occasion, and why the President's Working Group came out
the way that it did on that issue.
Senator Crapo. Well, thank you very much for that extended
explanation. Each time we face this issue we pick up a little
support and our strength grows, and I think it is because we
are better able to explain to the Members of the Senate the
issues as you have just done. So thank you very much.
Chairman Shelby. Thank you, Senator Crapo.
Senator Dodd.
STATEMENT OF SENATOR CHRISTOPHER J. DODD
Senator Dodd. Thank you very much, Mr. Chairman.
Mr. Chairman, thank you once again for being here. I
apologize, I was not here for your opening comments. We had a
briefing by Secretary Powell, so a lot of us, about half the
Members of the Senate were up there for about an hour or so.
Let me preface, I gather others have raised a number of
questions about the deficits and your thoughts about them. I
thank you again.
Your comments earlier this year about the tax cuts and
their being revenue neutral I think were tremendously helpful
to many of us. Unfortunately, they were not heeded by many,
nonetheless I think your cautionary note about the importance
of the revenue neutrality of those proposals was worthwhile to
be heard. Clearly, and obviously, I join with those who are
deeply worried about the overall condition of the economy. I
know you struck a more optimistic note, and I appreciate that,
but as I look at these numbers, with more than 3 million
private sector jobs having been lost over the last couple of
years and business investment is down by 12 percent. Consumer
confidence is down by 28 percent. This is the only
Administration in 70 years that has seen a decline in private
sector jobs. I find that deeply, deeply troubling. When you add
the fact that the Administration's solution to the Nation's
economic woes has been more tax cuts, and if you add them up
over the next few years, you get in excess of $3 trillion, not
to mention of course the cost of the war in Iraq and elsewhere.
In fact, the Administration's own estimate is that more
than half of the changes in the Federal deficit, changes which
total over $4 trillion, according to them between the years
2004 and 2008, are a result of the President's domestic
policies, which include three tax cuts and international
policies including the war with Iraq. So there is a real
concern here.
I would like to focus on the trade deficit and the loss in
manufacturing jobs. I spent some time over the last several
weeks, as all my colleagues have, in my State, I attended
meetings in my business community and labor community
separately. If I had been taken into both of them blindfolded
and not told which group was which, I could not have
distinguished them in terms of their concerns about job loss
and what is happening to the manufacturing sector in our
society and the growing trade deficits.
I was stunned, like many were, to read where Japan bought
up more than $42 billion in May, a record number. If you take
Japan, Taiwan, Korea, and China, there is a trillion dollars
that countries have accumulated in reserves. Now many would
argue that this amounts to manipulation, that this was not just
coincidental. I agree with you that these values ought to be
determined by the international marketplace, but nonetheless
there are provisions in the International Monetary Fund and
other organizations that require that when you have
manipulation of currencies, particularly when it affects jobs
to the extent that it appears to be doing in our own country,
than others have to step up.
I was disappointed. I know, Mr. Chairman, you have asked
the Secretary of the Treasury to be here before the Committee.
He was due to be here tomorrow, I think, or the next day, and
he turned us down. Of course under the Trade Act of 1988, the
Secretary of the Treasury is required to report to this
Committee and to submit a report twice a year. So, I am hopeful
that before this year is out he will be here to respond to
these questions about the trade deficit that now is going to,
based on a quarterly report, exceed $540 billion this year.
I know it is not the Fed's job to get into this
specifically, but this is such a growing concern to me about
what is happening here, when you look at the job loss, the
businesses that are going out of business. I see it in my own
State to an alarming degree. Someone has to respond to this. We
need some ideas on how to respond to this. If, in fact, we are
seeing currency manipulation going on by some of our partners,
particularly in the Pacific Rim, then I think it is critically
important that we answer this in some way, and I would be very
curious what your thoughts might be as to how we might respond
to this. First of all, is it a matter of concern to you? And if
so, what can the Fed do or what can we do to begin to try and
stem this tide?
Chairman Greenspan. Well, I think, Senator, it is important
to understand the causes of the problem before we try to
address them. On the import side, as I think I have indicated
to this Committee on many occasions, we observe in our
international accounts a fairly significant difference between
the propensity to import goods and services relative to our
incomes in the United States compared with our trading
partners, which is another way of saying, if everybody's GDP
were increasing at the same pace, we would have a trade deficit
which is ever increasing, and indeed there would be a
counterpart increase of surpluses elsewhere. So, we do have
this imbalance in the system which at some point is going to
adjust, and there is some evidence that it is in the process of
adjusting, but clearly, the proportion of the consumption of
goods in this country that is imported has been rising for
quite a long
period of time.
In addition, the productivity in manufacturing has been
exceptionally impressive, more so than for the economy as a
whole, and obviously if you have a very rapid rate of increase
in productivity, any particular increase in industrial output
will have a lower requirement for workers than one when
productivity were growing less. So it is the combination of
these two factors which has been decreasing the level of
employment in the manufacturing area, coupled with the fact
that there has been a gradual reduction in manufacturing
relative to the economy as a whole over and above these other
factors.
The question you raise with respect to currency
manipulation is a tricky issue because it would be desirable
and has evidently been desirable for emerging countries to have
reasonably high reserves because what has happened is that in
crisis conditions when their reserves are high there has been
less in the way of underlying world instability, say, as we had
in 1998. Now, having said that, there is no question that the
motives of some of the accumulation of reserves has been to
stabilize exchange rate against the dollar on the part of a
number of countries, and that process obviously means that you
will accumulate dollar denominated assets as indeed a large
number of them have, and the figures you cite are related to
this particular question.
This is not, however, an activity which a central bank can
engage in indefinitely because as you buy dollars, as indeed
you used to buy gold under the gold standard, the asset side of
the balance sheet of the central bank expands unless, as we
say, it has been sterilized, and it is increasingly more
difficult to sell off other non-U.S. dollar assets to
effectively neutralize the effect of accumulating these
dollars.
The consequence of the big rise in the asset side of the
central bank is to create a major increase in money supply
growth, and that cannot continue indefinitely. So this is not a
process which central banks can engage in indefinitely.
Something has to give. But there is no question that the motive
here in many respects at least as I judge it, is to suppress
the value of their currency. They cannot do it indefinitely,
and I think a number of my colleagues, the Secretary of the
Treasury, for example, have indicated that they would like to
see less of that going on.
Senator Dodd. I appreciate that, and I would hope that, Mr.
Chairman, he would be here. I do not know what his motivations
were for not coming tomorrow, but obviously there is a growing
concern.
Chairman Shelby. I understand he is going to be with the
President tomorrow, but Secretary Snow has indicated on many
occasions, that he will appear before the Banking Committee.
Senator Dodd. I hope so. Again, I appreciate the Chairman
of the Fed's response, and obviously, I am fully aware that the
Central Bank's responsibility in this regard is very different,
but as I hear from my own constituencies and others--and a lot
of it is unemployment, but going out of business too. I mean
their produc-
tivities are rising but they are finding it more and more
difficult to compete in the marketplace. I have been supportive
in the past on free trade agreements and so forth for all the
obvious reasons, but that free trade is always conditioned on
fair trade as well, and when you have what you and I suspect is
currency manipulation going on simultaneously, then it makes it
very, very difficult for us. As I sat in a room the other day,
one fellow got up and he said: ``I am the CEO of a company. I
am the only one in this room that still makes anything.'' There
is a growing concern in the United States about the fact that
we are making fewer and fewer things.
Chairman Greenspan. Just remember that the nature of the
economy is becoming increasingly conceptual as distinct from
physical, in the sense that ideas are becoming increasingly the
predominant means by which we create wealth. The consequence of
that is that there is less physical stuff around. I think that
is good, not bad for the economy as a whole, but if you are a
maker of stuff, it is not.
Senator Dodd. If your job depends upon being a maker of
stuff, it is more than just a conceptual kind of problem you
have. It is a real problem.
As I saw the other day in Wal-Mart, they had a sale on and
they sold $1 billion in one day of television sets made in
China. One day, $1 billion. Not a single one of them made in
the United States. Now there is something fundamentally wrong
if we cannot do a better job of at least creating an atmosphere
where there is an opportunity for U.S. manufacturers to have
the same kind of opportunity. I worry about that, and I know
you do as well.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Schumer.
COMMENTS OF SENATOR CHARLES E. SCHUMER
Senator Schumer. Thank you, Mr. Chairman. I want to thank
you again for the job you do.
I have a few questions. One is a little bit related to
Chris Dodd's but somewhat different. One of the reasons we lose
manufacturing jobs is trade with China, and there are the
classic free trade arguments about why businesses would go to
China. But there is something else that has been happening, and
I would like your comment on that, and that is that the Chinese
have tightly pegged their currency--it is a fixed rate. The
yuan has been, since 1994, at 8.3 yuan per dollar.
Now if you let that currency float, almost every economist
says it would be valued higher. Goldman Sachs says 15 percent;
some say 25 to 40 percent. And the natural reason that we all
went to floating currencies among the major currencies is, it
is a self-correcting mechanism that you and Chris Dodd were
talking about.
Why wouldn't it be a good idea for our President to jawbone
the Chinese, or our Treasury Secretary, to let their currency
float? You know, the Chinese seem in a lot of ways to want to
be part of the family of nations when it benefits them, you
know, the bigger, more productive nations, but not when it
doesn't. Why wouldn't it help everybody to let the yuan float?
And why wouldn't it be a good idea for our Government to urge
the Chinese to make it happen?
Chairman Greenspan. Well, the Secretary of the Treasury has
indicated that.
Senator Schumer. I have not heard any public pronouncements
about that.
Chairman Greenspan. No, indeed, there has been a public
statement.
Senator Schumer. Why do the Chinese resist? Well, we know
why but----
Chairman Greenspan. Let me just say this----
Senator Schumer. If you could comment in general on that.
Chairman Greenspan. Yes. There is an issue here, but
remember that it is very much to the advantage of the United
States to have China involved in world trade interrelated to
all the various institutions with which we are involved. They
had and indeed still have the centrally planned economy, which
has considerable rigid-
ities in it, and they have been endeavoring, and with some
success, to open it up, creating property rights, creating
markets, which seems to be contradictory to their political
system. But, so far, it is working and they are increasingly
engaging on trade throughout the world. I happen to think that
is very good. Most economists would say that is good.
In the process of doing that, because of the structure of
the rigidities of their system, they tended for purposes of
stability to fix the yuan to the dollar. And to date----
Senator Schumer. They have not changed it----
Chairman Greenspan. No, they have not, exactly. And that
obviously from their point of view has created a degree of
stability, but it has required them, in order to hold that
rate, to be very heavy purchasers of U.S. dollar-denominated
assets. And they have accumulated a very large store of assets,
as has been indicated in various different fora.
At some point they will no longer be able to do that
because it will create an inability of their monetary system to
function well. How one approaches the issue of getting the
exchange rates better balanced is partially an economic issue,
partially a political issue.
Senator Schumer. You are good at both.
Chairman Greenspan. My tools are limited.
Senator Schumer. But would it be, all things being equal,
better to have either a revaluation of the yuan or at least to
let it float? Aren't they a big enough economy now? It is not
1994. Do you think they should be letting it float?
Chairman Greenspan. I think that from an economic point of
view it is going to become increasingly evident that that is
what is going to have to happen if the existing cost structures
around the world remain as they are. And I think the Chinese
economists are sufficiently sophisticated to understand that.
Senator Schumer. When you hear--and we are all hearing what
Senator Dodd talked about--that manufacturing is just shrinking
and shrinking, and you are right, you said once before,
something I have repeated often, high value is added more by
thinking things than by making things these days. That is
correct. But you still have a large manufacturing base. I do
not know if the same is happening in agriculture as in
manufacturing; in other words, there is more production with
fewer workers, or is it less production?
Chairman Greenspan. Oh, no, in fact, if anything, it may be
more impressive.
Senator Schumer. More than agriculture.
Chairman Greenspan. Remember, crop yields are incredible.
Senator Schumer. Okay, so I understand that. Let me ask you
one other question, if I might, Mr. Chairman. We are in this
period now where the economy moves along at not a terribly
rapid pace, but a decent pace, 1 percent, 2 percent, maybe 3
percent growth. Because productivity outstrips that growth, the
number of jobs declines, and I am sure my colleagues have
talked about that. This is the first Administration since
Herbert Hoover's where the absolute number of jobs has
declined, even though growth has occurred.
How long can this continue? Now, I understand that incomes
are going up. But if incomes continue to go up and jobs
continue to
decline, it means that wealth, almost by definition, is being
more concentrated.
Is this bad for the economy? Can we just continue to go
along at this pace? And doesn't the job loss--if it does
matter--help drag the economy and instead of creating an upward
cycle, which we had in the 1990's where productivity and job
growth went hand-in-hand, really provide a drag on the economy
where productivity goes up and jobs go down?
Chairman Greenspan. It has certainly been our experience,
Senator, that you cannot have the situation with productivity
growth growing faster than the economy as a whole; in other
words, essentially rising output, falling employment. The
reason basically is that one must presume that the consequence
of that is an opening up of profit margins as one
characteristic and historically increased capital investment.
Over time, that situation is unstable and eventually
adjusts to a higher level of economic growth and, hence,
increasing employment, or productivity growth slowing down.
Obviously, if you continue GDP growing and employment
declining, at the end of the day everything is being produced
by nobody.
Senator Schumer. Right. Or another country. See, that is
what may change this, the interrelatedness of the world
economy.
Chairman Greenspan. But then the question is: Where do we
get the purchasing power, meaning the goods and services we
produce, to be able to buy it from others? So it is an
internally long-term inconsistent framework, and our
expectation is that what will occur as a consequence is that
the GDP growth will move above the productivity rate and
employment will start to turn up accordingly.
Senator Schumer. Thank you, Mr. Chairman.
Chairman Shelby. Chairman Greenspan, could you just briefly
highlight for the Committee the nature of your concerns
regarding the industrial loan corporations and the extent to
which your concerns are based on safety and soundness
consideration?
Second, could you provide commentary as to the deficiencies
in the current regulation, if any, of industrial loan
corporations that lead you to these concerns, if you have them?
Chairman Greenspan. Mr. Chairman, my major concern is the
fact that under Gramm-Leach-Bliley, we significantly increased
the powers of our financial system, and in very important ways,
in my judgment. But with the advent of these increased powers
and the new technologies and products--for example,
derivatives, as I mentioned before--we have a whole new array
of types of regulatory issues which confront us.
I believe, as I have stated previously, that in the future
it is going to be impossible to distinguish between commerce
and banking, and ultimately we are going to be in a position
where we are not going to try to make that distinction.
But, it is important, in my judgment, to move in that
direction in a calibrated way and to understand first what the
consequences from a regulatory point of view have been as a
consequence of the significant changes that have occurred in
regulation in the last decade. It is not only Gramm-Leach-
Bliley. It is a whole series of other regulatory changes.
If we eventually get to the point where we fully understand
and are comfortable with the issue that we have imposed a new
set of regulations on the system, then I think we can start to
think about the issue of moving further. However, I do not
believe we are there at this point.
My concern is that the vehicle of the industrial loan
company, as it is being currently constituted and expanded
under existing proposals, will, for all practical purposes,
create an institution which will be very attractive for
commercial enterprises, irrespective of their size, and will
have a functioning commercial bank with Federal deposit
insurance, and that will effectively create a melding of
commerce and banking inadvertently--if I may put it that way,
because that is not the purpose, obviously, of this----
Chairman Shelby. But we are not there yet, are we?
Chairman Greenspan. We are not there yet, but I would
suggest that it is very important, before we move to
effectively convert
industrial loan corporations into commercial banks without
overriding supervision, that the issue of whether we wish to
move more broadly in this direction come before this Committee
and your counterparts in House Financial Services, because
there is a very major policy question here which, in my
judgment, is not being addressed. And I think prior to moving
forward and changing the structure, as indeed it will change
under certain proposed legislation, it is important that the
Congress come to a policy conclusion of a much broader
dimension.
Chairman Shelby. Mr. Chairman, tomorrow this Committee will
hold a hearing focused on the oversight of Government-sponsored
enterprises with an eye toward the accounting issues that have
recently surfaced at Freddie Mac. Some people have criticized
OFHEO, the regulator, noting that it lacks many of the powers
that the bank regulatory agencies possess.
Without getting into this morning who the GSE regulator
should be or where the regulator should be situated, what
additional authorities, if any, in your judgment, should the
GSE regulator have?
Chairman Greenspan. It is difficult to say because I think
the broader issue, as I have indicated in public testimony
previously, is the question of the subsidy which the financial
markets grant to the GSE's on the presumption that they will be
bailed out in the event of difficulty by the Federal
Government.
Their debentures, as they point out quite correctly, are
not guaranteed by the full faith and credit of the United
States, and there is no statute under which there is
effectively a Government guarantee or subsidy issue.
Chairman Shelby. It is all perception, isn't it?
Chairman Greenspan. There is a strong perception, and I do
think that, in considering the issue of where the focal point
of supervision and regulation is, it be in the context of
understanding how that particular subsidy impacts on the
financial structure of those institutions and the various
markets they are involved in.
As I have said previously, these are very well-run
companies, leaving aside the most recent problems with regard
to accounting, and it is not an issue of them having, for
example, techniques in derivative employment that are not the
very finest in risk management. They do very well in that
regard.
The problem has to do with a much broader question, and I
think what you need is a regulatory supervisor which has the
capability of viewing the GSE's in total, not only Fannie and
Freddie, but also I will include the Federal Home Loan Banks in
this as well. You need to construct a regulator which has the
reach to fully grasp the very major questions which were
involved in these now very important institutions in our
financial system.
Chairman Shelby. They would need the reach and the depth,
wouldn't they, to get into real regulation?
Chairman Greenspan. It is going to be an interesting
transition, I believe.
Chairman Shelby. Senator Sarbanes.
Senator Sarbanes. Thank you, Mr. Chairman. I will be very
quick. I have just a few points on this second round.
First of all, Chairman Greenspan, I have to say I think we
are being much too sanguine about this trade deficit and
foreign indebtedness. As recently as 1982, just over 20 years
ago, we had a net asset position worth 7 percent of our GDP.
Our liabilities to foreigners now exceed our assets abroad by
$2.6 trillion, equal to 25 percent of the GDP. We ran a current
account deficit in the first quarter of $544 billion, a record
5.1 percent of GDP. That deficit that is financed by more
foreign borrowing will raise our indebtedness another 3 to 4
percent, depending on the growth of GDP. Japan bought more than
$40 billion in dollar assets in the month of May alone. And the
governments of China, Korea, and Taiwan have been actively
intervening to keep their currencies low relative to a market-
determined price for their currencies.
We are becoming increasingly dependent on the kindness of
strangers and, in particular, on foreign government lenders. In
fact, the Fed pointed out in its report, ``The U.S. current
account deficit continued to be financed in large part by
private flows into U.S. bonds and by foreign official inflows.
Private foreign purchases of U.S. securities, which slowed in
the latter part of 2002, stepped down a bit more in the first
quarter of 2003. In contrast, inflows into the United States
from official sources, which surged in 2002, picked up further
in the first half of 2003.''
I mean, we are obviously, it seems to me, being taken
advantage of in the international marketplace because others
are not playing by the rules of international trade, and it is
working very much to their advantage, and we continue to get
deeper and deeper into the hole. And it seems to me we need to
move this up on the priority list of our concerns, and
certainly that is one of the matters we will focus on when
Secretary Snow comes.
I do not really have a question. I just want to put that to
you and hope you will take it under advisement in terms of the
need to really start thinking seriously about this issue.
Otherwise, one of these days things may just snap, and we will
find ourselves in a difficult situation.
Let me ask you, just as kind of an aside: Do you think that
the responsibilities of the presidents of the Federal Reserve
branch banks are equal to or perhaps greater than the
responsibilities of the presidents of Federal Home Loan Banks?
Chairman Greenspan. I would certainly think so. At least it
is my judgment. I am sure that they have a different view. I
mean the Federal Home Loan Bank presidents.
Senator Sarbanes. I am not putting a question--I mean, that
is the question I want to ask. Mr. Chairman, Chairman Shelby, I
just want to note for the record this is not the hearing to
explore that, but these salaries and compensation of the
presidents of the Federal Home Loan Banks are going through the
roof. In most instances, they have doubled or tripled over the
last 3 years. They far exceed, again, by a factor of 2 to 3
times, what Federal Reserve branch bank presidents are making.
They are now up counting their other benefits in excess of $1
million in some of these Federal Home Loan Banks. It is a
bonanza.
Now, you know, we need to address that when we have the
Federal Home Loan Bank people here.
Chairman Shelby. Proper hearing, absolutely.
Senator Sarbanes. But I have been looking at some of these
figures, and they just leap off the page at you in terms of
what is taking place.
Now, Chairman Greenspan, you said in your statement, ``The
Federal Reserve has been studying how to provide policy
stimulus should our primary tool of adjusting the target
Federal funds rate no longer be available. Indeed, the FOMC
devoted considerable attention to this subject at its June
meeting.''
I think the Fed has done a good job in increasing
transparency in recent years, and I think that is a very
important contribution to enabling people to know where the Fed
is going with respect to its policy.
If you have to shift off the Federal funds rate, what will
you go to in terms of assuring transparency out there for the
public? How will you signal policy for longer-term rates? Would
you choose a specific maturity, or set some sort of time frame?
You know, your policy has been widely acclaimed on
transparency, but if you shift the focus, how will you do that?
Chairman Greenspan. There are a large number of variations,
any one of which could be usable. Remember, the major issue
that we are confronted with is expanding the balance sheet of
the Federal Reserve in total.
Now what that means is we, as I indicated previously, could
move out on the maturity schedule and buy longer-term bonds.
There has been a big discussion of whether you try to peg the
rates or not peg the rates.
Remember, we did peg the rates from 1942 to 1951. That was
a wholly different world, of course, and markets were
different. But we have examined a number of different issues
and, needless to say, discarded a large number of them as
impractical or inappropriate. But all I can say to you is that,
for what we would have to do in the remote event that those
conditions arose, it is not that we have inadequate choices. We
have more than we need. And we would then have to choose
amongst them. Because we can create what we need to create in
any of a number of different ways----
Senator Sarbanes. Yes, but the thrust of my question is not
whether you have these tools, but whether you will depart from,
I think, the welcome trend toward greater transparency in the
Fed's decisionmaking and go to a more opaque approach so that
people perceive----
Chairman Greenspan. No, no. Remember, Senator, we publish
our balance sheets every week, and it is in sufficient detail
to be able to very quickly understand exactly what it is the 12
operating central banks are doing.
Chairman Shelby. Senator Bennett----
Chairman Greenspan. I will say to you that if we do things
which are somewhat different, we will alter our reporting in a
manner to make clear what it is we are doing.
Senator Sarbanes. Will your policy statement make this
clear? Or will we have to get a whole new breed of Fed watchers
or----
Chairman Greenspan. No, if we go in this direction--I just
want to emphasize this is a remote contingency. It will be
clear what we are doing, and there will be no purpose in being
obscure or unclear. It will not serve the purposes of monetary
policy to do that.
Senator Sarbanes. Thank you.
Chairman Shelby. Senator Bennett.
Senator Bennett. Thank you, Mr. Chairman.
Chairman Greenspan, listening to this whole conversation
this morning, first, I share your sense of optimism about the
economy near term. I think we are rebounding. We are coming
back. And as we come back, Federal revenues as a percent of GDP
will go up, and we will see, as we always see, revisions in the
projections as to what the deficit or the surplus will be. I
have said before and repeat here, the only thing I know about
the figures we are seeing for the future is that they are
wrong. I do not know whether they are too high or too low, but
I know that they are wrong.
Chairman Greenspan. I think that is a sound judgment,
Senator Bennett.
Senator Bennett. Okay. Now, I would like to go where some
of the conversation here has gone, which is beyond the near
term, beyond this recovery and how long will it take and how
good will it be, on into those dreaded years of 2012 and
beyond. And I think we have a model--imperfect, of course, but
a model of what might very well happen to us as we look at
contemporary Germany.
In Germany, if they had an unemployment rate of 6.4 percent
right now, they would rejoice and think that was absolutely
wonderful. If they had a deficit at our percentage of GDP, they
would rejoice. If they had a national debt at our percent of
GDP, they would rejoice.
They have over the years built into their entire culture a
welfare state mentality of the things that they will take care
of and the things that they will fund, and now they are hitting
the demographic wall that we are facing, much more rapidly than
we. And because they do not have the level of immigration that
we do, it is going to be far worse. That is, the overall
population is shrinking; ours will continue to grow. Even in
the face of the retiring baby boomers, we will still continue
to have new workers coming into the country by virtue of
immigration, and our population will grow. Their people are
stagnant, if not, in fact, scheduled to shrink. And they are
faced with the systematic dismantling of many of the social
services that they have built into their culture over the
previous decades.
We have held hearings in the Joint Economic Committee about
medical costs, and there is a perverse and counterintuitive
circumstance going on in that the more technology we bring into
health care, the more it costs. This is exactly different from
the way things work in other parts of the economy. The more
technology you apply, the lower the cost becomes. And as we
have tried to pursue why we have the opposite trend in health
care, it is because you keep people alive longer. If you were
aimed at cost control only, you would let them die and thereby
save the cost of their medical care in their later years. But
we get technology coming along that solves some of the health
care problems, keeps them alive longer, but in terms of the
impact on Medicare, raises the overall cost. So the more
technological innovation we have and the more breakthroughs we
have, from an economic point of view the more expensive
Medicare is going to get.
Can we look at Germany and some of the other countries that
are seeing this demographic impact more rapidly than we see it,
that is, it is coming 10 years or 15 years before it will hit
us, and learn anything, or do we just look at them and say:
Gee, there is where we will be and we have no choice but to
start to lower benefits and dismantle services later on if we
are going to afford it?
Chairman Greenspan. Senator, I certainly hope that we can
learn. Indeed, I think the Germans are learning from us in the
sense that they are aware that their labor market, which has
become exceptionally rigid, has been a major factor in the
sluggish growth in their country, and they are endeavoring to
change it, and the model they are moving toward, not fully but
at least in the direction, is the one that we have, which does
work in a remarkably flexible way, at least certainly
considering all others.
I think we learn from each other and I do agree that it is
an unusual phenomenon of watching an economy essentially
decline as population declines, even though standards of living
per capita can be rising, the aggregate economy can be
declining. That will change the structure of how production is
organized, and it has a very major impact obviously on the
relationship of retirees to workers, especially, as you point
out, if the medical technology increases life expectancy.
We are all going to be learning from each other, but you
are quite correct in saying that Germany, Italy, Japan,
specifically, and maybe Europe in general, are clearly well
ahead of us in that regard, and so we will be observing what
can happen to an economy in which population is stable or
declining, and while that is not on the horizon directly for
the United States, remember, our fertility rates are higher
than theirs. I notice we had a surprisingly low birth rate the
last year, but our fertility rates generally have been up at
least to replacement levels, and immigration has increased the
population. So, we are not confronting the same problems they
do, but the underlying pressures are there and it is important
that we recognize the implications of what it means to have an
increasing retirement-to-working age population even if your
population in itself is not slowing.
Senator Bennett. That is my point. Their situation is worse
than ours, but the underlying pressures are basically the same.
Chairman Greenspan. Indeed they are.
Senator Bennett. Thank you.
Chairman Shelby. Senator Corzine.
Senator Corzine. Thank you, Mr. Chairman.
I appreciate this wide-ranging discussion and find it
highly informative, and I am going to say all the positive
things and then come back to an overview.
Chairman Greenspan. Mr. Chairman, may I have a 5-minute
break at this moment?
Chairman Shelby. You can. The Committee will stand in
recess.
[Recess.]
Chairman Shelby. The Committee will come to order.
Senator Corzine.
Senator Corzine. Thank you. I knew my questions were going
to scare him to death.
Chairman Shelby. I do not believe that now.
Senator Corzine. I do not either.
[Laughter.]
As I was beginning, Mr. Chairman, I want to preface what I
say by saying I have great respect for you and all you have
done, and the Federal Reserve as an institution, which I think
is terrific. I have listened both to recaps of yesterday's
hearing and today's hearing, and frankly, one individual. I do
not come away as sanguine as I think the tone of the discussion
has been.
My colleagues have talked about the straight deficit and
its translation into the loss of manufacturing jobs, which
there was a response yesterday that did not seem as serious to
me as it is in the lives of the people that I see in New
Jersey. Federal budget deficits, a $4 trillion negative cash
swing in 2\1/2\ years by projections, is by anybody's standards
an incredible change in fiscal circumstances. The demographic
problem that we know we face. Our State and local governments,
we see $100 billion, give or take a little bit, at the State
level in the fiscal time frame. It is much larger at the State
level. Property taxes are going up to offset in many places all
of the Federal tax cuts we have had. There is 8 out of 9
quarters we have under this Administration, we have seen a
decline in business investment by the GDP numbers, not a long-
run formulation for a long-term increase in productivity, even
though I understand we are in a conceptual economy as opposed
to a physical economy, accept that. But it is not a statement
of confidence if nothing else. And the job deficit is real. We
have used the headline, used the 21 weeks of initial claims,
and set aside the seasonal adjustment issues. These are real
problems. The unemployment rate for African-Americans has gone
up 3\1/2\ percent while for white Americans it is 1.7. We are
up at something like 11.5 percent. Minorities are suffering a
disproportionate burden, and as I think Senator Sarbanes
indicated in his first question, that there have been
projection errors, not only by the Federal Reserve but also by
private sector and a broad set of economists. We have not
really changed the policy mix.
I am going to read a quote from Mr. Rosenberg from a firm
that I know well, but did not work at one that I worked with.
``This is the third round of Bush tax cuts, the thirteenth
round of Fed rate relief and about the sixth mortgage
refinancing wave so far this cycle,'' Mr. Rosenberg from
Merrill Lynch said in a report commenting on the latest rate
cut. ``And what do we have to show for it except an economy
struggling at a 1 or 2 percent rate.''
Now maybe that is changing, but I do not understand what is
different in the policy mix we have today versus what we had
2\1/2\ years ago, a year and a half ago, and now, that gives us
so great a confidence that this is all going to work as well as
everybody projects it is, and I could not agree more, that the
one thing that is for certain, projections are likely not to be
met. We do not know whether they are going to be under or over,
but we seem sanguine about a state of occurrence in our economy
where there is real job loss, it is making a real difference,
the income distribution is more than likely widening, given the
kinds of nature of where tax cuts and job cuts and
manufacturing are going in this country. I am troubled more
than what the tone of the discussion is about.
Chairman Greenspan. I think the best way to confront the
issue is that there is a good deal more to how an economy
evolves than what policy is. Policy is at the margins of what
an economy is doing. I think that we have to go back to how the
economy evolved subsequent to the big stock market break, the
sharp decline in
capital investment, and indeed the shocks to our economy that
occurred subsequent to that.
I have testified on numerous occasions that in spite of
those, we have hung in there. The economy has not grown
particularly, but it has not receded. This is a very unusual
cycle, and as you well know, the recession has been very
shallow, and as a consequence of that, you cannot have a
kickback from a nonsignificant recession. There is no bounce in
the structure of the economy.
What strikes me about the degree of flexibility which is
broad, is it has been able to absorb a very surprisingly large
number of the types of shocks that in my historical experience
would have created real serious problems to this economy, and
they did not. What it did do, however, is it took all of the
buoyancy out of the economy. That is, rather than have
significant negative GDP numbers, what we have had is absorbing
a whole series of negative forces and essentially stand still,
so to speak, or grow very gradually. That is far superior in my
judgment.
Senator Corzine. I would say though we have had 13 rate
cuts and something that is approaching, depending on how you
count the numbers, $1.8 to $3 trillion in tax cuts. I mean
these are not light stimulants to an economy.
Chairman Greenspan. No. And I would go further. I would say
that it has required all of this to essentially be able to come
off a very substantial collapse of a bubble and yet have an
economy which is at least gradually growing, which it has been.
And one has to presume that if that is the correct analysis of
what it is we are observing, at some point we absorb the full
negative shocks and the underlying flexibility shows through.
Now, I am fully aware of the fact that out there
everybody's forecasts, including those of your old firm and all
of its competitors, have fairly significant acceleration in the
current quarter and in the fourth quarter, and the reason is
they all have the standard basic models which we all employed
to forecast the economy, and the general presumption is, if
even a modest part of the big tax cut is spent in retail, the
GDP will go up. That is what is causing these forecasts to be
what they are.
I try to indicate within the context of my prepared remarks
that there is a distinction between what is occurring and what
the forecasts are. Now the data that had been coming in are not
inconsistent with this economy picking up. I do not know
whether they can meet the particular forecasts of some of the
forecasters, but we are seeing gradual changes, all which are
consistent with that process happening. Are we far along in
that process? We are not. We first had to stop eroding, because
remember, in April and May this economy was weakened, or I
should say more exactly in March and April. May stabilized, and
as best we can judge, June has come back a bit. The crucial
issue is going to be whether, in fact, capital investment comes
back because that is the key link to this system, and right at
the moment it is a forecast, and we will be watching it very
closely. If it fails to materialize we will continue to be
going up and going down, but not carrying through in a way
which one would call a vibrant economy. I happen to be
optimistic about how this process is going, but I must tell you
I do recognize the difference between economic reality and a
forecast, and all I will say to you is that we are not quite up
to where we are getting clear indications that the forecast is
coming up, but we are moving in that direction. Statistic by
statistic tends to be coming in somewhat better than we expect,
and that is usually a sign that things are changing.
Senator Corzine. Thank you.
Chairman Shelby. Senator Schumer.
Senator Schumer. Thank you.
I want to thank you for staying and answering these
questions. It is a great discussion. I just want to go back to
the yuan for a minute. My staff, who is usually right, although
not infallible, says that while Secretary Snow has talked in
general about floating rates, he has never specifically and
publicly talked about devaluing the yuan, and it just seems to
me that China should be stepping up to the plate here, and we
should not wait until they can no longer buy any United States
Treasuries and then let it unravel at that point in time.
Chairman Greenspan. Senator, unless I am mistaken, the
Secretary did raise the issue enough so that the Chinese
officially said it was false. Now if they did not, my memory
may be faulty in this regard, but I suggest that----
Senator Schumer. Do you not think a little more of this
would be helpful? I mean, here is something that is not against
free trade principles. In fact, the fixed income rate probably
is. We have a huge problem with China. That is going to be a
problem because of discombobulations of the economy, no matter
what the yuan is pegged at, but it is artificially low, and it
is being kept that way by the Chinese for their own advantage.
Chairman Greenspan. You know, a number of trading partners
with China have raised this issue. I think the question is
whether or not public discussion moves the ball further down
the road than private discussion.
Senator Schumer. Right. You have now answered my question.
I appreciate it. Next question I have is, just related to your
last interchange with Senator Corzine. It is a very interesting
perspective. I think it helps us understand things, and that is
that with all this stimulus and which is very significant. I
cannot remember interest rates being low and taxes being cut as
much in my lifetime as now. You needed this to shield the
economy or at least temper, cushion the economy from the bubble
bursting and all the effects there, not only stock market but
also I guess over investment in certain sectors as well. It
would seem to me that if you are right and we have overcome
these bumps, then something we have not worried about in a long
time, which is the dangers of inflation, might rear its head
back. It just strikes me as, you know, your assurance yesterday
that interest rates are going to stay low for a long period of
time, do not quite fit into the puzzle of dramatic stimulus of
the economy, shocks that obviously should be receding as we
move on in time from them, we are 2 years and 3 years away
rather than 1 year. Could you comment on that?
Chairman Greenspan. Certainly. It is our judgment that the
extent of the downward pressures on the price level that are
coming not only from the aftermath of the bubble, but also
increasing globalization are significantly greater than the
inflationary forces that are emerging in various different
areas of the world economy. Remember, it is not only the United
States who has had a significant reduction in the inflation
rate, but also it is pretty much around the world, including a
number of emerging countries whose problems were chronic
inflation of a most destabilizing form. This is a world
phenomenon, and in that sense it is larger than the United
States as such. It has been the conclusion of the Federal
Reserve that while we obviously over the years have been
extraordinarily sensitive to the issue of inflation, and indeed
our policies were fundamentally to get to price stability, we
have recognized that the world has changed in a way which
requires us to alter our policy mix, but I do not deny that
some time down the road, that the situation will turn again,
and I trust we will have a very long lead time to anticipate
that.
Senator Schumer. One final question, Mr. Chairman. There
has been a recent discussion between two of my fellow New
Yorkers, your colleague and a man I supported for the SEC, Mr.
Donaldson, our New York Attorney General in the last while,
about--and I have not made up my mind on this one, so I would
like your guidance--basically on whether legislation in
Congress or some attempt to say that State regulators, they can
prosecute wrongdoers under their local security laws but not
sort of set agreements, change the basic tableau, that that
ought to stay national. And obviously, the Donaldson argument
is this is a national function, we have national markets and to
have 50 regulators go willy-nilly creates a nearly impossible
situation. Spitzer's counter argument is we had that, and when
you have one regulator, the chance of that regulator being
asleep at the switch is greater than if you had 50, and he did
a good job stepping into this.
Would you comment, if not on the specific legislation that
is approaching, if you want to do that, great, but on the
general conflict between those two ideas?
Chairman Greenspan. I think the argument that you have
national markets and you should have a single regulator is the
correct position. If you are worried about a single regulator
having problems, that is a legitimate concern. It does not
follow that that is solved by having 50 additional regulators,
but it does suggest that there needs to be oversight of all
regulatory agencies. I think that it is important that the
Federal Reserve has Congressional oversight. The oversight of
the SEC is this Committee. And indeed, it is important that
they have the authority to do what they need to do, but there
is always the danger that monopoly regulators can begin to
become very inefficient and very disturbing.
I, for example, have argued in the past that we should not
have a single regulator for American banking because I am
worried about monopoly regulation. But the answer is not an
indefinite proliferation of alternate regulators.
Senator Schumer. So, you would be sympathetic to the
legislation the House just passed?
Chairman Greenspan. I am.
Senator Schumer. Thank you, Mr. Chairman.
Chairman Shelby. Mr. Chairman, we appreciate your staying
with us all morning and into the early afternoon. We appreciate
always your appearance here and your insightful views. Thank
you.
Chairman Greenspan. Thank you, Mr. Chairman.
Chairman Shelby. The hearing is adjourned.
[Whereupon, at 12:55 p.m., the hearing was adjourned.]
[Prepared statements, response to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF SENATOR MICHAEL B. ENZI
The U.S. economy is still the greatest economy in the world.
However, there are certain issues that we need to address to ensure
that we retain that position. If I had to pick the one single issue
that has the greatest impact on the financial affairs of Wyoming, and
the rest of our Nation for that matter, I would have choose the state
of our Nation's energy development. Every sector of our economy relies
on some form of technology that, in turn, relies on electricity and/or
fossil fuels to function. Our economy is literally driven, therefore,
by our ability to develop and maintain a steady, constant energy
supply.
Wyoming's role in this situation is much like the position held by
the colonies during America's first years of European settlement. We
provide the raw materials, or in other words the feedstock, that makes
the rest of our Nation's energy economy function. If my home county,
Campbell County, Wyoming, were its own country we would be the third
largest coal producing Nation in the world. One-third of our
Nation's coal is produced in this one county alone. We also produce
more uranium annually than the rest of the Nation combined and have the
greatest potential for natural gas development in the entire
continental United States. In short, we have what the rest of the
Nation needs to keep its technology fueled and running.
Unfortunately, however, most of that energy is now stranded in
Wyoming and is inaccessible to the parts of the country that need it.
Our natural gas development is being slowed down by the inability to
get the gas out of the State. Our electricity runs into bottlenecks
where the power lines outside the State do not have enough capacity to
carry what we can generate and our coal is being hit with the threat of
new regulations and bureaucratic limitations that could eventually slow
down exploration and development. All of these limitations are having
an effect on the rest of the economy.
I understand Chairman Greenspan has already visited the Hill on a
number of occasions and has testified on this issue. I look forward to
any additional insights he might offer on how we can bolster our
economy by increasing energy stability, and I hope he could address
what future role Wyoming can play in meeting our
energy demands.
In addition to the importance of natural gas prices on our Nation's
economy, we also must ensure that we have a favorable business climate
to encourage the creation and growth of our small businesses. For many
industries, small businesses represent more than 97 percent of the
number of businesses in the industries and the vast majority of them
are critically reliant upon access to credit from our financial
institutions.
Recently, the Office of Advocacy of the Small Business
Administration released an independently conducted study that showed
that small businesses are disproportionately affected by a tight
Federal monetary policy. Specifically, the study showed that the vital
link between small businesses and small community banks can be worsened
when community banks have difficulty adjusting to tighter monetary
policies and to adverse banking developments and lending conditions.
The study also found that community bank capital was capable of
stimulating employment about three times compared to large bank
capital. While the study cited the importance of SBA loan programs to
stabilize lending to small business in tight monetary policy times, I
believe that it is more important to keep in mind the effects on small
business as the Federal monetary policy is being developed.
Another critical issue for small businesses and our economy is the
state of our initial public offering (IPO) market. Recently, news
articles cited statistics that China has gained the crown for the IPO
market and that Singapore has the fastest growing IPO market. In the
first 6 months of this year, each of those countries had more IPO's
than the U.S. markets. Last year, Congress took great pains to pass the
Sarbanes-Oxley Act to help restore investor confidence in our financial
markets, however, it is clear that the IPO market has failed to
materialize. I am very concerned that our overall business climate may
not be sufficient to encourage the
creation and growth of our small businesses.
In addition, recent news articles cite that many of our high-
technology jobs may be heading overseas. The combination of the loss of
high-technology jobs and of the rise in the overseas IPO markets, is
troublesome at best. I would like to hear Chairman Greenspan's
perspective on how we can remedy this situation.
Mr. Chairman, thank you again for holding this hearing. I look
forward to hearing from Chairman Greenspan.
PREPARED STATEMENT OF ALAN GREENSPAN
Chairman, Board of Governors of the Federal Reserve System
July 16, 2003
Mr. Chairman and Members of the Committee, I am pleased to present
the Federal Reserve's Semi-Annual Monetary Policy Report to the
Congress. When in late April I last reviewed the economic outlook
before this Committee, full-scale military operations in Iraq had
concluded, and there were signs that some of the impediments to brisker
growth in economic activity in the months leading up to the
conflict were beginning to lift. Many, though by no means all, of the
economic uncertainties stemming from the situation in Iraq had been
resolved, and that reduction in uncertainty had left an imprint on a
broad range of indicators.
Stock prices had risen, risk spreads on corporate bonds had
narrowed, oil prices had dropped sharply, and measures of consumer
sentiment appeared to be on the mend. But, as I noted in April, hard
data indicating that these favorable developments were quickening the
pace of spending and production were not yet in evidence, and it was
likely that the extent of the underlying vigor of the economy would
become apparent only gradually.
In the months since, some of the residual war-related uncertainties
have abated further and financial conditions have turned decidedly more
accommodative, supported, in part, by the Federal Reserve's commitment
to foster sustainable growth and to guard against a substantial further
disinflation. Yields across maturities and risk classes have posted
marked declines, which together with improved profits boosted stock
prices and household wealth. If the past is any guide, these domestic
financial developments, apart from the heavy dose of fiscal stimulus
now in train, should bolster economic activity over coming quarters.
To be sure, industrial production does appear to have stabilized in
recent weeks after months of declines. Consumer spending has held up
reasonably well, and activity in housing markets continues strong. But
incoming data on employment and aggregate output remain mixed. A
pervasive sense of caution reflecting, in part, the aftermath of
corporate governance scandals appears to have left businesses focused
on strengthening their balance sheets and, to date, reluctant to ramp
up significantly their hiring and spending. Continued global
uncertainties and economic weakness abroad, particularly among some of
our major trading partners, also have extended the ongoing softness in
the demand for U.S. goods and services.
When the Federal Open Market Committee (FOMC) met last month, with
the economy not yet showing convincing signs of a sustained pickup in
growth, and against the backdrop of our concerns about the implications
of a possible substantial decline in inflation, we elected to ease
policy another quarter-point. The FOMC stands prepared to maintain a
highly accommodative stance of policy for as long as needed to promote
satisfactory economic performance. In the judgment of the Committee,
policy accommodation aimed at raising the growth of output, boosting
the utilization of resources, and warding off unwelcome disinflation
can be maintained for a considerable period without ultimately stoking
inflationary pressures.
* * *
The prospects for a resumption of strong economic growth have been
enhanced by steps taken in the private sector over the past couple of
years to restructure and strengthen balance sheets. These changes,
assisted by improved prices in asset markets, have left households and
businesses better positioned than they were earlier to boost outlays as
their wariness about the economic environment abates.
Nowhere has this process of balance sheet adjustment been more
evident than in the household sector. On the asset side of the balance
sheet, the decline in longer-term interest rates and diminished
perceptions of credit risk in recent months have provided a substantial
lift to the market value of nearly all major categories of household
assets. Most notably, historically low mortgage interest rates have
helped to propel a solid advance in the value of the owner-occupied
housing stock. And the lowered rate at which investors discount future
business earnings has contributed to the substantial appreciation in
broad equity price indexes this year, reversing a portion of their
previous declines.
In addition, reflecting growing confidence, households have been
shifting the composition of their portfolios in favor of riskier
assets. In recent months, equity mutual funds attracted sizable inflows
following the redemptions recorded over much of the last year.
Moreover, strong inflows to corporate bond funds, particularly those
specializing in speculative-grade securities, have provided further
evidence of a
renewed appetite for risk-taking among retail investors.
On the liability side of the balance sheet, despite the significant
increase in debt encouraged by higher asset values, lower interest
rates have facilitated a restructuring of existing debt. Households
have taken advantage of new lows in mortgage interest rates to
refinance debt on more favorable terms, to lengthen debt maturity, and,
in many cases, to extract equity from their homes to pay down other
higher-cost debt. Debt service burdens, accordingly, have declined.
Overall, during the first half of 2003, the net worth of households
is estimated to have risen 4\1/2\ percent--somewhat faster than the
rise in nominal disposable personal income. Only 15 percent of that
increase in wealth represented the accumulated personal saving of
households. Additions to net worth have largely reflected capital gains
both from financial investments and from home price appreciation. Net
additions to home equity, despite very large extractions, remained
positive in the first half.
Significant balance-sheet restructuring in an environment of low
interest rates has gone far beyond that experienced in the past. In
large measure, this reflects changes in technology and mortgage markets
that have dramatically transformed accumulated home equity from a very
illiquid asset into one that is now an integral part of households'
ongoing balance-sheet management and spending decisions. This enhanced
capacity doubtless added significant support to consumer markets during
the past 3 years as numerous shocks--a stock price fall, September 11,
and the Iraq war--pummeled consumer sentiment.
Households have been able to extract home equity by drawing on home
equity loan lines, by realizing capital gains through the sale of
existing homes, and by
extracting cash as part of the refinancing of existing mortgages, so-
called cash-outs. Although all three of these vehicles have been
employed extensively by homeowners in recent years, home turnover has
accounted for most equity extraction.
Since originations to purchase existing homes tend to be roughly
twice as large as repayments of the remaining balances on outstanding
mortgages of home sellers, the very high levels of existing home
turnover have resulted in substantial equity extraction, largely
realized capital gains. Indeed, of the estimated net increase of $1.1
trillion in home mortgage debt during the past year and a half,
approximately half resulted from existing home turnover.
The huge wave of refinancings this year and last has been
impressive. Owing chiefly to the decline in mortgage rates to their
lowest levels in more than three decades, estimated mortgage
refinancings net of cash-outs last year rose to a record high of more
than $1.6 trillion. With mortgage rates declining further in recent
months, the pace of refinancing surged even higher over the first half
of this year. Cash-outs also increased, but at a slowed pace. Net of
duplicate refinancings, approximately half of the dollar value of
outstanding regular mortgages has been refinanced during the past year
and a half. Moreover, applications to refinance existing mortgages
jumped to record levels last month. Given that refinance applications
lead originations by about 5 weeks and that current mortgage rates
remain significantly below those on existing mortgages, refinance
originations likely will remain at an elevated level well into the
current quarter.
We expect both equity extraction and lower debt service to continue
to provide support for household spending in the period ahead, though
the strength of this support is likely to diminish over time. In recent
quarters, low mortgage rates have carried new home sales and
construction to elevated levels. Sales of new single-family homes
through the first 5 months of this year are well ahead of last year's
record pace. And declines in financing rates on new auto loans to the
lowest levels in many years have spurred purchases of new motor
vehicles.
* * *
In addition to balance sheet improvements, the recently passed tax
legislation will provide a considerable lift to disposable incomes of
households in the second half of the year, even after accounting for
some State and local offsets. At this point, most firms have likely
implemented the lower withholding schedules that have been released by
the Treasury, and advance rebates of child tax credits are being mailed
beginning later this month. The Joint Committee on Taxation estimates
that these and other tax changes should increase households' cashflow
in the third quarter by $35 billion. Most mainstream economic models
predict that such tax-induced increases in disposable income should
produce a prompt and appreciable pickup in consumer spending. Moreover,
most models would also project positive follow-on
effects on capital spending. The evolution of spending over the next
few months may provide an important test of the extent to which this
traditional view of expansionary fiscal policy holds in the current
environment.
* * *
Much like households, businesses have taken advantage of low
interest rates to shore up their balance sheets. Most notably, firms
have issued long-term debt and employed the proceeds to pay down
commercial paper, bank loans, and other short-term debt. Although rates
on commercial paper and bank loans are well below yields on new long-
term bonds, firms have evidently judged that now is an opportune time
to lock in long-term funding and avoid the liquidity risks that can be
associated with heavy reliance on short-term funding. At the same time,
the average coupon on outstanding corporate bonds remains considerably
above rates on new debt issues, suggesting that firms are well
positioned to cut their debt service burdens still further as
outstanding bonds mature or are called. The net effect of these trends
to date has been a decline in the ratio of business interest payments
to net cashflow, a significant increase in the average maturity of
liabilities, and a rise in the ratio of current assets to current
liabilities.
With business balance sheets having been strengthened and with
investors notably more receptive to risk, the overall climate in credit
markets has become more hospitable in recent months. Specifically,
improvements in forward-looking measures of default risk, a decline in
actual defaults, and a moderation in the pace of debt-rating downgrades
have prompted a marked narrowing of credit spreads and credit default
swap premiums. That change in sentiment has extended even to the
speculative-grade bond market, where issuance has revived considerably,
even by lower-tier issuers that would have been hard-pressed to tap the
capital markets over much of the last few years. Banks, for their part,
remain well-capitalized and willing lenders.
In the past, such reductions in private yields and in the cost of
capital faced by firms have been associated with rising capital
spending. But, as yet there is little evidence that the more
accommodative financial environment has materially improved the
willingness of top executives to increase capital investment. Corporate
executives and boards of directors are seemingly unclear, in the wake
of the recent intense focus on corporate behavior, about how an
increase in risk-taking on their part would be viewed by shareholders
and regulators.
As a result, business leaders have been quite circumspect about
embarking on major new investment projects. Moreover, still-ample
capacity in some sectors and lingering uncertainty about the strength
of prospective final sales have added to the reluctance to expand
capital outlays. But should firms begin to perceive that the pickup in
demand is durable, they doubtless would be more inclined to increase
hiring and production, replenish depleted inventories, and bring new
capital online. These actions in turn would tend to further boost
incomes and output.
Tentative signs suggest that this favorable dynamic may be
beginning to take hold. Industrial production, as I indicated earlier,
seems to have stabilized, and various regional and national business
surveys point to a recent firming in new orders. Indeed, the backlog of
unfilled orders for nondefense capital goods, excluding aircraft,
increased, on net, over the first 5 months of this year. Investment in
structures, however, continues to weaken.
The outlook for business profits is, of course, a key factor that
will help determine whether the stirrings we currently observe in new
orders presage a sustained pickup in production and new capital
spending. Investors' outlook for near-term earnings has seemed a little
brighter of late.
The favorable productivity trend of recent years, if continued,
would certainly bode well for future profitability. Output per hour in
the nonfarm business sector increased 2\1/2\ percent over the year
ending in the first quarter. It has been unusual that firms have been
able to achieve consistently strong gains in productivity when the
overall performance of the economy has been so lackluster. To some
extent, companies under pressure to cut costs in an environment of
still-tepid sales growth and an uncertain economic outlook might be
expected to search aggressively for ways to employ resources more
efficiently. That they have succeeded, in general, over a number of
quarters suggests that a prior accumulation of inefficiencies was
available to be eliminated. One potential source is that from 1995 to
2000 heavy emphasis on new and expanding markets likely diverted
corporate management from tight cost controls whose payoffs doubtless
seemed small relative to big-picture expansion.
However, one consequence of these improvements in efficiency has
been an ability of many businesses to pare existing workforces and
still meet increases in demand. Indeed, with the growth of real output
below that of labor productivity for much of the period since 2000,
aggregate hours and employment have fallen, and the unemployment rate
rose last month to 6.4 percent of the civilian labor force.
* * *
Although forward-looking indicators are mostly positive, downside
risks to the business outlook are also apparent, including the partial
rebound in energy costs and some recent signs that aggregate demand may
be flagging among some of our important trading partners. Oil prices,
after dropping sharply in March on news that the Iraqi oil fields had
been secured, have climbed back above $30 per barrel as market
expectations for a quick return of Iraqi production appear to have been
overly optimistic given the current security situation.
Also worrisome is the rise in natural gas prices. Natural gas
accounts for a
substantial portion of total unit energy costs of production among
nonfinancial, nonenergy-producing firms. And as I noted in testimony
last week, futures markets anticipate that the current shortage in
natural gas will persist well into the future. Although they project a
near-term modest decline from highly elevated levels,
contracts written for delivery in 2009 in excess of $4.50 per million
Btu are still at double the levels that had been contemplated when much
of our existing gas-using capital stock was put in place.
The timing and extent of the pickup in economic activity in the
United States will also depend on global developments. Lethargic growth
among many of our important global trading partners is posing some
downside risk to the U.S. economic outlook. As has been true for some
time, Japan's economy remains in difficult straits, burdened by a weak
banking sector and an ongoing deflation, although recent data have
seemed somewhat less negative. Economic activity in many European
countries--especially Germany--has been soft of late and has been
accompanied by a
decline in inflation to quite low levels. While Japan and Europe should
benefit from global economic recovery, the near-term weakness remains a
concern.
* * *
Inflation developments have been important in shaping the economic
outlook and the stance of policy over the first half of the year. With
the economy operating below its potential for much of the past 2 years
and productivity growth proceeding apace, measures of core consumer
prices have decelerated noticeably. Allowing for known measurement
biases, these inflation indexes have been in a neighborhood that
corresponds to effective price stability--a long-held goal assigned to
the Federal Reserve by the Congress. But we can pause at this
achievement only for a moment, mindful that we face new challenges in
maintaining price stability, specifically to prevent inflation from
falling too low.
This is one reason the FOMC has adopted a quite accommodative
stance of policy. A very low inflation rate increases the risk that an
adverse shock to the economy would be more difficult to counter
effectively. Indeed, there is an especially pernicious, albeit remote,
scenario in which inflation turns negative against a backdrop of weak
aggregate demand, engendering a corrosive deflationary spiral.
Until recently, this topic was often regarded as an academic
curiosity. Indeed, a decade ago, most economists would have dismissed
the possibility that a government issuing a fiat currency would ever
produce too little inflation. However, the recent record in Japan has
reopened serious discussion of this issue. To be sure, there are
credible arguments that the Japanese experience is idiosyncratic. But
there are important lessons to be learned, and it is incumbent on a
central bank to anticipate any contingency, however remote, if
significant economic costs could be associated with that contingency.
The Federal Reserve has been studying how to provide policy
stimulus should our primary tool of adjusting the target Federal funds
rate no longer be available. Indeed, the FOMC devoted considerable
attention to this subject at its June meeting, examining potentially
feasible policy alternatives. However, given the now highly stimulative
stance of monetary and fiscal policy and well-anchored inflation
expectations, the Committee concluded that economic fundamentals are
such that situations requiring special policy actions are most unlikely
to arise. Furthermore, with the target funds rate at 1 percent,
substantial further conventional easings could be implemented if the
FOMC judged such policy actions warranted. Doubtless, some financial
firms would experience difficulties in such an environment, but these
intermediaries have exhibited considerable flexibility in the past to
changing circumstances. More broadly, as I indicated earlier, the FOMC
stands ready to maintain a highly accommodative stance of policy for as
long as it takes to achieve a
return to satisfactory economic performance.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM ALAN GREENSPAN
Accuracy of Credit Reports
Q.1. The Banking Committee is currently considering whether to
reauthorize the preemption provisions of the Fair Credit
Reporting Act. An issue that has emerged from our hearings is
the fundamental importance of the accuracy of the information
contained in credit reports.
A.1. The information gathered by credit reporting companies on
the borrowing and payment experiences of consumers is a
cornerstone of the consumer credit system in this country.
Experience indicates that the information assembled and
provided by these companies enables our consumer credit and
mortgage markets to function much more efficiently than would
otherwise be possible. Moreover, automated credit evaluation
systems based on that information have improved the overall
quality and reduced the cost of credit decisions while
expanding the availability of credit. These benefits of the
credit reporting system are evident both from comparison with
other countries that have less developed information sharing
structures, and from statistical analyses demonstrating the
usefulness of credit history information for predicting an
individual's future performance with new credit.
Q.1.a. Would you agree that accurate reports are essential for
the efficient operation of our economy considering the
prevalence of their usage and the manner in which risk-based
pricing calibrates credit risk to credit price?
A.1.a. Clearly, some minimum degree of accuracy of credit
reports is required for such benefits to be realized. Moreover,
the more accurate the information assembled by credit reporting
companies, the greater the potential to enhance efficiency in
the credit granting process, reducing costs to the advantage of
both the consumers and creditors.
Although inaccuracy can limit the potential efficiency
benefits from a well-developed credit reporting system as well
as disadvantage individual consumers who have errors in their
credit reports, there are limits to the degree of accuracy that
can be obtained without undue costs. Some inadvertent errors
inevitably will arise in a system comprising millions of
account records and billions of transactions yearly. The fact
of some degree of inaccuracy does not necessarily argue that
the system is not functioning well, or for strong measures to
make changes in the system. Ultimately, the question is the
frequency with which errors in credit files actually lead to
improper credit-granting decisions.
At present it appears that the system is functioning
reasonably well and it is not obvious there are easy ways to
improve accuracy substantially without also raising costs. It
is always useful to keep in mind the importance of maintaining
a system that serves its
intended purposes without onerous requirements that inflate
costs with only limited benefit.
More important, the FCRA itself has long contained a
mechanism whereby consumers are able to review their credit
reports without cost in the case of an adverse action based
upon a credit report. More recently, many consumers have
availed themselves of opportunities provided by credit
reporting companies to review their own reports as frequently
as they desire at nominal cost. Over time, both mechanisms
should continue to lead to improvements in the quality of
information held by the credit reporting companies.
Q.1.b. Does the Federal reserve have any definitive statistics
regarding the current level accuracy of credit reports?
A.1.b. The information the Federal Reserve has concerning the
accuracy of credit reports was reported in the Federal Reserve
Bulletin earlier this year. This information was based on a
nationwide sample of credit records drawn as of June 1999, and
as such may not be representative of the information currently
in credit reporting files. These data supported an assessment
of the degree to which credit files contain missing and
``stale'' (nonupdated) information, but did not permit an
assessment of the degree to which wrong information is present
in credit files. The Federal Reserve does not have any
definitive statistics concerning the current level of accuracy
of credit reports. A copy of the article in the Federal Reserve
Bulletin is attached. *
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* Held in the Senate Banking Committee files or available at http:/
/www.federalreserve.gov/pubs/bulletin/2003/0203lead.pdf.
Q.1.c. In light of the significance of this matter, do you
believe there should be an effort to obtain information
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regarding the level of accuracy?
A.1.c. There has been little direct analysis of the degree of
accuracy of credit reports; to the extent that studies have
been done, they are limited in scope or lacking in statistical
rigor. On the other hand, the credit reporting system is
operating quite well at present, despite some degree of
inaccuracy in credit reporting. It is not clear that the
usefulness of an effort to obtain fuller information regarding
the level of accuracy would justify the substantial costs such
an effort would require.
Potential Weaknesses in the Housing Market
Q.2. The housing market continues to prosper with low interest
rates spurring home purchases and refinancings. However, a
recent report from the Harvard University Joint Center for
Housing Studies cited two concerns. First, the growing number
of loans to borrowers with weak credit histories. Second, the number of
homeowners who have spent more than 50 percent of their incomes
on housing has increased significantly. To the extent these
borrowers are concentrated in particular markets or
neighborhoods, any economic downturn could lead to an
increasing number of late payments, and even foreclosures. Do
you share these concerns and how significant are they?
A.2. Recent developments in mortgage markets have provided
broader access to mortgage financing for borrowers with lower
incomes and less-established credentials for borrowing. As you
noted from the report from the Joint Center for Housing
Studies, expanding the availability of mortgage credit entails
some risks. However, the overall impact of this additional risk
on the mortgage market and the economy as a whole is likely to
be rather small. Data from the Federal Housing Finance Board
indicate that the average loan-to-value ratio for mortgages
excluding refinancings has decreased from a touch below 80
percent in the mid-1990's to an average of 73 percent so far
this year. In addition, mortgages with loan-to-value ratios of
90 percent or more have declined from 27 percent of total
mortgages in 1995 to less than 20 percent so far this year.
Moreover, house prices generally have risen fairly rapidly in
recent years, providing an equity cushion for many mortgagors.
Bank Capital and Credit Extension
Q.3. You mentioned in your testimony that the banks remain well
capitalized. How does this compare to previous recessions? Did
banks largely manage to avoid overextending credit during the
1990's expansion?
A.3. Bank capital ratios by virtually all measures (including
equity relative to problem assets) are significantly higher now
than in the prior economic cycle, that is, in the early 1990's.
Moreover, 98.4 percent of all insured commercial banks meet the
regulatory criteria to be considered ``well capitalized,''
which is the highest percentage in more than a decade of
calculating the statistic. As stated in my testimony, this
depth and breadth of capitalization leaves banks well-
positioned to support economic growth through sound lending.
It appears that banks have largely avoided the temptation
to overextend credit in the more recent period. Increases in
problem assets and credit losses over the past few years, while
significant, have been modest relative to those seen in the
last recession. Nonperforming assets represent only about 5
percent of the capital and reserves in place to absorb them
compared with more than 27 percent at the end of 1991. Indeed,
despite somewhat elevated levels of nonaccrual loans, capital
ratios have risen significantly during the recent cycle,
reflecting both record industry earnings and continuing
supervisory attention to capital adequacy. Early indications
suggest that credit quality problems may have reached their
peak in the fall of last year and have receded gradually since
then.
Basel II Capital Accord
Q.4. On July 11, 2003, the banking regulators released proposed
rules and guidance relating to the Basel II Capital Accord. It
appeared from these releases that the bank regulators are not
in total agreement about these standards. What is the process
for resolving any disagreements between the regulators
regarding the application of these standards?
A.4. Because the Basel II Capital Accord revisions encompass a
number of significant and complex issues, interagency
differences of opinion are to be expected. In our experience,
these differences and the interagency process in place that
allows, as a matter of course, for them to be fully aired and
discussed, almost invariably result in a better outcome from
both a supervisory and industry perspective than would be the
case if a single agency was the sole decisionmaker. Each agency
has unique insights and experiences it brings to particular
issues and it is the agencies' collective belief that it is
crucial to the success and the effectiveness of the final
outcome that these be thoroughly considered and debated before
a final consensus is achieved.
The agencies have well-established interagency mechanisms
for communication and decisionmaking at all levels within the
agencies. In particular, for the Basel revision process several
chains of communication are in place to develop U.S. views and
communicate them consistently to the Basel Supervisors
Committee, the industry as a whole, and to other interested
parties. For example, interagency staff meetings and conference
calls are held almost daily on one or more of the substantive
issues raised by the proposed new framework. Senior staff
regularly schedules interagency meetings prior to significant
Basel meetings (most notably the Basel Supervisors Committee or
the Capital Task Force). The agency principal representatives
also have scheduled meetings prior to significant international
meetings. Through these discussions, the U.S. views on
particular issues are formulated. In addition, as is always the
case, bilateral discussions on individual issues on an as-
needed basis are conducted so that concerns and objectives are
appropriately addressed and achieved.
At the current stage of development of the revised Basel
Capital Accord, we expect that the agencies will have different
views on a number of issues. We are confident that, as we work
through these differences, the end result will be the best
product for U.S. banking organizations.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SARBANES
FROM ALAN GREENSPAN
Q.1. There are many questions as to how the Federal Reserve
would conduct monetary policy if it should decide that further
easing was appropriate but that further reductions in the Fed
funds rate was not appropriate. In testimony before the Joint
Economic Committee in May, you stated that the Fed: ``do[es]
have the capability, should that be necessary, of clearly
moving out on the yield curve, essentially moving longer-term
rates down and in the process expanding the monetary base and
the degree of monetary stimulus.''
In your written testimony at this hearing you also raised
that point: ``The Federal Reserve has been studying how to
provide policy stimulus should our primary tool of adjusting
the target Federal funds rate no longer be available. Indeed,
the FOMC devoted considerable attention to this subject at its
June meeting, examining potentially feasible policy
alternatives.''
Chairman Greenspan could you describe in some detail what
conclusions have been drawn from your research and conversation
during the June meeting? In addition, could you also answer the
following specific questions regarding the use of nonprimary
tools to provide economic stimulus:
Will the Fed set a target rate at a single point or range
along the yield curve as it currently does with the Fed funds
rate?
If so:
What point or range along the yield curve will the
FOMC target? Will the FOMC announce the target point or
range along the yield curve? Will the FOMC announce the
target interest rate for that point or range?
If not:
Will the FOMC specify some other policy variable
related to longer term interest rates? If so, what
would that policy variable be?
Will the FOMC communicate its decisions in a manner similar
to its announcements regarding the Federal funds target rate or
will another method of communication be used? If you are
contemplating additional or alternative methods of
communication, could you please describe how you envision they
would operate?
A.1. The Federal Open Market Committee recently released the
minutes of its June 24-25, 2003, meeting, at which the issue of
unconventional monetary policy tools was discussed. I have
attached the relevant section of those minutes for your
convenient reference. As that section makes clear, the FOMC
believed that the probability that unconventional tools would
be needed was quite low. Consequently, the Committee's
discussion of unconventional policies was very general. Apart
from agreeing that it would not be appropriate to establish an
artificial floor below which the Federal funds rate could not
be lowered, the FOMC reached no decisions on specific
approaches to unconventional policies. As stated in those
minutes, ``[t]he members did not see the need at this time to
reach a consensus on the desirability of any specific
nontraditional approach to the implementation of monetary
policy, particularly given the low probability of its near-term
use. As experience had shown, at times of economic and
financial market stress the specific policy tools used would
depend on circumstances. For now, however, they believed that
arriving at an understanding of the various options that might
be employed prepared them to respond more flexibly and
effectively to unanticipated developments.'' Consequently, it
is not possible to answer your specific questions at present.
However, as I indicated at the July hearing, the Federal
Reserve will communicate the relevant information to the public
in a timely fashion in the event that the adoption of
unconventional policies ever proves necessary.
Q.2. The President's Fiscal Year 2004 Budget includes an
increase for the Bureau of Economic Analysis to launch several
initiatives: (1) purchase of more real-time data now collected
by the private sector, particularly scanner data; (2)
collection of missing information on derivatives; (3) meeting
international commitments for the collection and presentation
of information on international transactions and asset
positions; and (4) acceleration of the processing and release
of balance of payments data. The BEA also continued to purse
its plan to accelerate the production of input-output tables
based on the 2002 economic census. What is your evaluation of
these initiatives?
A.2. The Fiscal Year 2003-2007 Strategic Plan prepared by the
BEA lays out a well-designed plan for improving the national
economic accounts as well as the international accounts. The
plan
reflects the input of many facets of the BEA's user community,
including the Federal Reserve. The initiatives presented in the
President's Fiscal Year 2004 Budget reflect the BEA's
requirements for carrying out its strategic plan. The specific
initiatives you mention in your question will help BEA achieve
two laudable objectives: (1) improve the reliability and
timeliness of GDP and related measures, and (2) meet the
commitments of the United States to the International Monetary
Fund to increase the transparency, time-
liness, and accuracy of data on our international investment
position. Achieving these objectives will provide important
benefits to the formulation and the implementation of monetary
and financial policy at the Federal Reserve.
Excerpt from Minutes of the Federal Open Market Committee
June 24-25, 2003
The Committee discussed at length alternative means of
providing monetary stimulus should the target Federal funds
rate be reduced to a point where there was little or no
latitude for additional easing through this conventional policy
instrument. The members agreed that current economic conditions
and the prevailing stances of monetary and fiscal policy made
the need to use unusual monetary policy tools a quite remote
possibility. Even so, they believed it was useful to discuss
that possibility because of the implications for financial
markets and institutions and for the conduct of monetary policy
of reducing short-term interest rates to very low levels. An
environment involving such interest rates could have adverse
repercussions on the functioning of some sectors of the money
market, but the members agreed that the potential
extent of such disruptions would not be sufficient to prevent
the Committee from taking advantage of the full scope of
conventional easing of the Federal funds rate, should that
become necessary. Beyond that, a variety of nonconventional
measures for further easing was available. In this regard, the
members discussed the advantages and disadvantages of various
approaches that, possibly employed in some combination, would
alter the size and composition of the System's balance sheet.
They also considered aspects of the Committee's communications
as a means of underscoring to the public its willingness to
follow a sufficiently accommodative path of monetary policy for
as long as necessary to foster improved economic performance.
The members did not see the need at this time to reach a
consensus on the desirability of any specific nontraditional
approach to the implementation of monetary policy, particularly
given the low probability of its near-term use. As experience
had shown, at times of economic and financial market stress the
specific policy tools used would depend on circumstances. For
now, however, they believed that arriving at an understanding
of the various options that might be employed prepared them to
respond more flexibly and effectively to unanticipated
developments. While considerable uncertainty surrounded each
individual policy option, the members agreed that the
effectiveness of these alternative tools, along with the 125
basis points of conventional easing still available, would
allow monetary policy to combat economic weakness and forestall
any unexpected tendency for a pernicious deflation to develop.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING
FROM ALAN GREENSPAN
Q.1. The last time the FOMC met, you cut the Fed funds rate by
25-basis-points. The markets did not react well because they
were expecting a 50-basis-point cut. Yesterday, you indicated
that more cuts will be made in the near future. Why didn't you
just cut the rate by 50-basis-points last time the FOMC met?
A.1. The Federal Open Market Committee judged at the time of
the June FOMC meeting that a 25-basis-point reduction in the
Federal funds rate, in the context of a substantial previous
easing of monetary policy, a stimulative fiscal policy, and
strong growth in productivity, would be sufficient to foster
satisfactory growth in economic activity. The economic data
that have since come in hand have tended to confirm that
judgment.
I did not indicate that more rate cuts will be made in the
future. Rather, my point was that they could be made if
circumstances warrant.
Q.2. I want to get back to your testimony of last week on
Natural Gas Prices. Do you feel the high prices that we have
had and expect in the future are largely because of past
Federal Government policies? Specifically, do you agree that in
the past we have encouraged demand for natural gas by giving
incentives to use it for electricity generation and for other
uses without increasing supply by allowing for new drilling?
A.2. We cannot on the one hand encourage the use of
environmentally desirable natural gas in this country while
being conflicted on larger imports of liquefied natural gas
(LNG) and new wells. Such contradictions are resolved only by
debilitating spikes in price.
Q.3. Would opening up the Artic National Wildlife Refuge (ANWR)
help the demand side?
A.3. Unquestionably, the more oil and gas that we get down into
the lower 48 the better for meeting our energy needs. I realize
that there is a very difficult tradeoff between maintaining the
pristine nature of the wilderness in the ANWR and the economic
value of producing the oil and natural gas that is located
there. The tradeoff is a value judgment that is up to Congress
to make on behalf of the American people.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER
FROM ALAN GREENSPAN
Manufacturing
Q.1. Many small manufacturing companies in my State feel that
they are under assault (principally from China) and if the
trend continues there will be few, if any, manufacturing
(mostly textile manufacturing) jobs left in America. On the
other hand, large manufacturing companies like the fact that
they can do more business in China. How do we balance out the
needs of both the large and small manufacturing concerns? What
should I tell my constituent companies?
A.1. Economists generally believe that the extent of a
country's openness to trade and its integration with the rest
of the world exert positive influences on its economic growth
and standard of living. Among other things, international trade
allows the United States to purchase goods abroad at lower cost
than we could produce them at home. This raises our standard of
living both directly, by reducing costs, and indirectly, by
allowing us to specialize in products in which we are most
competitive. In some cases, the opportunity to buy raw
materials and intermediate inputs at lowest global cost is the
key to success for both large and small U.S. manufacturing
concerns. Moreover, less competitive operations shrink while
capital investment contributes to the expansion of competitive
enterprises that embody cutting-edge technologies; this process
of ``creative destruction'' leads to higher productivity and
higher incomes. International trade, it should be added, is not
a one-way street: Not only does an open global trading system
allow us to import more and at lower cost, but it also allows
us to access foreign markets and sell more of our product
abroad.
It is certainly the case that as the adjustment engendered
by international trade proceeds, some industries that were once
thriving but are now less competitive will experience distress.
This may lead to factories being shut down and workers being
laid off. However, the proper response to the distress of
particular sectors is not to inhibit international competition,
thereby limiting the growth potential of the economy as a
whole. Rather, we should focus our response on enhancing job
skills and retraining workers. If necessary, selective income
maintenance programs could also be employed for those workers
for whom retraining is problematic. More generally,
establishing the conditions for sustained economic growth--
macroeconomic stability, a strong financial system, and
institutions that support market-driven private investment--
should allow the U.S. economy to fully exploit the benefits of
international trade while easing any associated transitional
difficulties.
Q.2. I understand that in an answer yesterday to Representative
Mark Green, you said you had visited textile factories in the
1970's and also recently. Based upon this recent visit, you
said you had noticed how technology had become an integral part
of manufacturing. I think you also said that as long as we have
technology we could be self-sufficient, and that ``one pound of
technology versus one ton of raw materials,'' means we have
shifted resources to our most effective parts. Am I quoting you
correctly and what is your overall view of what is happening to
the manufacturing sector?
A.2. Modern technology has become an integral part of U.S.
manufacturing in two ways. First, all products that we
manufacture are now produced with far more technology and
appropriately different infrastructure than used to be the
case. Second, the composition of U.S. manufacturing has been
shifting toward goods that make greater use of high technology
in their manufacture. However, I would not argue that
technology makes the United States self-sufficient. Self-
sufficiency is not, in itself, a valuable goal. Rather, the
specialization that goes with globalization has been extremely
valuable to our economy and living standards. Where national
security is a concern, producing particular goods here rather
than importing them from abroad may be essential. In other
cases, the key objective is to raise the productivity of
American workers in whatever they are producing.
Effects of State Budget Deficits
Q.3. Just yesterday, in The Washington Post a lead story
entitled ``Budget Woes Trickle Down'' discussed a lady who said
``her taxes are going up so much that, at 70, she may have to
sell her house to pay them.'' The article goes on to say that
State and local governments, to meet their Federal
responsibilities in education, health care, and homeland
security obligations, are either having to make cuts or raise
taxes. In February, the National Conference of State
Legislatures said States' current budget gaps have grown to a
total of nearly $26 billion [for this year]. What is more, the
shortfall projected for fiscal 2004, the budget year that
States are now planning for, is forecast to be at least $68.5
billion--and probably will rise significantly since 11 States
had no projections.'' Chairman Greenspan, what impact will the
State and local governments decisions to either cut programs or
raise taxes have on an economic recovery?
A.3. In the short-run, State and local government decisions to
cut spending or raise taxes would tend to reduce aggregate
demand and slow (other things held constant) the growth of
output a bit. However, in comparison to other factors that
recently have had a positive effect on aggregate demand and the
economy (such as the recent Federal tax cut and added spending
for the Iraq war and homeland security), the adjustments that
States and localities will need to make to restore budget
balance are small. Indeed, the effects of an improving economy
on State and local tax receipts likely will produce a
significant portion of the required adjustment.
Moreover, in the longer run, improved State and local
budget balances also have a positive effect on national saving
and the economy. In particular, the increased saving will set
the stage for
future productivity gains by keeping long-term interest rates
low and encouraging investment.
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