<DOC>
[109 Senate Hearings]
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S. Hrg. 109-325
FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2006
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
ON
OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU-
ANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978
__________
FEBRUARY 16, 2006
__________
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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 THOMAS R. CARPER, Delaware
JOHN E. SUNUNU, New Hampshire DEBBIE STABENOW, Michigan
ELIZABETH DOLE, North Carolina ROBERT MENENDEZ, New Jersey
MEL MARTINEZ, Florida
Kathleen L. Casey, Staff Director and Counsel
Steven B. Harris, Democratic Staff Director and Chief Counsel
Mark Oesterle, Counsel
Peggy R. Kuhn, Senior Financial Economist
Dean V. Shahinian, Democratic Counsel
Aaron D. Klein, Democratic Economist
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
(ii)
C O N T E N T S
----------
THURSDAY, FEBRUARY 16, 2006
Page
Opening statement of Chairman Shelby............................. 1
Opening statements, comments, or prepared statements of:
Senator Reed................................................. 2
Senator Bunning.............................................. 3
Senator Menendez............................................. 4
Senator Sununu............................................... 4
Senator Stabenow............................................. 4
Senator Dole................................................. 5
Senator Carper............................................... 6
Senator Crapo................................................ 7
Senator Sarbanes............................................. 8
Senator Bayh................................................. 8
WITNESS
Ben S. Bernanke, Chairman, Board of Governors of the Federal
Reserve System, Washington, DC................................. 9
Prepared statement........................................... 35
Response to written questions of:
Senator Menendez......................................... 39
Senator Crapo............................................ 43
Senator Enzi............................................. 43
Additional Material Supplied for the Record
Monetary Policy Report to the Congress, February 15, 2006........ 46
Letter to Senator John E. Sununu from Alan Greenspan, Chairman,
Board of Governors of the Federal Reserve System dated January
3, 2006........................................................ 74
(iii)
FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2006
----------
THURSDAY, FEBRUARY 16, 2006
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:02 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. We are
very pleased this morning to welcome Chairman Bernanke before
the Committee on Banking, Housing, and Urban Affairs to provide
his first testimony on the Federal Reserve Semiannual Monetary
Policy Report to the Congress. On behalf of this Committee, I
want to congratulate Dr. Bernanke on becoming only the 14th
Chairman of the Federal Reserve Board. This Committee has had
the opportunity to work with you in your previous tenure as
Board Governor and as Chairman of the Council on Economic
Advisors. We look forward to continuing that good and
productive relationship as you guide the Federal Reserve System
over the next years.
Our hearing this morning serves as an important part of the
Committee's oversight function over the Federal Reserve System.
It is also an important mechanism for assuring that Congress
maintains accountability over the Fed's policies and
operations. Within broad statutory parameters, the Fed sets and
implements U.S. monetary policy independent from the Congress
and the President. This hearing, which is also required by
statute, provides the Congress an opportunity to have an open
and detailed discussion and debate about the Fed's monetary
policy goals and their implementation.
Chairman Bernanke, your testimony and report this morning
note the economy's impressive performance in 2005. GDP growth
continues to be strong and core inflation remain moderate. We
also saw continued improvement in the labor markets with the
number of jobs created and a low unemployment rate.
At its meeting on January 31, the Federal Open Market
Committee raised its target for the Federal funds rate by 25
basis points to 4.5 percent. This is the 14th increase since
June 2004 when the FOMC began raising the target rate from a
low of 1 percent. The Federal Open Market Committee will meet
next at the end of March, its first session under your
leadership. Clearly, new economic data will be reported and
other events will transpire between now and then so you cannot
tell us exactly what will happen at that meeting and you should
not. However, our discussion this morning gives us the
opportunity to discuss which factors will be significant in
your deliberations leading up to that meeting. In that sense,
we hope our hearing and discussion this morning can add to the
transparency of the FOMC process.
Mr. Chairman, this Committee is eager to hear your views on
the future direction of our Nation's economy and how you plan
to guide the Federal Reserve System in the months and years
ahead. I look forward to raising a number of issues during our
discussion this morning.
Senator Reed, do you have an opening statement?
STATEMENT OF SENATOR JACK REED
Senator Reed. Thank you very much, Mr. Chairman, and thank
you, Chairman Bernanke. Welcome and congratulations. You come
to this job, Mr. Chairman, with considerable bipartisan
goodwill, with very strong academic credentials, and a
reputation for independent thinking, and you will need to draw
on all these resources as you confront an economy that seems to
be humming along on the surface, but in fact there is a number
of lurking problems, problems such as large budget deficits, a
record trade deficit, negative household saving rate, high
energy prices, and a disappointing labor market recovery. All
of these pose tremendous challenges in setting monetary policy.
We welcome your championship of greater openness and
demystification of the Fed. You really assured us during the
confirmation process that you are sensitive to the multiple
goals of monetary policy so I hope that you will continue the
Greenspan model of responding to changing economic
circumstances with flexibility rather than a rigid adherence to
a predetermined policy.
Now, critical tests will be balancing the goals of fighting
inflation with allowing sufficient employment growth. These are
difficult economic times for many Americans who are facing
stagnant incomes, rising costs for health care, rising costs of
home heating, rising costs for education, and so I hope,
Chairman Bernanke, that you will look hard at the economic data
at the FOMC meetings rather than allowing some type of rigid
plan to take hold.
GDP is growing, but the typical American worker has been
left out of the economic gains of this recovery. Strong
proprietary gains have shown up in the bottom lines of
shareholders but not in the paychecks of many workers. Clearly,
there is room for real wages to catch up with productivity
before the Fed needs to worry about inflationary pressure from
the labor market.
Finally, I hope you keep your promise to not comment on the
public policy matters beyond the realm of monetary policy and
to remain politically independent. I think that will be a major
service to the Nation. I look forward to your discussion about
the issues that are important to all of us today and thank you,
again, for not only attending but also your service.
Chairman Shelby. Senator Bunning.
STATEMENT OF SENATOR JIM BUNNING
Senator Bunning. Thank you, Mr. Chairman. Welcome, Chairman
Bernanke, to your first appearance before this Committee as
Chairman of the Federal Reserve.
I would like to point out that at the beginning of your
hearing yesterday, the stock market indexes jumped and then
fell throughout the hearing. Fortunately, after it was over
they recovered and ended up back in positive territory.
On the way out the door last month, Chairman Greenspan left
us with another hike in interest rates to 4.5 percent. His
recent comments, which came at a much higher price to his
fellow diners than the taxpayers, seem to have tied your hands
at the beginning of your term.
You will not chair your first FOMC meeting until next
month, but it is already taken for granted that another rate
hike is coming and probably more after that. As I told Mr.
Greenspan at his last appearance before this Committee, I do
not think that increases are needed, especially with your
projections of reasonable inflation for the coming year.
I hope they do not continue until it is too late and damage
is done. Our economy is strong and inflation is low, despite
high energy prices. Several other factors pose dangers to
sustained economic growth in the short and long terms.
We all know that inverted yield curves have been a reliable
indicator of trouble ahead. Increased Federal budget deficits
cause uncertainty and long-term obligations will begin to soak
up more and more capital that could be put to other productive
uses. And our trade deficit means that we are more dependent on
other countries to sustain our lifestyle and could lead to job
loss if we do not begin to close the gap. Even with those
negative factors hanging out there, the Fed paints a strong
picture of the economy.
During your confirmation process, I urged you to be
independent of the other Fed Members, as well as Congress and
the executive branch. I also stressed the importance of further
openness at the Fed and the tolerance of other viewpoints. In
other words, I would like to see less group-think.
I criticized your predecessor for speaking out of place
when it comes to policy matters that do not belong to the Fed.
I encourage you to stay away from those discussions and I am
glad that to some extent you did so yesterday.
Something about this town makes people want to be liked.
The longer someone stays here, the more they seem to want to be
liked. Maybe it has something to do with one day getting paid
more than your previous salary for attending a few dinners and
not even having to pay for your own food.
Do not fall into that trap and do not be afraid to tell
people ``no.'' It is an uncommon thing to say around here, but
do not try to follow in the footsteps of your predecessor. In
other words, be yourself, do not be ``Greenspan-lite.'' I hope
when your time at the Fed is over people will look back and see
a record of doing no harm. I think the decisions you and the
other Board Members make in the next few months will have a lot
to do with the success of your leadership at the Fed.
Thank you, Mr. Chairman, and I look forward to asking some
questions.
Chairman Shelby. Senator Menendez.
STATEMENT OF SENATOR ROBERT MENENDEZ
Senator Menendez. Thank you, Mr. Chairman. Mr. Chairman,
welcome, congratulations. We are pleased to welcome you, as a
fellow New Jersian, and we know that you will do an exceptional
job in this regard. I certainly look forward to your testimony
today and to some of the challenges I think we face: The
cooling off of the housing market and what that may mean,
rising energy prices, consequences of deficit and debt, a
variety of global influences, and a dynamic, modern economy
that we have.
Those are all the challenges that you face before you and
so we look forward to your stewardship in meeting, having a
steady hand in the midst of all of the dynamic realities that
we face, so we look forward to hearing your testimony, and once
again congratulations on your appointment, Mr. Chairman.
Chairman Shelby. Thank you. Senator Sununu.
STATEMENT OF SENATOR JOHN E. SUNUNU
Senator Sununu. Thank you, Mr. Chairman, and welcome,
Chairman Bernanke. Yesterday, you touched briefly on issues
related to the GSE's, better regulation of Fannie Mae and
Freddie Mac. This is something that has been of interest to the
Committee.
We enacted legislation that you spoke to at the hearing
yesterday, and I note that you emphasized two specific concerns
with the portfolios held by the GSE's, one, the systemic risk
that they create inevitably because of the nature of the
portfolios carrying interest rate risk and prepayment risk, and
two, the fact that they really do not contribute directly to
the GSE's fulfilling their mission.
I appreciate you making these points, some points that are
very consistent with testimony and presentation by other
representatives from the Fed in the past, and I think it is
important because we have an opportunity to take up legislation
this year, probably the best opportunity to improve the
regulation of these large institutions that we will have in a
long time.
Mr. Chairman, I have a letter that I received from the
outgoing Fed Chairman speaking to these issues at the beginning
of January. I would ask that that be included in the record so
that I do not have to belabor these points in any greater
detail.
Chairman Shelby. It will be part of the record without
objection.
Senator Sununu. I appreciate the comments that you made
yesterday. Perhaps we will have an opportunity to get into them
in more detail, but not surprisingly you were very direct and
plain-spoken and I appreciate having you on the record.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Stabenow.
STATEMENT OF SENATOR DEBBIE STABENOW
Senator Stabenow. Thank you, Mr. Chairman, and welcome,
Chairman Bernanke. This is an important time and we wish you
all of the best as we all work together on so many issues that
relate to our economy and what is happening in terms of
monetary policy.
The Annual Monetary Policy Report comes at a very important
time for many middle class Americans, and I know in my home
State right now, the headlines everyday relate to manufacturing
loss in Michigan and families are feeling squeezed on all sides
from concerns about losing their job, losing their pension,
their health care costs rising, businesses, manufacturers
seeing their health care costs go through the roof basically,
and it relates to their ability to compete internationally.
We also know that issues of unfair trade practices are not
just words for us in manufacturing. In Michigan, things like
currency manipulation are real with Japan or with China when we
look at the differences in costs coming in. Counterfeiting,
counterfeit auto parts, which is a $12 billion business costs
us 200,000 jobs.
So when we look at all of the issues, the fact that we have
lost 2.4 million jobs, 2.4 million people plus their families.
Since 2000, we have lost over 200,000 jobs, families
experiencing layoffs in the last 5 years in my State alone.
Just last year, 21,000 manufacturing jobs were lost. I say this
because the trade deficit is a critical issue for us, a trade
deficit now that is about twice as much as the budget deficit,
the budget deficit being the highest in our Nation's history,
but the trade deficit now hitting $726 billion.
This is real for us and so I know your basket of economic
metrics, the international component, is just a piece of the
analysis, but I want to stress with you that this is extremely
important piece to us in manufacturing and in Michigan.
And I hope your analysis now and in the future will
consider the global issues that are devastating middle class
families and devastating American businesses. We need to be
focused on that. We need your leadership, your thoughts, and
your recommendations as it relates to this global economy now
and the international pressures, the unfair trade practices,
the currency manipulation, other kinds of issues in the
economy, the way we fund health care which is different than
any other country in the world, and the impact on our
businesses.
All of these issues come down on the people that I
represent, my own family in Michigan and the others that I
represent, and so I hope this international component of your
analysis is something that you will place an emphasis on and
work with us on as we address monetary issues and the economy
in America.
Thank you.
Chairman Shelby. Thank you, Senator. Senator Dole.
STATEMENT OF SENATOR ELIZABETH DOLE
Senator Dole. Thank you, Mr. Chairman. Chairman Bernanke, a
very warm welcome to you. I certainly look forward to working
with you very closely in the months and years to come, and I
have every confidence in you. I want to underscore what Senator
Sununu said about the GSE's, and one of the issues that I
raised when we met in November was the economic transition that
we are going through in North Carolina.
We continue to experience job loss, especially in textiles
and furniture manufacturing. The national economy is indeed
trending positively, but I think we must continue to focus
special attention on the areas where people have lost their
jobs, where companies struggle to compete with foreign firms,
and their dramatically lower cost structures.
We have to work toward trade agreements that benefit
American workers and consumers and support jobs and growth in
our domestic industries.
One issue I was focused on during my days as Secretary of
Labor was addressing the growing gap between skilled and
unskilled workers. Today in our changing economic environment,
this gap has unfortunately widened, and as our economy moves
forward, the opportunities for lower skilled workers are
diminishing. We have to do everything in our power to ensure
that these people realize new opportunities, educate our less
skilled workers so they can take advantage of the new jobs that
are being created.
To this end, I believe that we should take steps to improve
trade adjustment assistance and continue to make strengthening
our community colleges a top priority, and I might add that the
Labor Department has estimated that 80 percent of new jobs that
are going to be created over the next decade will require
postsecondary education.
Now, in my conversations with many North Carolinians, I
hear concerns about job creation, high energy and health care
costs, and our growing trade imbalance. I continue to have
confidence that the very forces that stimulate economic
growth--tax relief to spur investment, free but fair trade,
ever-improving global communications, higher education and
training for our workforce, and of course hard work--these
forces indeed will put us on a course toward greater
opportunity for North Carolina and this Nation.
Mr. Chairman, thank you for being here today. I look
forward to your testimony and again to working closely with
you. Thank you.
Chairman Shelby. Senator Carper.
STATEMENT OF SENATOR THOMAS R. CARPER
Senator Carper. Thanks, Mr. Chairman. Welcome. It is good
to have you back. Thank you for joining us today and again for
your service to our country.
I think others have indicated that they have an interest in
questioning you on some of these same subjects. I will mention
them again. I will be asking you about our savings rate or
really our lack of savings or negative savings rate and what
you think we are doing right to turn that around and maybe what
more we could do or should do.
I want to also visit the issue, the interplay between the
trade deficit and the budget deficit, and the potential effect
of doing the wrong thing or not doing the right thing with
respect to interest rates going forward.
Playing into the trade deficit, our growing reliance on
foreign oil. I think I read the other day that our trade
deficit for last year topped out at a little bit more than $700
billion and roughly a third of that is now our reliance on
foreign oil.
And others have suggested--I think Senator Dole and I
believe Senator Sununu have mentioned the regulatory structure
for Government Sponsored Enterprises, Fannie Mae, Freddie Mac,
and some of our Federal Home Loan Banks--and I understand, I
read in a news account that you addressed that in your
testimony before the House of Representatives, but I want us to
have a chance maybe to talk with you a bit further about that
today.
And finally, just some general thoughts. Maybe put on your
old hat from one of your last jobs about economic policy, and
just to talk about some steps we need to take if our country is
going to continue to be an economic superpower in this century,
what we are doing right and what we are doing wrong, and what
we need to do differently, more of or less of.
Welcome. Thanks for coming.
Chairman Shelby. Senator Crapo.
STATEMENT OF SENATOR MIKE CRAPO
Senator Crapo. Thank you very much, Mr. Chairman, and
Chairman Bernanke, I welcome you to your first appearance
before this Committee. I look forward to many more and
appreciate the opportunity we have already had to work together
on important issues, and I am certain that the forecast and
information that you will give us today will be very helpful to
us.
I share a lot of the other feelings that have already been
expressed to you so I will not repeat them now. There are two
issues that I wanted to raise in addition to those, and if I am
here when it is time for questions, I will go through this a
little more in questions, but I have three hearings going on
today, one with a member of the cabinet, one with the U.S.
Trade Ambassador, and one with yourself. And they are all going
on right now.
So if I slip out to try to catch a little bit of one of
those other hearings and miss the chance to ask you questions,
I wanted to just toss these two things out right now.
We are getting very close to a markup on the regulatory
reform legislation that we have been working on for several
years now, and we are talking, I think, in terms of weeks, not
months, before we are going to move forward, and I would like
to have some kind of an indication from you as to when the
Federal Reserve will be able to give us its comments on the
proposals that are out there.
So, I just toss that one out to you.
And then the second issue is one which you will probably
hear me talk to you a lot about as we have opportunities, and
that is the question of derivatives. I am very concerned about
the potential efforts in this Congress to change the manner in
which we regulate derivatives or to impact the manner in which
derivatives operate in the economy, and I would like to have
your comments on the importance of having a strong, stable, and
dynamic derivatives market in this country and what it means to
our economy.
So, again, in addition to the other issues that we have
talked about, those are just a couple specific ones that I
would like you to think about. If I am not here to ask
questions, maybe we can talk later at a different time.
Thank you.
Chairman Shelby. Senator Sarbanes.
STATEMENT OF SENATOR PAUL S. SARBANES
Senator Sarbanes. Thank you very much, Mr. Chairman. I join
my colleagues in welcoming Chairman Bernanke before the
Committee. I think we had him last year at his nomination
hearing in November, and given the schedule, he went to the
House first, not by his choice. That was the process, I hasten
to add, so that the Members of the Committee do not feel
slighted in any way, but actually I want to say just a word
about that.
We think the Semiannual Report by the Fed is a very
important step forward in the transparency and oversight with
respect to monetary policy. It was a change that Chairman
Greenspan welcomed at the time, and I think I recall we had
talked about that, and you indicated very strong support for
that process as well.
And I think it does give the public a chance on a regular
basis for the Fed to come before the Congress and spell out its
views with respect to monetary policy and the health of the
economy.
And Mr. Chairman, I want to thank you for your oversight
and focus in that regard. It is clearly important.
Chairman Shelby. I had a good trainer.
Senator Sarbanes. The Federal Reserve has a double mandate,
as we all know: Stable prices and maximum employment. And we
have seen in recent years that the goals are not inherently in
conflict, as some had argued in the past, and we got
unemployment down to below 4 percent actually, inflation below
3 percent, and at his hearing, Dr. Bernanke told the Committee,
and I quote him, that he ``subscribes entirely to the Humphrey-
Hawkins mandate which puts employment growth and output growth
on a fully equal footing with inflation in terms of the Federal
Reserve's objectives.''
And we look forward to working with him in that regard. I
am a little concerned about how sanguine we are about the
economy. Paul Volcker not long ago in an editorial in the
Washington Post said this about our economy:
Under the placid surface, there are disturbing trends, huge
imbalances, disequilibria, risks, call them what you will,
although the circumstances seem to me as dangerous and
intractable as any I can remember, and I can remember quite a
lot.
Of course, the Commerce Department recently reported that
our Nation ran a record trade deficit of over $725 billion last
year. Warren Buffett summarized the situation: ``Right now the
rest of the world owns [$] three trillion more of us than we
own of them. In my view, it will create political turmoil at
some point. Pretty soon, I think there will be a big
adjustment.''
And I hope to go into that with Chairman Bernanke when we
reach the question period or in subsequent meetings, but we
welcome you back before the Committee as Chairman of the Fed,
and we wish you well in this new responsibility.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Bayh.
STATEMENT OF SENATOR EVAN BAYH
Senator Bayh. Thank you, Mr. Chairman. Welcome, Chairman
Bernanke. Just two quick things. First, congratulations on
apparently being able to speak in plain English and still not
moving the markets. That is quite an accomplishment.
Second, I want to follow up on something that Senator
Sarbanes mentioned. I am increasingly concerned with some of
the global imbalances that are accumulating and their effect
not only on our potential economic performance but also on our
Nation's security. I am going to save my time for questions,
but I would like to delve into that with you later today and
perhaps at a later point.
Having said that, I have learned from hard experience that
we are all here to hear from you, not from me, and so I would
just congratulate you and welcome you again.
Chairman Shelby. If you will put up with us for a few
minutes, Mr. Chairman, we have established a quorum, and at
this time I would like to move----
Senator Sarbanes. Does he have an alternative to putting up
with us?
[Laughter.]
Chairman Shelby. I am not going to say. If you will stay
put just a few minutes, Mr. Chairman.
[Recess.]
Chairman Shelby. Chairman Bernanke, your written testimony
will be made part of the record. You may proceed. Welcome again
to the Committee.
Chairman Bernanke. Thank you.
STATEMENT OF BEN S. BERNANKE, CHAIRMAN
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Chairman Bernanke. Thank you. Mr. Chairman and Members of
the Committee, I am pleased to be here today to present the
Federal Reserve's Monetary Policy Report to the Congress. I
look forward to working closely with the Members of this
Committee on issues of monetary policy as well as on matters
regarding the other responsibilities with which the Congress
has charged the Federal Reserve System.
The U.S. economy performed impressively in 2005. Real gross
domestic product increased a bit more than 3 percent, building
on the sustained expansion that gained traction in the middle
of 2003. Payroll employment rose two million in 2005 and the
unemployment rate fell below 5 percent. Productivity continued
to advance briskly.
The economy achieved these gains despite some significant
obstacles. Energy prices rose substantially yet again in
response to the increasing global demand, hurricane-related
disruptions to production, and concerns about the adequacy and
reliability of supply. The Gulf Coast region suffered through
severe hurricanes that inflicted a terrible loss of life,
destroyed homes, personal property, businesses and
infrastructure on a massive scale, and displaced more than a
million people. The storms also damaged facilities and
disrupted production in many industries with substantial
effects on the energy and petrochemical sectors and on the
region's ports. Full recovery in the affected areas is likely
to be slow. The hurricanes left an imprint on aggregate
economic activity as well, seen in part in the marked
deceleration of real GDP in the fourth quarter. However, the
most recent evidence, including indicators of production, the
flow of new orders to businesses, weekly data on initial claims
for unemployment insurance, and the payroll employment and
retail sales figures for January, suggest that the economic
expansion remains on track.
Inflation pressures increased in 2005. Steeply rising
energy prices pushed up overall inflation, raised business
costs, and squeezed household budgets. Nevertheless, the
increase in prices for personal consumption expenditures
excluding food and energy, at just below 2 percent, remained
moderate, and longer-term inflation expectations appear to have
been contained.
With the economy expanding at a solid pace, resource
utilization rising, cost pressures increasing, and short-term
interest rates still relatively low, the Federal Open Market
Committee over the course of 2005 continued the process of
removing monetary policy accommodation, raising the Federal
funds rate 2 percentage points in eight increments of 25 basis
points each. At its meeting on January 31 of this year, the
FOMC raised the Federal funds rate another one-quarter
percentage point, bringing its level to 4\1/2\ percent.
At that meeting, monetary policymakers also discussed the
economic outlook for the next 2 years. The central tendency of
the forecast of Members of the Board of Governors and the
Presidents of the Federal Reserve Banks is for real GDP to
increase about 3\1/2\ percent in 2006 and 3 percent to 3\1/2\
percent in 2007. The civilian unemployment rate is expected to
finish both 2006 and 2007 at a level between 4\3/4\ percent and
5 percent. Inflation, as measured by the price index for
personal consumption expenditures excluding food and energy, is
predicted to be about 2 percent this year and 1\3/4\ percent to
2 percent next year. While considerable uncertainty surrounds
any economic forecast extending nearly 2 years, I am
comfortable with these projections.
In the announcement following the January 31 meeting, the
Federal Reserve pointed to risks that could add to inflation
pressures. Among those risks is the possibility that to a
greater extent than we now anticipate, higher energy prices may
pass through into the prices of nonenergy goods and services or
have a persistent effect on inflation expectations. Another
factor bearing on the inflation outlook is that the economy
appears now to be operating at a relatively high level of
resource utilization. Gauging the economy's sustainable
potential is difficult and the Federal Reserve will keep a
close eye on all the relevant evidence and be flexible in
making those judgments. Nevertheless, the risk exists that with
aggregate demand exhibiting considerable momentum, output could
overshoot its sustainable path, leading ultimately--in the
absence of countervailing monetary policy action--to further
upward pressure on
inflation. In these circumstances, the FOMC judged that some
further firming of monetary policy may be necessary, an
assessment with which I concur.
Not all of the risks to the economy concern inflation. For
example, a number of indicators point to a slowing in the
housing market. Some cooling of the housing market is to be
expected and would not be inconsistent with continued solid
growth of overall economic activity. However, given the
substantial gains in house prices, and the high levels of home
construction activity over the past several years, prices and
construction could decelerate more rapidly than currently seems
likely. Slower growth in home equity, in turn, might lead
households to boost their saving and trim their spending
relative to current income by more than is now anticipated. The
possibility of significant further increases in energy prices
represents an additional risk to the economy. Besides affecting
inflation, such increases might also hurt consumer confidence
and thereby reduce spending on nonenergy goods and services.
Although the outlook contains significant uncertainties, it
is clear substantial progress has been made in removing
monetary policy accommodation. As a consequence, in coming
quarters, the FOMC will have to make ongoing, provisional
judgments about the risks to both inflation and growth, and
monetary actions will be increasingly dependent on incoming
data.
As I noted, core inflation has been moderate despite sharp
increases in energy prices. A key factor in this regard has
been confidence on the part of public and investors in the
prospects for price stability. Maintaining expectations of low
and stable inflation is an essential element in the Federal
Reserve's effort to promote price stability, and thus far the
news has been good. Measures of longer-term inflation
expectations have responded only a little to larger
fluctuations in energy prices that we have experienced, and for
the most part they were low and stable last year.
Inflation prospects are important, not just because price
stability is in itself desirable and part of the Federal
Reserve's mandate from the Congress, but also because price
stability is essential for strong and stable growth of output
and employment. Stable prices promote long-term economic growth
by allowing households and firms to make economic decisions and
undertake productive activities with fewer concerns about large
or unanticipated changes in the price level and their attendant
financial consequences. Experience shows that low and stable
inflation and inflation expectations are also associated with
greater short-term stability and output and employment, perhaps
in part because they give the central bank greater latitude to
counter transitory disturbances to the economy. Similarly, the
attainment of the statutory goal of moderate long-term interest
rates requires price stability, because only then are the
inflation premiums that investors demand for holding long-term
instruments kept to a minimum. In sum, achieving price
stability is not only important in itself; but it is also
central to attaining the Federal Reserve's other mandated
objectives of maximum sustainable employment and moderate long-
term interest rates.
As always, however, translating the Federal Reserve's
general economic objectives into operational decisions about
the stance of monetary policy poses many challenges. Over the
past few decades, policymakers have learned that no single
economic or financial indicator or even a small set of such
indicators can provide reliable guidance for the setting of
monetary policy.
Rather, the Federal Reserve, together with all modern
central banks, has found that the successful conduct of
monetary policy requires painstaking examination of a broad
range of economic and financial data, careful consideration of
the implications of those data for the likely path of the
economy and inflation, and prudent judgment regarding the
effects of alternative courses of policy action on the
prospects for achieving our macroeconomic objectives. In that
process, economic models can provide valuable guidance to
policymakers and over the years substantial progress has been
made in developing formal models and forecasting techniques.
But any model is by necessity a simplification of the real
world and sufficient data are seldom available to measure even
the basic relationships with precision. Monetary policymakers
must therefore strike a difficult balance, conducting rigorous
analysis informed by sound economic theory and empirical
methods while keeping an open mind about the many factors
including myriad global influences at play in a dynamic modern
economy like that of the United States. Amid significant
uncertainty, we must formulate a view of the most likely course
of the economy under a given policy approach while giving due
weight the potential risks and associated costs to the economy
should those judgments turn out to be wrong.
During the 3 years that I previously spent as a Member of
the Board of Governors of the Federal Open Market Committee,
the approach to policy that I have just outlined was standard
operating procedure under the highly successful leadership of
Chairman Greenspan. As I indicated to the Congress during my
confirmation hearing, my intention is to maintain continuity
with this and the other practices of the Federal Reserve in the
Greenspan era. I believe that with this approach, the Federal
Reserve will continue to contribute to the sound performance of
the U.S. economy in the years to come.
Thank you, Mr. Chairman.
Chairman Shelby. Mr. Chairman, we are in our last few
minutes of a vote on the floor. We are going to recess and we
will probably be back in 15 or 20 minutes, soon as we can get
here.
The hearing will stand in recess.
[Recess.]
Chairman Shelby. The hearing will come back to order. Mr.
Chairman, some Fed watchers speculate that the Federal Open
Market Committee may--may--continue to increase its Federal
funds rate target to 5 percent while others seem to believe
that 5.5 percent may be likely.
Do you regard either of these speculations regarding the
level as more likely than the other giving the FOMC forecast
that you have outlined today?
Chairman Bernanke. Mr. Chairman, as I mentioned, in the
statement following the January 31 meeting, the Committee
pointed to some potential pressures on inflation and suggested
that some additional firming may be necessary.
However, as you know, it is still about 6 weeks until the
next FOMC meeting.
Chairman Shelby. You will have to examine the data at
that----
Chairman Bernanke. We will be examining the data as it
comes in and, of course, my colleagues and I will have an
extensive discussion and we will be thinking about both our
inflation mandate and our full employment mandate as we make
our decision.
Chairman Shelby. To what extent, Mr. Chairman, does the
Federal Open Market Committee consider the long-term interest
rate in pursuing changes to the Federal funds rate? For
example, would the FOMC continue raising the Federal funds rate
even if the yield curve remains inverted in the months ahead
and will that be a factor or is that bothersome to you, the
inverted yield?
Chairman Bernanke. Mr. Chairman, the inversion of the yield
curve is due to a number of different factors which have
different implications for policy.
Chairman Shelby. But historically they meant something?
Senator Bunning alluded to that earlier.
Chairman Bernanke. That is true that historically an
inverted yield curve has often predicted slowing economic
activity. That relationship seems to have weakened in the past
15 years or so.
Chairman Shelby. Why?
Chairman Bernanke. Well, one of the reasons, as we looked
into it, is that the inverted yield curve is more likely to be
indicative of coming slowing when interest rates in general are
high, when real rates in general are high, because when real
rates in general are high, that tends to restrain activity.
We have an inverted yield curve at this point. It is due to
a number of factors which I can go into, if you are interested,
but the short-term, real interest rate is in a fairly normal
range and the long-term real interest rate is actually
relatively low historically speaking. So we are not overly
concerned about the implications of the inverted yield curve
for future economic activity.
Chairman Shelby. Mr. Chairman, your testimony also notes
the possibility of some risk which could add to inflationary
pressures such as high energy prices feeding into the prices of
nonenergy goods and services.
Your testimony further notes the risk to our economy due to
a slowing housing market you reference. What would be the
impact on the economy if both of these effects materialize to a
greater degree than is currently anticipated? How would the
Federal Reserve be likely to respond to such a scenario if you
found the pressure there from a double hit?
Chairman Bernanke. That would be a difficult situation
because, on the one hand, higher energy prices would put
pressure on inflation, but higher energy prices would also hurt
consumer budgets and would probably or could possibly lead
consumers to spend less. Together with weakening of the housing
market, which might also lead to a higher savings rate and
slower consumption spending, we would be in a situation with
pressures in both directions, and I cannot really offer much
more guidance other than to say that we would have to weigh the
relative severity of the two risks.
Chairman Shelby. If they were to come about?
Chairman Bernanke. If they both were to come about, and
then try to manage those risks in a way that would give us the
best outcome.
Chairman Shelby. You reference further in your testimony
your thoughts on global savings glut, with this glut being part
of the reason that the real interest rate in global markets is
low. In other words, there is a lot of money out there.
How does this factor into the Federal Reserve's growth
projections and how would you envision economic events
unfolding to bring returns back to more historical normal
levels?
Chairman Bernanke. Well, we were just discussing the
relatively low level of long-term real interest rates. I think
one of the factors relevant to the long-term, low, real
interest rates is that there is a lot of savings coming into
the global capital market, from emerging market economies and
from oil producers, which is looking for returns.
I think that over time, as the global economy continues to
grow and as those economies find more investment opportunities
in their domestic economies, that some of this global savings
glut may begin to dissipate, but I think that is likely to be a
relatively gradual process.
Chairman Shelby. Yesterday, did the market behavior reflect
an accurate interpretation of the Federal Reserve's report and
your comments? Do you think it is a good outcome when markets
receive enough signals to know what to expect about monetary
policy? Is that a prediction?
Chairman Bernanke. We are trying, and we have been for some
time trying, to be transparent and as clear as we can about our
strategy, our objectives, and our approach, and one of the
implications of that has been that interest rate moves have
been highly predicted by the markets, and I think, as a general
matter, that is good. It reduces volatility in financial
markets and makes policy actually more effective.
Chairman Shelby. Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman. I would like to
go back to the inverted yield curve for a minute. You were a
professor at this time. Maybe you remember this at Princeton.
In 1989, if I am wrong, I think you were a professor at
Princeton.
Chairman Bernanke. Yes, sir.
Senator Bunning. In 1989, even as the economy slowed, the
Fed continued to raise interest rates, and we had a recession.
The signs of the economic problems were ignored. Yesterday, you
stated that the inverted yield curve was ``not signaling'' a
slowdown. Those were your words--``not signaling.'' But in
recent economic history, the inverted yield curve has predicted
a recession, not just sometimes, but almost every time.
Now, the Fed has pushed interest rates to the highest level
in 4\1/2\ years. The January rate hike was the 14th consecutive
25 basis point move since the Fed began raising interest rates
in June 2004. You said you think we are not facing a downturn
because interest rates are lower now than in past inversions.
Do you have any other reason to think that this inverted
yield curve is not a warning, any other reason, other than we
started lower?
Chairman Bernanke. Yes, Senator. As I was indicating in my
testimony, we look at a wide variety of indicators. We do look
at the structure of interest rates and other financial asset
market prices, but we also look at a wide variety of indicators
in the real economy, and we are seeing very low unemployment
insurance claims, for example, and we are seeing strong retail
sales. We are seeing increased industrial production.
My comments notwithstanding about slowing of the housing
market, the level of activity in housing construction remains
strong, and so the economic expansion appears still to be on a
solid track. When we make policy, we have to think not only
about all these indicators, but we also have to think in terms
of a forecast. We look ahead and try to think where the economy
is likely to be at a period 6 months, a year, 18 months in the
future, and based on that forecast and the risk to that
forecast, we try to pick the best policy.
Senator Bunning. You know as well as I do that normal
everyday citizens do not borrow at the Fed funds rate, but
about a 300 basis point markup from that. So if Fed funds get
to 5\1/2\ percent, the prime rate for borrowing would be about
8\1/2\ percent. I do not know too many Americans that can
borrow at 8\1/2\ percent on prime rate. Most Americans pay
prime plus. So we are getting to the point, if the Fed moves
two more times, and Fed funds increase 25 basis points and 25
basis points, we are to that point, eight plus on prime.
Do you find that disturbing to the economy or would that be
just normal for our economic outlook?
Chairman Bernanke. Well, Senator, again, the choices we
make will be conditioned on our views of where the economy is
going and what interest rates are needed to give us the best
combination of growth and low inflation. The interest rates we
currently see are in some cases historically low. Take mortgage
rates, for example; they are about 6\1/4\ percent right now
which is relatively low historically.
It is not really a question of comparing it to rates at
another period of time, but rather asking, given those rates,
what will be the level of activity in the economy? Will we be
on a path that is strong and sustainable going forward? So we
will try to do our very best to get the best outcome we can for
the American people.
Senator Bunning. Do you not think with the past history of
the Fed and looking at interest rates, when we get them too
high, the economy kind of does a little swan song and turns
over for awhile and we have some kind of a recession? I am
talking on Fed funds. Do you see that happening in the future
or do you see that you would anticipate that before it
happened?
Chairman Bernanke. Senator, there are two possible
mistakes. One is to go on too long and one is not to go on long
enough, and it is a very difficult balancing act, and as I said
earlier, we do not have any kind of mechanical rule. We do not
have built in any kind of set of future moves. As we go along,
we are going to be looking carefully at all the data, trying to
make our best assessment where the economy is, where it is
going, and respond to that.
Senator Bunning. Last question. Is there a lot of
discussion at the FOMC meeting on this very topic when you
meet? In other words, it is not that the Chairman leads and
everybody follows?
Chairman Bernanke. There is extensive discussion and I look
forward to getting a lot of input from my colleagues on the
FOMC.
Senator Bunning. Thank you.
Chairman Shelby. Senator Bayh.
Senator Bayh. Mr. Chairman, I would like to follow up on my
brief comment in the introductory component here about our
increasing global interdependence, some advantages, benefits
that come from that, also some potential threats to both our
economy and our national security, potentially even our
sovereignty, and that is what I would like to ask you about.
And increasingly, these are not hypothetical risks. Let me
start by remembering, it was a year or so ago, maybe a year and
a half, there was a rumor going through Seoul, Korea that they
were going to begin to diversify out of dollar denominated
assets, and for a brief period of time, that sent the U.S.
dollar into a free fall.
Sometime after that, a matter of months, the Prime Minister
of Japan misspoke, and similar phenomenon followed. He said we
perhaps will start diversifying out of dollar denominated
assets; the dollar headed straight down. Someone from the
ministry comes out and says, no, no, the Prime Minister
misspoke.
My question to you is twofold. Number one, does it trouble
you that a mere statement by a foreign leader could have such a
profound effect on our Nation's currency? And number two, what
if the Chinese were to misspeak? Or even more, what if they
were to announce a similar policy? What kind of impact would
that have on our currency and should we be concerned about
that? Is there not a loss of sovereignty involved in such a
situation? So does this bother you that a mere misstatement can
impact in our currency in a tangible way? And what about the
Chinese and their possible course of action in the future?
Chairman Bernanke. Senator, as you know, the Chinese
central bank and other Asian central banks do hold large
quantities of U.S. dollar assets in the form of foreign
exchange reserves. They hold those assets because they are very
attractive assets to hold. They are highly liquid, they are
very safe, and they are very good assets to hold in that form
as reserves. I am not aware of any significant changes in the
plans to hold U.S. dollar assets by foreign central banks and
my belief is that moderate changes in the holding of dollar
assets would not have significant impact on U.S. asset values.
You have to remember that whereas Chinese holdings of U.S.
dollar reserves of about $800 billion is an enormous number----
Senator Bayh. Could I interject just for a moment, Mr.
Chairman, with my apologies? Boy, when the rumor was going
through Seoul and the Japanese Prime Minister misspoke, the
markets seemed to disagree with your evaluation and we are more
reliant on the Chinese than we are either of them. So I want
to--look, I do not expect you in an open forum here to give
me--let me just fall back on my first question, and we will
kind of save the others for a little bit later.
Does it trouble you that a mere statement could have that
kind of impact at least in the marketplace?
Chairman Bernanke. Well, I cannot speak to the marketplace,
but I think that over a longer period of time, always there is
information that comes in that can affect markets. Perceptions
can affect markets. Psychology can affect markets. But over a
longer period of time, the holdings of U.S. dollar assets by
foreigners are only a portion of the very deep, very large
markets in U.S. dollar assets, not only in treasuries but also
in other high quality assets, such as corporates and the like,
and I believe that those markets are sufficiently deep and
liquid that they can withstand moderate changes in the holdings
of any group, whether it be domestic or foreign.
Senator Bayh. I have time for one more question so I will
move on. And I hope you are right. But with the kind of
imbalances that we are building up, we may be testing the
definition of moderate adjustments and that is my concern going
forward, that the longer these things accumulate, the greater
risk we run that there will be a disorderly rather than an
orderly adjustment of some kind and that does put us--last
comment I would make is I always hear the argument, well, they
have to consider their own financial interests and that is
true.
But nation states sometimes have interests other than their
own pecuniary gain, and I am concerned that we rely upon their
financial interests perhaps at our peril because there are
other interests that might motivate their actions moving
forward. That is my concern as these balances pile up.
My final thing is somewhat related. It is the energy front.
This is no longer a hypothetical concern. Russia used their gas
exports to leverage Ukraine and possibly Western Europe. Iran
has now said, well, if you pressure us unduly on our nuclear
program, we will just shut off the oil spigot. Does that
concern you, and if so, what would the impact be on our economy
if the Iranians were to make good on their threat?
Chairman Bernanke. Once again, of course, it cuts two ways.
It would hurt the Iranians quite a bit to stop exporting their
oil. It hurt the Russians quite a bit to stop exporting their
natural gas. But I agree in the following general sense, that
whereas there are substantial reserves of oil and natural gas
in the world, a large share of them are in areas where there is
geopolitical uncertainty or geopolitical risk, and that means
that is a risk factor for the economy.
We do not have a wide range of spare capacity in these
energy areas so that a major change in the supply of energy
available could make prices move a lot and that could have a
major impact on the economy. That is a concern that we are
going to have, I think, for a number of years. My view, in the
long-run, is that with energy prices at current levels, over a
longer period of time, there are going to be substantial new
substitutes, alternative sources of energy, as well as new ways
of conserving and reducing the use of energy.
But over the next few years, our room for error is modest
and we do face the risk that energy prices may fluctuate with
changes in supply.
Senator Bayh. Thank you. My closing comment, Chairman
Bernanke, would be, you know, interdependence is one thing,
increasing dependency is another, and it raises potential risks
that we best think about in advance so that we do not face a
potentially difficult situation at some point down the road.
That is the underlying theme of my remarks. Thank you very
much.
Chairman Shelby. Senator Sarbanes.
Senator Sarbanes. Thank you, Mr. Chairman. Actually, I want
to pursue a line of questioning that just follows along with
what Senator Bayh has been examining in the course of his
questioning, which I thought was right on target and, of
course, this is an issue--he chairs our Subcommittee in the
international arena--and this is an issue on which he has
focused and made some very substantial and positive
contributions.
Chairman Bernanke, you said to Senator Bayh, they like to
hold our dollar assets. They are attractive to hold. I am
interested whether there is not something more than that here.
Now, these dollar assets, at least according to Marty
Feldstein, are being purchased by foreign governments
primarily, not by foreign individuals. Feldstein writing in the
Financial Times on January 10 said:
My own belief, based on widespread conversations with
officials and with private bankers, is that the inflow of
capital that now finances the U.S. current account deficit is
coming primarily, perhaps overwhelmingly, from governments and
from institutions acting on behalf of those governments.
Do you agree with that statement? Is that your perception
as well?
Chairman Bernanke. We do not have complete information on
these numbers, as you know, Senator, but I do not agree with
the thrust of the statement. I think that there are substantial
private sector inflows that play a big role in the financing of
the U.S. current account deficit.
Senator Sarbanes. If Feldstein were right, that the holders
or that this inflow is primarily from foreign governments,
would that raise your concern, or do you have any concern about
the current account deficit? Let me start there first. I mean
it is now at, well, the trade deficit is at $725 billion last
year. That is the largest figure we have ever had for a trade
deficit. Is that a matter of concern for you?
Chairman Bernanke. Yes, Senator, it is.
Senator Sarbanes. Okay. All right. Now, if Feldstein is
right, that it is foreign governments that are putting in the
capital, would that cause you added concern?
Chairman Bernanke. I do not think he is correct, Senator.
There is something on the order----
Senator Sarbanes. No, I understand that, and that would
require presumably some factual examination, but if he were
right, would that heighten your concern?
Chairman Bernanke. It depends really on which type of
investor is more sensitive to changes in yields. Central banks
have actually been less sensitive to changes in yields than
private sector investors.
So, I cannot say a priori which situation would be one of
more concern. I think it is really not so much the portfolio
situation; it is the fact that we are accumulating foreign debt
over time, year by year. We can do that because foreigners are
willing to finance that debt, but I do not think that we can
continue to finance the current account deficit at 6 or 7
percent of GDP indefinitely, and it is desirable for us to
bring down that ratio over a period of time.
Senator Sarbanes. Now it is your view, I take it, that they
are doing this because these are attractive investments; is
that right?
Chairman Bernanke. Attractive in not only the return sense
but also in the sense that they are safe, liquid, and easily
negotiated.
Senator Sarbanes. Well, now if the governments are doing
it, would it not have an added significance in terms of trying
to gain a trade advantage? Now this is the change in foreign
currencies versus the dollar, the appreciation.
[Chart.]
Senator Sarbanes. This line is the euro, which generally is
seen as free floating, responding in a market forces and so
forth, the euro-dollar relationship. And this line down here is
the Chinese currency, the yuan, right down here.
Now that is a pretty dramatic contrast. And China, which of
course is holding more and more of our Government debt,
actually our trade deficit with China last year was a record in
terms of the trade deficit ever recorded with a single country;
is that correct?
Chairman Bernanke. I believe so.
Senator Sarbanes. Over $200 billion. Does this not enable
them to gain an unfair trade advantage?
Chairman Bernanke. Senator, if you are asking me whether I
would support or advocate that the Chinese go to greater
flexibility in their exchange rate, I certainly would.
Senator Sarbanes. Yes.
Chairman Bernanke. I think it is, in fact, in their own
long-term interest to do so for a number of reasons. It will
give them more monetary policy independence. It will reduce the
overdependence of their economy on exports and I think it will
be commensurate with their increasing global role for them to
take an interest in the overall stability of global financial
markets and trade.
Senator Sarbanes. But if they can do this on the currency
relationship, does it not give them a step up in the trade
relationship?
Chairman Bernanke. To the extent that their currency is
undervalued, it does, yes.
Senator Sarbanes. Yes. In fact, we are becoming more and
more dependent. Tennessee Williams has that wonderful line in
``A Streetcar Named Desire'' where Blanche DeBois says
dependent upon the kindness of strangers, and there are some
who look at the American economy and are increasingly concerned
that that is what is happening.
I quoted Warren Buffett earlier in my opening statement
saying right now the rest of the world owns $3 trillion more of
us than we own of them. In my view, it will create political
turmoil at some point. Pretty soon, I think there will be a big
adjustment.
Aren't the Chinese accumulating a leverage over our
decisionmaking as a consequence of increasing so substantially
these holdings of our Government debt?
Chairman Bernanke. First, Senator, I think the $3 trillion
should be put in some context. If I recollect, there is
something like $15 trillion gross holdings of U.S. assets from
foreigners and U.S. holders own about $12 trillion foreign
assets, so that is a net number, part of a much bigger flow of
in and out of capital.
Senator Sarbanes. But that is a big change from what it
used to be----
Chairman Bernanke. We have much more open capital markets.
Senator Sarbanes. --not so long ago; is it not?
Chairman Bernanke. Yes, we have much more open capital
markets, much greater capital flows, and it is worth noting
that U.S. national wealth as of the third quarter was $51
trillion to compare that to the $3 trillion.
Now, as I said, I think that we should work to reduce the
current account deficit over time. I think that would reduce
the possibility of an uncomfortable adjustment process. But,
again, as I said earlier in response to Senator Bayh, I do not
think that the Chinese ownership of U.S. assets is so large as
to put our country at risk economically.
Senator Sarbanes. You do not think they could use it for
political purposes?
Chairman Bernanke. It would be very much against their own
interest to do so.
Senator Sarbanes. Well, it would be against their economic
interest. It might not be against their political interests in
the particular context of what the issue might be. I mean we
are struck by the fact--Senator Bayh, I think, made reference
to it--a South Korean Government official, and of course their
holdings are much less, but still substantial, made a comment
about South Korea continuing to hold the dollar, maybe that
they would not do it and so forth, and it sent the stock market
down over 150 points. Of course, then everyone scrambled and he
pulled the statement back and so forth.
But if it can have that kind of impact, is it not
suggestive of the leverage that the Chinese may have in this
situation, or others as well for that matter, but I mean since
the deficit with China was at a record last year, I am focusing
on them?
Chairman Bernanke. Again, information, psychology, and news
can always affect markets in the short-term, but I think that
over a longer period of time that the depth and liquidity of
U.S. financial markets would be sufficient to sustain changes
in holdings by foreign central banks.
Senator Sarbanes. Mr. Chairman, I see my time is up. I just
want to, in closing----
Chairman Shelby. Take another minute.
Senator Sarbanes. --when we talk about the deterioration
and the net international investment position, when you talk
about so much, this is the chart which illustrates what has
happened.
[Chart.]
Senator Sarbanes. The first line back there is 1980. We had
a positive net position. We then went into a negative position,
but look at what has happened to it in recent years. I mean if
you regard a minus or a negative position as something to worry
about, it seems to me we have very good reason to be worried
about what has happened to our net international investment
position.
It is no wonder Buffett is saying this or Volcker says,
``Under the placid surface there are disturbing trends, huge
imbalances, disequilibria, risk, call them what you will. All
together the circumstances seem to me as dangerous and
intractable as any I can remember, and I can remember quite a
lot.''
Thank you, Mr. Chairman.
Chairman Shelby. Thank you, Senator Sarbanes. I want to
shift to Basel II capital requirements, Mr. Chairman. The
Federal Reserve is presently in the process of implementing the
Basel II Capital Accord, which will establish new capital
requirements for our largest banks.
Capital requirements play a vital role in protecting the
safety and soundness of the U.S. banking system. I think it is
very important that there be no surprises to this Committee and
others in the implementation of Basel II, especially
unanticipated reductions in capital requirements.
Last year, Chairman Bernanke, this Committee held a hearing
at which several witnesses here expressed concerns that the
adoption of Basel II would result in the lowering of capital
requirements. In addition, last year, the Fourth Quantitative
Impact Study, unexpectedly, Mr. Chairman, showed that Basel II
would result in substantially lower capital requirements which
gives then this Committee concern.
What steps, Mr. Chairman, need to be taken to make sure
that Federal banking regulators, and you are one of these
regulators, Congress and the public at large are confident that
the implementation of Basel II will not, will not adversely
impact the safety and the soundness of the banking system that
we know today?
Chairman Bernanke. Mr. Chairman, let me just assure you
that the Federal Reserve does not want to see a significant
reduction in capital in the U.S. banking system. We are
prudential supervisors. We have a very strong interest in
maintaining a safe and sound banking system and a stable
financial system.
We are planning a very slow phase-in process, one that will
involve considerable consultation, will involve a variety of
safeguards such as floors that will be phased out over a period
of time. Moreover, there are a number of other safeguards such
as the leverage ratio and Pillar II which allows the
supervisors to evaluate the overall safety and soundness of the
bank and look at such things as compliance risk or interest
rate or liquidity risk.
We are very much on the same page as you are, Mr. Chairman.
We think Basel II is very important because it will allow
banks' capital holdings to be sensitive to the risks that they
take, and it will be consistent with modern risk management
techniques, so we think it is important to move forward with
Basel II. But we do not see this, we certainly do not want
this, to be a source of a significant reduction in aggregate
capital in the U.S. banking system.
Chairman Shelby. Senator Sarbanes wants to be recognized
now. Go ahead.
Senator Sarbanes. Mr. Chairman, I just want to observe that
is kind of calming the waters in terms of assurance. Vice
Chairman Ferguson did that when this Basel II was under his
jurisdiction. Mrs. Bies has it now, I think, in her portfolio.
And he told us that they were not going to lower capital and so
forth and so on.
But you ran the formula in the QIS-4 and it resulted in
very substantial capital reductions. Everyone said, the
regulators all rushed to say, well, we do not want that; that
is not where we want to go. We do not intend to do that if the
Congress raises questions about it. But you are moving ahead
with a proposed regulation, as I understand it, that is still
utilizing the same formula that produced the QIS-4 result, and
you are saying, well, if it produces these bad results, we will
take all kinds of band-aid measures in order to contain it.
But why would you not pull the regulation back, develop a
revised formula as part of the proposed regulation, which upon
testing did not produce these kind of results about which
everyone says, oh, we are very concerned about it, and yet they
move ahead with the proposed regulation, still encompassing the
formula that everyone admitted created a terrific problem?
Chairman Bernanke. Senator, the QIS-4 results were on a
best efforts basis. The banks did the best they could with the
information they had. They had not yet developed the models.
They do not have all the data they need. It was just a very
experimental kind of study. In order for this to be really put
to the test, the banks need to have the guidance from the
regulators about what our expectations are so that they can
actually go ahead and develop the models, get the data, and
take this to the next level.
They really cannot proceed with the process and allow us to
do further analysis without some guidance from us. This is very
much a dialectical process. We are going to provide guidance,
we are going to see the results, we are going to get
commentary, and we are going to work together with the banks to
make sure that the bank capital is adequate.
Senator Sarbanes. I understand all that, but why are you
moving ahead with a formula that has been shown to be faulty?
Why do you not pull back and develop a different formula?
Chairman Bernanke. We are adjusting the formulas based on
what we have learned and we will continue to do so.
Senator Sarbanes. What is going to happen, and I just sound
a warning, is you are going to continue down this path, you are
going to become more committed, as it were, to your
international partners. You are already very heavily committed,
I think overcommitted, because you have moved way ahead there,
created a problem, and then one day the Congress is going to
say to you wait a minute, this is not the path we want to go
on; this path is going to lead to a significant reduction in
capital. And somehow or other we are going to put a stop to it.
Now that is the potential that I see developing by what I
think is a faulty process. I think once you had these bad
results from the QIS, you should have pulled back, revised the
formula, and gone back into a--so when you moved ahead on the
process, you had some confidence it was meeting all of these
concerns. You are moving ahead on a process now that still has
within it the very seeds from which all this concern flows.
Chairman Bernanke. Senator, first, we cannot really
evaluate the formulas unless we see the results from the banks'
own models and their own analyses. There needs to be a dialogue
process going on so that we can continue to learn, and second,
it is, after all, a very flexible framework that allows for
capital under Pillar II. It allows for multipliers and other
changes.
I hear you very clearly and I assure you once again that it
is not in the Federal Reserve's interest to allow inadequate
capital in the banking system because financial stability is
one of our primary objectives.
Senator Sarbanes. Let me just add. Is it a conflict for the
banks, to look to the banks to develop the model since the
banks stand to benefit in significant ways if they can lower
the capital requirement? It will enhance their competitive
position vis-a-vis other banks in the U.S. and it will keep
them, or they would argue presumably, in a competitive position
vis-a-vis banks in other countries that are moving to Basel II.
So you keep telling me, well, we are looking for the banks
to give us the models, but don't the banks have a particular
vested interest in what they want the models to produce?
Chairman Bernanke. Well, actually we are looking for them
to give us statistical indicators of their own loss experience
in their past credits. And part of the process will be
validation. That is, they have to show us that their numbers
were derived from their actual experience over a period that
encompasses both strong and weak credit conditions and that
they are using those models for their own internal analysis of
capital. So there will be a lot of checks and we will continue
to work with the banks and with the Congress on this issue.
Chairman Shelby. Mr. Chairman, before I recognize Senator
Carper for his first found of questions, I just want to
emphasize that Senator Sarbanes and I have talked at length to
our counterparts in the House, Democrats and Republicans. They
have the same concerns we do. We have all been on this
Committee--Senator Sarbanes and I have been on this Committee
during the thrift bailout and everything. We believe that
capital is very, very important for the safety and soundness of
our banking system, period.
Senator Carper.
Senator Carper. Mr. Chairman, I think I would like to ask
you a human question before we get into some of the other
things I mentioned earlier. I told you I wanted to talk about
our savings rate, our poor savings habits in this country, and
I wanted to talk about the interplay between the trade deficit
and the budget deficit and potential impact on interest rates.
But just really a human question at first. You have been in
your new job for how long?
Chairman Bernanke. Oh, about 14 days now.
Senator Carper. And we were talking in the anteroom before
we came in, and I was asking you how you are doing as a human
being. And you mentioned jumping right into these hearings 2
weeks into the job was a challenge, and I can understand that.
But where does so far 2 weeks into this job, where does it meet
your expectations; maybe where is it a little bit different
from the expectations you had for it?
I say that recognizing that you are probably uncommonly
well prepared for this position.
Chairman Bernanke. Well, it has been very challenging and
very interesting, and I do have the benefit of having spent
almost 3 years at the Board as a Governor, and that experience
has been invaluable in trying to address the wide range of
issues the Federal Reserve deals with.
Senator Carper. You will be scheduled to come back before
us when? About 6 months or so from now?
Chairman Bernanke. That is correct.
Senator Carper. And one of the questions--this is
telegraphing my pitch--but one of the questions I will ask you
then is with 6 months of experience under your belt, how do you
see the world or this job, your responsibilities, differently,
if at all, then than you do as you assume these
responsibilities?
Let us talk about savings rates. Just share with us, if you
will, your view of the kind of job we are doing as savers in
this country, where we might do better, and some things that
not just the Federal Reserve but those of us in the Congress
should be thinking about to encourage a better savings rate?
And why should this or should this not be a concern to us?
Chairman Bernanke. Senator, this actually ties back to the
questions raised about the current account, for example. The
reason we have a current account deficit is that we invest
more, including housing, than we save, and we have to make up
the difference by borrowing abroad, so our national saving is
not sufficient to fund our domestic investment opportunities.
It is a good thing in a sense that we are able to go to the
international capital markets and find funding for good
domestic investment opportunities, but we would be better off
in some sense if we ourselves could fund those investment
opportunities creating more wealth for Americans and greater
capacity in the future for us to deal with the long-term
challenges associated with demographic changes and the like.
So, I think it is desirable for us to try to raise our
national saving. There are various dimensions to that. One is
on the fiscal side. We are looking in the next 5, 10, 15 years
to increasing obligations and entitlement spending, for
example, and increasing challenges in the Government's budget.
Congress is going to have to make some very tough decisions
about controlling the deficit, and by doing so, to the extent
that the deficit can be reduced, that is a direct contribution
to national saving and would be constructive.
In addition, Americans, in part because of the increased
wealth they have gained through increased home values and
through other asset price increases, have not saved too much
out of current income. In fact, the current saving out of
disposable income is a negative rate.
Senator Carper. Say that one more time.
Chairman Bernanke. The savings rate, the ratio of household
savings to after-tax income, is currently less than zero. That
is, spending is more than income. Our expectation is that that
saving rate will increase over time for a number of natural
reasons, including the possibility that house prices will no
longer rise as quickly as they have and so people will be
forced to turn to saving out of current income in order to
build their assets.
But in addition, it would be desirable for Americans to
save more to prepare better for the future. The problem is we
do not have really good effective tools to achieve that. There
are obviously ways of providing tax incentives or other kinds
of tax-favored vehicles to help people save.
There is a lot of debate about how effective those actually
are and I really cannot give you a strong answer there. One
thing which I think can be done and would be positive would be
on the financial literacy front. When I was on the school board
in New Jersey many years ago, I argued for more economics in
the schools. I thought that it was very important for young
people to understand early on that they need to put something
away; they need to develop a habit of saving, and they need to
understand enough about financial markets and financial
instruments that they can save effectively.
So that is one dimension where I think we can be helpful,
but I agree that saving is something that needs to be promoted
and that it is good for our long-term future to have greater
wealth accumulation.
Senator Carper. I would just say, Mr. Chairman, and to my
colleagues and to Chairman Bernanke, in our experience in
Delaware, trying to get people to save through the State of
Delaware's deferred compensation program, State employees,
people who were higher income, and there are not very high-
income State employees in Delaware, but people whose incomes
are higher tend to save a lot. They maxed out in the deferred
comp program.
But in order to get the people who were at the lower end to
save, we had to be able to provide some incentives for them,
and to say for every dollar that you save, we will like match
it with two dollars, and to get to prime the pump, and once we
did, they would participate.
And the other thing I would say, for most of us, the
biggest source of savings is really the equity in our homes,
and to the extent that we can include homeownership
opportunities not for people like $150,000 or $200,000, but to
the people who are making $25,000, then we do a very good thing
for them as they prepare for their golden years.
Thank you, sir.
Chairman Bernanke. Thank you.
Chairman Shelby. Senator Schumer for your first round.
Senator Schumer. Thank you, Mr. Chairman, and I thank you,
Chairman Bernanke--that has a nice ring to it. I am glad you
are here. I thought your confirmation process was both a
tribute to you and a model of how we should do other
confirmations, particularly on other Committees on which I
might serve or do serve, with a lot of consultation,
bipartisanship, et cetera.
I have a bunch of questions. The first relate to the
overall global situation of the United States and as it relates
to China. You said yesterday that we need to increase national
savings as one of the ways to deal with our big trade deficit
with the rest of the world and China.
Yet, the budget we passed 2 weeks ago increased the debt we
have further and there is a push to put new tax cuts in that.
Now, I am not asking you to opine on tax cuts. I know you do
not want to do that.
I do want to ask you does it make sense, from a global
perspective, for us to continue to increase this deficit,
whether it is by tax cuts or increased savings? Does that not
weaken the position of the United States in trying to
accomplish many of our other international economic goals?
Chairman Bernanke. As I indicated to Senator Carper, I
think reducing the fiscal deficit is an important priority. It
is important because looking forward 10, 15, 20 years, we have
a demographic challenge coming, and we need to be prepared for
that, and it does contribute to national savings which enhances
our wealth creation and the strength of our economy in the
future.
So, I do think that we should look at that. There really
are two separate questions. I just would note the first one is
the size of the Government itself. I mean what we should agree
on how big the Federal Government, that is the Federal budget,
should be, and then we need to make sure that the revenues we
collect are commensurate with those expenditures over a period
of time.
Senator Schumer. You do agree that, again, now looking more
at the type of actions that Senator Graham and I have been
active in, not commenting on our methodology, that it would be
better for the world economy and for the United States if China
were after some point of time to allow its currency to float,
which would adjust for trade imbalances that would occur. Do
you agree with that?
Chairman Bernanke. Yes, Senator, I do. I think China should
move toward a more flexible exchange rate.
Senator Schumer. And why do you think we are making so
little progress with China right now?
Chairman Bernanke. That is a good question. They have, I
think, mixed views about the benefits to their own economy of
making that change.
Senator Schumer. Right.
Chairman Bernanke. They see some benefits in what they view
as stability. They see an advantage in exports from keeping
their exchange rate where it is. But as I was suggesting, I
think, to Senator Sarbanes, it is very much in their interest
to move toward a more flexible exchange rate to increase their
monetary independence, to reduce their reliance on exports, and
just to continue to play an appropriate role in contributing to
global financial and trade stability.
Senator Schumer. Right. And I agree with the thrust of your
comments there. The Chinese seem to want a lot of the benefits
of being part of the global system, but are much less quick to
take their responsibilities.
What would you suggest to people like Senator Graham and I?
Now make no mistake about it, our legislation is very popular
in Congress, but lots of economists and people I respect say
you are right on your goals and you are right that China is not
moving quickly enough, but this is the wrong way to go.
The problem is we are ready to tear our hair out. There
seems to be no other way to go. The Administration has tried
talking softly and talking loudly. It just seems nothing gets
them to move. Do you have any suggestions on how we can get the
Chinese to let the currency float? No one is saying it has to
float freely, completely, immediately. There have to be
adjustments. But what can we do other than the legislation that
Senator Graham and I have introduced?
We do not see any other solution at this point. The Chinese
say to us if you put pressure on us, we will not move, and then
when we do not put pressure on them, they do not move.
Chairman Bernanke. I appreciate your frustration, Senator
Schumer. As you probably know, I think it is not a good idea to
break down some of the gains we have made in terms of free and
open trade in the world economy. We should be very careful
about that.
But in terms of working with China, there are really two
things we can do. We can continue to try to be persuasive and
we can try to offer technical assistance in helping them. They
have taken some steps in terms of increasing their trading
platforms and their capacity to allow the exchange rate to
float. I agree they need to do more and we just need to
continue to work with them and be as persuasive as possible.
Senator Schumer. One final question on this, if I might,
Mr. Chairman.
Chairman Shelby. Go ahead.
Senator Schumer. Doesn't the fact that China and other
countries, Japan, have such large amounts of American reserves
mean that they could, if they wanted, actually have a little
bit of your job, have some effect over interest rates in the
United States by what they do?
Chairman Bernanke. As I indicated already this morning, I
think that the capital markets for U.S. dollar assets are
sufficiently large, deep, and liquid that the impact of such
changes would be mostly transitory and could be managed.
Senator Schumer. Thank you, Mr. Chairman.
Chairman Shelby. Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman. We are on 5
minute round of questions, are we not?
Chairman Shelby. Or as much time as you need.
Senator Bunning. Thank you. Just to follow up on Senator
Schumer's discussion about China. We took six Senators to China
to talk trade with the Chinese. They would not even visit with
us. Six U.S. Senators, five were on the Trade Subcommittee of
the Finance Committee, and we got number six in line in the
Chinese bureaucracy and he knew nothing about trade.
So, I just want you to know what a problem there is, and we
worked like the devil to get them into the WTO, and I wish that
they would just follow the rules of WTO. That is an aside.
Yesterday, you talked a lot about our budget deficits and
particularly our long-term obligations that are only going to
increase. You also rightly said those decisions are ones that
Congress needs to make. How much of a factor are those long-
term entitlements in your economic forecast? I am speaking
about Medicare, Medicaid, and Social Security.
It looks like by the year 2030 that they will take up about
70 to 75 percent of our budget. So we will be squeezed down to
about 25 percent for discretionary spending. So how much do
they come into your forecast?
Chairman Bernanke. Senator, your basic facts are absolutely
right. The numbers I have are that in the next 40 years the
share of GDP being devoted to Social Security, Medicare, and
the Federal part of Medicaid is going to go from about 8
percent today to about 16 percent 40 years from now.
Since the historical share of GDP collected as tax revenues
is something in the order of 18.2 percent, that suggests there
will be very little room in the budget for anything other than
entitlement spending and suggests it is very important for
Congress to begin thinking about how it wants to reorder or set
its priorities.
It is important to get that going soon, first of all, to
assure financial markets that Congress will be responsible and,
second, and perhaps even more importantly, to give people the
time they need to plan for retirement and make provision based
on any changes that Congress might decide to make.
In terms of our forecast, as I reported today, are usually
only a year or two in the future, uncertainty being what it is.
So only the near-term effects are reflected in our forecasts.
We are already beginning to see some effects of entitlement
spending on the budget deficit. We factor that in, but since we
are only looking at the near-term effects, we obviously are not
incorporating these very large, long-term entitlement
obligations into the near-term forecasting exercise.
Senator Bunning. If nothing is done to shore up these
programs, and I am speaking about entitlements, for several
more years, what kind of impact is this going to have on our
economic growth and employment and how will that affect your
ability to act?
Chairman Bernanke. Well, the widening deficits over a
period of years will reduce national savings, will probably
exacerbate the current account deficit, may raise interest
rates, and will probably inhibit the dynamism of the economy.
I do not foresee, in the near-term, that these factors are
going to substantially affect monetary policy or the way
monetary policy functions in the economy, but from a broader
perspective, the health of our economy, in the long-run,
requires that we achieve a better fiscal situation and higher
national saving.
Senator Bunning. In reference to the trade deficit, how
long do we have to reduce trade imbalances before our economy
starts to suffer because of them?
Chairman Bernanke. Senator, it is very hard to judge. It
took us about 10 years to get where we are today from about
1995 when the current account deficit began to open up. It
might take that long to reverse. It might take a number of
years to reverse, and I think that it is certainly possible to
have a decline in the current account taking place over a
number of years, but it is very hard to judge exactly how long
the process is going to take.
Senator Bunning. Thank you, Chairman.
Chairman Shelby. Mr. Chairman, the January survey of senior
loan officers indicated that 40 percent of respondents felt
that the outlook for delinquencies and chargeoffs of
nontraditional mortgages was likely to deteriorate somewhat.
Would this type of credit quality deterioration be
consistent with the forecast that you outlined for a soft
landing in housing markets? And do you believe that bank
regulators including the Fed, yourself, acted quickly enough in
putting out supervisory guidance regarding these types of
nontraditional mortgage products?
Chairman Bernanke. I cannot really speak to the timing. We
have put out----
Chairman Shelby. First of all, I realize you have just gone
to the Fed.
Chairman Bernanke. We have put out guidance for comment on
nontraditional mortgages and I think that it is good guidance.
It addresses what I think are the main issues. First, are banks
underwriting nontraditional mortgages in an appropriate way? In
particular, are they selling these mortgages to people who are
able to manage them effectively?
Chairman Shelby. Will you as a regulator at the Federal
Reserve require banks to take any additional steps to mitigate
the risk and how might these steps affect the economy if you
see it is necessary?
Chairman Bernanke. Mr. Chairman, as I was saying, the
guidance includes several components, including both
underwriting and consumer disclosure to protect consumers, but
also safety and soundness. The banks should manage the risks
associated with nontraditional mortgages in a way that
maintains their capital at a safe and sound level.
Chairman Shelby. Your report this morning, Chairman
Bernanke, indicates that growth in labor productivity over the
past 5 years has averaged over 3 percent per year.
For the fourth quarter of 2005, it declined 0.2 percent in
the business sector and 0.6 percent in the nonfarm business
sector. The productivity declines were unexpected by most
market watchers.
What is your assessment of these numbers? Do they represent
a one time aberration or are they indicative of things to come?
Do you believe it is possible for us to sustain the pace that
we have seen over the past 5 years?
Chairman Bernanke. Mr. Chairman, the fourth quarter appears
to have been a transitory decline in growth related to a number
of special factors, including effects of the hurricanes, the
seasonal pattern of sales of automobiles, and some other
factors as well.
So with output down more than the underlying trend would
indicate, productivity, which of course is output per worker,
also declined in the fourth quarter.
Chairman Shelby. Think that will continue?
Chairman Bernanke. It appears that the first quarter will
see significant rebound from the fourth quarter and likely
productivity will come back with it. We, in the Federal
Reserve, pay most attention to productivity growth over the
longer-term, and the ability of the U.S. economy to generate
ongoing productivity gains through use of technology, through
the flexibility of our labor and capital markets has been most
impressive. And we expect good productivity gains to continue
for the next few years.
Chairman Shelby. Thank you. Senator Bennett for your first
round.
Senator Bennett. Thank you, Mr. Chairman. I apologize for
coming in late. I have been over in the House side chairing the
meeting of the Joint Economic Committee to hear the President's
Annual Economic Report from the Council of Economic Advisors,
and they miss you, Mr. Chairman, but they acquitted themselves
extremely well, and your former colleagues did a great job.
Let me focus on an area where you had questioning on the
House side where some of your comments were, shall I say, not
the ones that I would have wanted. I want to talk to you about
ILC's. I am sure that comes as no surprise to you. Being the
Senator from Utah, I represent the State where the ILC's are a
very significant industry.
I have not had a chance to review the transcript directly.
I have been told by one of the Members of the House who was
there that you were told that some ILC's have failed, and that
is not true.
Chairman Bernanke. I was not told that.
Senator Bennett. Okay. I want to get the record straight on
that. The ILC's are back in the news right now because of Wal-
mart's application, and people are saying, well, we have to
prevent Wal-mart from getting an ILC charter. That is just
awful. No one wanted to prevent Target from getting an ILC
charter, and I have a hard time understanding why it is okay
for one large retailer to have such a charter and not for its
competitor to have such a charter.
I have talked with the Wal-mart executives. I believe they
are sincere in their statement that they do not intend to go
into the banking business. Indeed, they are signing long-term
leasing contracts with community banks, community banks
entering Wal-mart with their own branches. The Wal-mart people
told me we have looked at this, but we are not bankers, we are
retailers, they are different businesses, and we do not want to
go into a business we do not understand.
However, simply getting an ILC charter will save Wal-mart
$30 million a year in processing fees to a bank. If they are
technically a bank, they do not have to pay another bank to
process all the charges, all the credit card charges, all the
checks, and money orders, et cetera, that they process. They
will process them themselves through their ILC. It is worth $30
million a year to them.
I do not see anything wrong with that, and I hope the FDIC
does not see anything wrong with that. They are the regulator
of the ILC's. For years, the staff at the Federal Reserve has
felt strongly that the FDIC is not capable of regulating the
ILC's and they either want them destroyed or short of that,
they want them transferred to the Fed, so that the Fed oversees
them.
I see no market reasons why that is necessary, no
circumstances in the real world that says the Fed could do a
better job than the FDIC. So, I would like your responses to
that and your comments about the ILC's, your attitude as to how
dangerous they may be, and any data that you might have to back
that up, and then your sense of what would happen to the ILC's
if indeed the Fed were to succeed in its crusade to get the
regulatory responsibility shifted away from the FDIC?
Chairman Bernanke. Senator, first of all, as you point out,
the specific case at hand, the Wal-mart case is the FDIC's
decision. I understand they are going to have a public hearing
and will evaluate the merits of that individual case.
The concerns that the Federal Reserve have had about ILC's
have turned largely on recent proposals that ILC's would have
additional powers including interest on business checking and
out-of-State branching which would de facto make ILC's the
functional equivalent of banks.
And our concern has been that if ILC's are to be the
functional equivalents of banks, that they receive parallel
treatment in terms of consolidated supervision and other
responsibility requirements that banks face. And it may be that
I have only been in the job 2 weeks, but I am not aware that
the Fed has lobbied to become the regulator of the ILC's.
Senator Bennett. I think the staff will make you aware of
that fairly soon.
Chairman Bernanke. Perhaps they will. The main thing is
that Congress should try to be consistent, make sure that rules
that they apply are applied consistently across similar types
of organizations, and that is the concern that we have had, and
we have been concerned about the ownership of ILC's by
nonfinancial institutions and whether or not that poses risks
to the safety net or creates an unlevel playing field with
other kinds of financial institutions.
Senator Bennett. I think those are legitimate questions,
and I believe the ILC's qualify for their present circumstance
in the face of all of those questions. In 1997, Chairman
Greenspan said, quote:
The case is weak in our judgment for umbrella supervision
of a holding company in which the bank is not the dominant unit
and is not large enough to induce systemic risk should it fail.
And that, of course, is the case with the ILC's. If Wal-
mart were to get its charter, the bank would clearly not be the
dominant unit. And its size would not indicate systemic risk.
Taking that statement from your predecessor, do you have any
ideas about how it no longer applies or any reaction or, again,
is this issue, and I am not saying this to put you down in any
sense, I think it is very possible that this issue is simply
too new for you to feel comfortable commenting on it, and I
would not complain if you said that was the case. But we do
have this comment by Chairman Greenspan, which he has
subsequently recanted, but which we really like. And I would
like your reaction to it.
Chairman Bernanke. Again, I think that it would probably
not be appropriate for me to comment on the Wal-mart case given
its status of being adjudicated by the FDIC.
Senator Bennett. Just comment about this whole idea
generally because this statement was made before Wal-mart
applied for their charter.
Chairman Bernanke. The general concern is that if a
commercial firm owns a bank, would there not be a possibility
that the safety net would be inadvertently extended to the
commercial firm? Would we be able to segregate the financial
condition of the commercial firm from the bank and would it be
possible for not just the FDIC but for any bank supervisor to
adequately supervise not only the bank but also the owning firm
to ensure that the safety and soundness rules were being met?
Senator Bennett. Now we are edging into Gramm-Leach-Bliley
and the conversation about banking and commerce. I used Wal-
mart as the example because they put a specific number on it.
Simply having an ILC charter is worth $30 million to them a
year if they do absolutely nothing as far as the consumer is
concerned and it does not change the safety and soundness of
anything to me.
Many of the largest ILC's in Utah are owned by automobile
companies. GMAC, Volkswagen, Mercedes, they do very large
financing operations, and they find that having an ILC charter
is enormously valuable to them even if they do not issue
checkbooks and they do not open branches, and they do not do
the traditional kinds of things that banks do. This is a
device, created by the Congress, that is helping the
marketplace, making things more efficient, saving money all the
way around, which presumably means that consumers benefit
because there is less money going into it.
We do not have to continue this, but I just want to lay
this issue on the table before you because I think you will see
down at the Fed that there is an effort on the part of some
members of the staff to, if not curtail the ILC's all together,
to bring them under Fed jurisdiction, and that is certainly
former Chairman Leach's desire. He is not fond of ILC's and I
think would like to see them eliminated, and I am laying down
again the marker, I am very fond of them, and I want to see
them continued.
Chairman Bernanke. Senator, the thrust of the Leach bill
would be essentially to restrict the kind of firm that could
own an ILC and that was the part that I commented on favorably
yesterday. Again, the Federal Reserve is not in itself looking
to find new areas, new domains, but having a financial holding
company or a financial company owning the ILC mitigates some of
the concerns that I have talked about relating to consolidated
supervision.
Senator Bennett. Thank you. I am sure we will be having
more conversations about this.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Sarbanes, you have any other
questions?
Senator Sarbanes. Senator Bennett having laid the issue on
the table, I think I should continue with it for a bit just to
be clear. As I understand it, the FDIC does not have
consolidated supervisory authority and that is the problem with
these ILC's, unlike the role the Fed has with respect to
regular financial institutions under the Federal Bank Holding
Company Act; is that correct?
Chairman Bernanke. That is correct.
Senator Sarbanes. And, of course, Chairman Greenspan was
quite outspoken about this issue. I do not know. You cited him
for something, but it is----
Senator Bennett. I acknowledge he has changed his mind
since he said that.
Senator Sarbanes. He has been quite strong about it. In
fact, he expressed a concern that the ILC's, which are
chartered in just a handful of States, represented a breach in
the traditional separation of banking and commerce in the
United States, and unlike the financial institutions with
banking subsidiaries, the owners of the ILC's are not currently
subject to the supervisory requirements of the Bank Holding
Company Act.
So you have a very significant loophole here. I mean these
ILC--I understand Senator Bennett's interest in this matter--
but, you know, they have grown at an incredible rate. The
aggregate amount of assets controlled by Utah-chartered ILC's
is 16 times the total of all the banks, savings associations,
and credit unions chartered in Utah.
Senator Bennett. We are very grateful.
Senator Sarbanes. It has become a huge business there. One
ILC has more than $58 billion in assets. I do not think Target
should have a bank. I mean you said no one questions that. I
question that.
Senator Bennett. Okay.
Senator Sarbanes. In Gramm-Leach-Bliley, we closed the
unitary thrift loophole as a way to further the separation of
banking and commerce, and this one loophole remained and is now
being exploited and expanded to the hilt, and I think it is a
very serious problem.
Now, the Leach legislation, as I understand it, would
simply subject the ILC's to the same prudential constraints
including consolidated supervisory requirements, bank level
capital, managerial criteria, enforcement mechanisms, as
applied to financial holding companies. And the GAO was asked
to do a study and they concluded that the ILC's were not
adequately regulated under current law.
The problem may come somewhere down the line, just like it
did with the savings and loans. I mean we had the savings and
loans people came in and said, well, we need to accommodate
here, it is an important part of our economy. And 50 percent of
the savings and loans that failed were in the State of Texas.
So we had Members of the Committee who were deeply interested
in that and so we went along, went along, and whammo.
I think the taxpayers paid $132 billion for the savings and
loans. So, I am concerned about these loopholes and the
exploitation of these loopholes because there is not around
them the kind of regulatory examination, the regulatory
framework, which helped to assure the safety and soundness of
the system. So the matter having been put on the table, I
thought I should contribute to the discussion.
Senator Bennett. I am always grateful for your
contribution.
Senator Sarbanes. I want to very quickly, Mr. Chairman, ask
you two or three quick questions, just as kind of an alert of
our interest. One is the remittances, an issue that you have
taken an interest in. I want to underscore that. Is there a
greater role for the Fed to play in expanding the service of
its international automated clearinghouse? There is some
opinion that think that.
I mean you have just reached an understanding with the
Mexican central bank and it is felt that that is going to make
a difference. What about expanding it?
Chairman Bernanke. It is correct that we have reached an
agreement with Mexico, and to the best of my knowledge we are
exploring further opportunities and we are open to your
comments or suggestions.
Senator Sarbanes. Okay. Everyone thinks of you as primarily
a monetary policy, and that is understandable, but the Fed has
a very significant role, of course, as a bank regulator.
Privacy and data security, something the Chairman has focused a
great deal of attention on. Last year, we had these incredible
instances of several financial institutions--actually
Government agencies, private companies as well--reporting these
breaches of Social Security numbers, credit and debit card
numbers, security codes, and bank account information.
What can the Fed do to help tighten up data privacy and
security and enhancing the privacy rights of consumers?
Chairman Bernanke. The Federal Reserve together with the
other banking regulators already has issued, I believe, its
regulations to the banking system concerning management of
data. There are really two parts to it. First, that banks are
required to have good internal controls, to make sure the data
are protected. And second, that banks are required, and other
financial institutions are required, to inform customers if
there is a data breach that has caused, or is likely to cause,
or be a source of fraud.
So we have created a structure in the banking system to
address these issues, and to my knowledge, I believe that
Congress is looking to some extent at our approach as a model
for thinking about extending these rules to other kinds of
organizations.
Senator Sarbanes. And finally this Committee has held a
number of hearings on money laundering and terrorism financing.
Actually, you know, the Department of Justice has undertaken
criminal investigations of bank officials in these areas. But
that suggests that the regulatory authorities, the bank
regulatory authorities of whom the Fed is one, somehow fell
behind the curve, so to speak. What can be done to boost that
oversight with respect to money laundering and terrorism
financing?
Chairman Bernanke. We consider it a very important issue,
and we are putting a lot of resources into it. Our approach is
again to assess information management systems that banks have
to make sure that they know their customer or they know the
source of a transaction. That is the best way we have to
approach this and again we will continue to work hard to make
sure that the Anti-Money Laundering and Bank Secrecy Act rules
are obeyed.
Senator Sarbanes. Is there a special unit at the Fed that
focuses on this?
Chairman Bernanke. I think it is part of the general Bank
Supervision Division, but there are certainly quite a number of
individuals who are specially involved in it, who have special
backgrounds.
Senator Sarbanes. Do you think it has a high enough profile
within the Fed organization or the Fed hierarchy?
Chairman Bernanke. Would you allow me more time to learn
more about the structure of the organization?
Senator Sarbanes. Fine. Thank you, Mr. Chairman. I do want
to commend the Fed on the work it is doing in the area of
financial literacy and in particular Chairman Bernanke's
commitment to that effort. He made reference to when he was on
the school board. It was an elected school board, as I recall;
correct?
Chairman Bernanke. Yes, sir. I received over 1,000 votes.
[Laughter.]
Senator Sarbanes. We are always impressed by that.
Senator Sarbanes. Thank you, Mr. Chairman.
Chairman Shelby. Chairman Bernanke, we look forward to
working with you in many areas, and we know you will be back
before the Committee. We wish you the best as you undertake
your new opportunities and responsibilities.
The hearing is adjourned.
Chairman Bernanke. Thank you, Mr. Chairman.
[Whereupon, at 12:23 p.m., the hearing was adjourned.]
[Prepared statements, response to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF BEN S. BERNANKE
Chairman, Board of Governors of the Federal Reserve System
February 16, 2006
Mr. Chairman and Members of the Committee, I am pleased to be here
today to present the Federal Reserve's Monetary Policy Report to the
Congress. I look forward to working closely with the Members of this
Committee on issues of monetary policy as well as on matters regarding
the other responsibilities with which the Congress has charged the
Federal Reserve System.
The U.S. economy performed impressively in 2005. Real gross
domestic product (GDP) increased a bit more than 3 percent, building on
the sustained expansion that gained traction in the middle of 2003.
Payroll employment rose 2 million in 2005, and the unemployment rate
fell below 5 percent. Productivity continued to advance briskly.
The economy achieved these gains despite some significant
obstacles. Energy prices rose substantially yet again, in response to
increasing global demand, hurricane-related disruptions to production,
and concerns about the adequacy and reliability of supply. The Gulf
Coast region suffered through severe hurricanes that
inflicted a terrible loss of life; destroyed homes, personal property,
businesses, and infrastructure on a massive scale; and displaced more
than a million people. The storms also damaged facilities and disrupted
production in many industries, with substantial effects on the energy
and petrochemical sectors and on the region's ports. Full recovery in
the affected areas is likely to be slow. The hurricanes left an imprint
on aggregate economic activity as well, seen, in part, in the marked
deceleration of real GDP in the fourth quarter. However, the most
recent evidence--including indicators of production, the flow of new
orders to businesses, weekly data on initial claims for unemployment
insurance, and the payroll employment and retail sales figures for
January--suggests the economic expansion remains on track.
Inflation pressures increased in 2005. Steeply rising energy prices
pushed up overall inflation, raised business costs, and squeezed
household budgets. Nevertheless, the increase in prices for personal
consumption expenditures excluding food and energy, at just below 2
percent, remained moderate, and longer-term inflation expectations
appear to have been contained.
With the economy expanding at a solid pace, resource utilization
rising, cost pressures increasing, and short-term interest rates still
relatively low, the Federal Open Market Committee (FOMC) over the
course of 2005 continued the process of removing monetary policy
accommodation, raising the Federal funds rate 2 percentage points in
eight increments of 25 basis points each. At its meeting on January 31
of this year, the FOMC raised the Federal funds rate another \1/4\
percentage point, bringing its level to 4\1/2\ percent.
At that meeting, monetary policymakers also discussed the economic
outlook for the next 2 years. The central tendency of the forecasts of
Members of the Board of Governors and the presidents of Federal Reserve
Banks is for real GDP to increase about 3\1/2\ percent in 2006 and 3
percent to 3\1/2\ percent in 2007. The civilian unemployment rate is
expected to finish both 2006 and 2007 at a level between 4\3/4\
percent and 5 percent. Inflation, as measured by the price index for
personal consumption expenditures excluding food and energy, is
predicted to be about 2 percent this year and 1\3/4\ percent to 2
percent next year. While considerable uncertainty surrounds any
economic forecast extending nearly 2 years, I am comfortable with these
projections.
In the announcement following the January 31 meeting, the Federal
Reserve pointed to risks that could add to inflation pressures. Among
those risks is the possibility that, to an extent greater than we now
anticipate, higher energy prices may pass through into the prices of
nonenergy goods and services or have a persistent effect on inflation
expectations. Another factor bearing on the inflation outlook is that
the economy now appears to be operating at a relatively high level of
resource utilization. Gauging the economy's sustainable potential is
difficult, and the Federal Reserve will keep a close eye on all the
relevant evidence and be flexible in making those judgments.
Nevertheless, the risk exists that, with aggregate demand exhibiting
considerable momentum, output could overshoot its sustainable path,
leading ultimately--in the absence of countervailing monetary policy
action--to further upward pressure on inflation. In these
circumstances, the FOMC judged some further firming of monetary policy
may be necessary, an assessment with which I concur.
Not all of the risks to the economy concern inflation. For example,
a number of indicators point to a slowing in the housing market. Some
cooling of the housing market is to be expected and would not be
inconsistent with continued solid growth of overall economic activity.
However, given the substantial gains in house prices and the high
levels of home construction activity over the past several years,
prices and construction could decelerate more rapidly than currently
seems likely. Slower growth in home equity, in turn, might lead
households to boost their saving and trim their spending relative to
current income by more than is now anticipated. The possibility of
significant further increases in energy prices represents an additional
risk to the economy; besides affecting inflation, such increases might
also hurt consumer confidence and thereby reduce spending on nonenergy
goods and services.
Although the outlook contains significant uncertainties, it is
clear that substantial progress has been made in removing monetary
policy accommodation. As a consequence, in coming quarters the FOMC
will have to make ongoing, provisional judgments about the risks to
both inflation and growth, and monetary policy actions will be
increasingly dependent on incoming data.
In assessing the prospects for the economy, some appreciation of
recent circumstances is essential, so let me now review key
developments of 2005 and discuss their implications for the outlook.
The household sector was a mainstay of the economic expansion again
last year, and household spending is likely to remain an important
source of growth in aggregate demand in 2006. The growth in household
spending last year was supported by rising employment and moderate
increases in wages. Expenditures were buoyed as well by significant
gains in household wealth that reflected further increases in home
values and in broad equity prices. However, sharply rising bills for
gasoline and heating reduced the amount of income available for
spending on other consumer goods and services.
Residential investment also expanded considerably in 2005,
supported by a strong real estate market. However, as I have already
noted, some signs of slowing in the housing market have appeared in
recent months: Home sales have softened, the inventory of unsold homes
has risen, and indicators of homebuilder and homebuyer sentiment have
turned down. Anecdotal information suggests that homes typically are on
the market somewhat longer than they were a year or so ago, and the
frequency of contract offers above asking prices reportedly has
diminished. Financial market conditions seem to be consistent with some
moderation in housing activity. Interest rates on 30-year, fixed-rate
mortgages, which were around 5\3/4\ percent over much of 2005, rose
noticeably in the final months of the year to their current level of
around 6\1/4\ percent. Rates on adjustable-rate mortgages have climbed
more considerably. Still, despite the recent increases, mortgage rates
remain relatively low. Low mortgage rates, together with expanding
payrolls and incomes and the need to rebuild after the hurricanes,
should continue to support the housing market. Thus, at this point, a
leveling out or a modest softening of housing activity seems more
likely than a sharp contraction, although significant uncertainty
attends the outlook for home prices and construction. In any case, the
Federal Reserve will continue to monitor this sector closely.
Overall, the financial health of households appears reasonably
good. Largely reflecting the growth in home mortgages, total household
debt continued to expand rapidly in 2005. But the value of household
assets also continued to climb strongly, driven by gains in home prices
and equity shares. To some extent, sizable increases in household
wealth, as well as low interest rates, have contributed in recent years
to the low level of personal saving. Saving last year was probably
further depressed by the rise in households' energy bills. Over the
next few years, saving relative to income is likely to rise somewhat
from its recent low level.
In the business sector, profits continued to rise last year at a
solid pace, boosted in part by continuing advances in productivity.
Strong corporate balance sheets combined with expanding sales and
favorable conditions in financial markets fostered a solid increase in
spending on equipment and software last year. Investment in high-tech
equipment rebounded, its increase spurred by further declines in the
prices of high-tech goods. Expenditures for communications equipment,
which had fallen off earlier this decade, showed particular strength
for the year as a whole. In contrast, nonresidential construction
activity remained soft.
Although the financial condition of the business sector is
generally quite strong, several areas of structural weakness are
evident, notably in the automobile and airline industries. Despite
these problems, however, favorable conditions in the business sector as
a whole should encourage continued expansion of capital investment.
For the most part, the financial situation of State and local
governments has improved noticeably over the past couple of years.
Rising personal and business incomes have buoyed tax revenues,
affording some scope for increases in State and local government
expenditures. At the Federal level, the budget deficit narrowed
appreciably in fiscal year 2005. Outlays rose rapidly, but receipts
climbed even more sharply as the economy expanded. However, defense
expenditures, hurricane relief, and increasing entitlement costs seem
likely to worsen the deficit in fiscal year 2006.
Outside the United States, economic activity strengthened last
year, and at present global growth seems to be on a good track. The
economies of our North American neighbors, Canada, and Mexico, appear
to be expanding at a solid pace. Especially significant have been signs
that Japan could be emerging from its protracted slump and its battle
with deflation. In the euro area, expansion has been somewhat modest by
global standards, but recent indicators suggest that growth could be
strengthening there as well. Economies in emerging Asia generally
continue to expand strongly. In particular, growth in China remained
vigorous in 2005.
Expanding foreign economic activity helped drive a vigorous advance
in U.S. exports in 2005, while the growth of real imports slowed.
Nonetheless, the nominal U.S. trade deficit increased further last
year, exacerbated in part by a jump in the value of imported petroleum
products that almost wholly reflected the sharply rising price of crude
oil.
Surging energy prices also were the dominant factor influencing
U.S. inflation last year. For the second year in a row, overall
consumer prices, as measured by the chain-type index for personal
consumption expenditures, rose about 3 percent. Prices of consumer
energy products jumped more than 20 percent, with large increases in
prices of natural gas, gasoline, and fuel oil. Food prices, however,
rose only modestly. And core consumer prices (that is, excluding food
and energy) increased a moderate 1.9 percent.
The relatively benign performance of core inflation despite the
steep increases in energy prices can be attributed to several factors.
Over the past few decades, the U.S. economy has become significantly
less energy intensive. Also, rapid advances in productivity as well as
increases in nominal wages and salaries that, on balance, have been
moderate have restrained unit labor costs in recent years.
Another key factor in keeping core inflation low has been
confidence on the part of the public and investors in the prospects for
price stability. Maintaining expectations of low and stable inflation
is an essential element in the Federal Reserve's
effort to promote price stability. And, thus far, the news has been
good: Survey measures of longer-term inflation expectations have
responded only a little to the larger fluctuations in energy prices
that we have experienced, and for the most part, they were low and
stable last year. Inflation compensation for the period 5 to 10 years
ahead, derived from spreads between nominal and inflation-indexed
Treasury securities, has remained well-anchored.
Restrained inflation expectations have also been an important
reason that long-term interest rates have remained relatively low. At
roughly 4\1/2\ percent at year-end, yields on ten-year nominal Treasury
issues increased only slightly on balance over 2005 even as short-term
rates rose 2 percentage points. As previous reports and testimonies
from the Federal Reserve indicated, a decomposition of long-term
nominal yields into spot and forward rates suggests that it is
primarily the far-forward components that account for the low level of
long rates. The premiums that investors demand as compensation for the
risk of unforeseen changes in real interest rates and inflation appear
to have declined significantly over the past decade or so. Given the
more stable macroeconomic climate in the United States and in the
global economy since the mid-1980's, some decline in risk premiums is
not surprising. In addition, though, investors seem to expect real
interest rates to remain relatively low. Such a view is consistent with
a hypothesis I offered last year--that, in recent years, an excess of
desired global saving over the quantity of global investment
opportunities that pay historically normal returns has forced down the
real interest rate prevailing in global capital markets.
Inflation prospects are important, not just because price stability
is in itself desirable and part of the Federal Reserve's mandate from
the Congress, but also because price stability is essential for strong
and stable growth of output and employment. Stable prices promote long-
term economic growth by allowing households and firms to make economic
decisions and undertake productive activities with fewer concerns about
large or unanticipated changes in the price level and their attendant
financial consequences. Experience shows that low and stable inflation
and inflation expectations are also associated with greater short-term
stability in output and employment, perhaps in part because they give
the central bank greater latitude to counter transitory disturbances to
the economy. Similarly, the attainment of the statutory goal of
moderate long-term interest rates requires price stability, because
only then are the inflation premiums that investors demand for holding
long-term instruments kept to a minimum. In sum, achieving price
stability is not only important in itself; but it is also central to
attaining the Federal Reserve's other mandated objectives of maximum
sustainable employment and moderate long-term interest rates.
As always, however, translating the Federal Reserve's general
economic objectives into operational decisions about the stance of
monetary policy poses many challenges. Over the past few decades,
policymakers have learned that no single economic or financial
indicator, or even a small set of such indicators, can provide reliable
guidance for the setting of monetary policy.
Rather, the Federal Reserve, together with all modern central
banks, has found that the successful conduct of monetary policy
requires painstaking examination of a broad range of economic and
financial data, careful consideration of the implications of those data
for the likely path of the economy and inflation, and prudent judgment
regarding the effects of alternative courses of policy action on
prospects for achieving our macroeconomic objectives. In that process,
economic models can provide valuable guidance to policymakers, and over
the years substantial progress has been made in developing formal
models and forecasting techniques. But any model is by necessity a
simplification of the real world, and sufficient data are seldom
available to measure even the basic relationships with precision.
Monetary
policymakers must therefore strike a difficult balance--conducting
rigorous analysis informed by sound economic theory and empirical
methods while keeping an open mind about the many factors, including
myriad global influences, at play in a dynamic modern economy like that
of the United States. Amid significant uncertainty, we must formulate a
view of the most likely course of the economy under a given policy
approach while giving due weight to the potential risks and associated
costs to the economy should those judgments turn out to be wrong.
During the nearly 3 years that I previously spent as a Member of
the Board of Governors and of the Federal Open Market Committee, the
approach to policy that I have just outlined was standard operating
procedure under the highly successful leadership of Chairman Greenspan.
As I indicated to the Congress during my confirmation hearing, my
intention is to maintain continuity with this and the other practices
of the Federal Reserve in the Greenspan era. I believe that, with this
approach, the Federal Reserve will continue to contribute to the sound
performance of the U.S. economy in the years to come.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ
FROM BEN S. BERNANKE
Chairman Bernanke, you wrote in your macroeconomic textbook
about the consequences of budget deficits.
The Congressional Budget Office estimates that the deficit
for 2006 will be $337 billion--even before including the cost
of an anticipated supplemental appropriation for Iraq and
Afghanistan expected early this year. The deficits for 2003,
2004, 2005, and 2006 are the four largest deficits in American
history.
Because of these deficits, the long-term attractiveness of
the United States as an investment destination could be hurt as
investors worry about our Nation's ability to manage its debts.
And the deficits could also cause consumers problems if foreign
investors stop buying U.S. assets, forcing interest rates to
rise sharply. Finally with the ongoing wars in Iraq and
Afghanistan, our budget is going to be under continued
pressures in the future.
Over time, large deficits and debt will raise interest
rates, crowd out private sector investment, and slow long-term
economic growth.
Q.1. How much importance do you put on paying down the publicly
held debt that our Nation currently holds?
A.1. I am quite concerned about the intermediate to long-term
Federal budget outlook. In particular, the budget is expected
to come under severe pressure as impending demographic changes
fuel rapid increases in entitlement spending. By holding down
the growth of national saving and real capital accumulation,
the prospective increase in the budget deficit will place at
risk future living standards of our country. As a result, I
think it would be very desirable to take concrete steps to
lower the prospective path of the deficit. Such actions would
boost national saving and ultimately the future prosperity of
our country, as our children and grandchildren would inherit a
larger capital stock that would support greater productivity
and higher income. Moreover, steps should be taken soon to
address the long-term budget pressures so that people have
adequate time to prepare for whatever changes might occur,
especially to entitlement programs.
Although the stock of debt held by the public would decline
in absolute magnitude only if budget surpluses are run, fiscal
actions that result in smaller deficits can slow the growth in
the stock of debt held by the public and reduce the Federal
debt relative to the size of the economy. The key is not so
much the absolute level of Federal debt, but rather that we
take deficit-reducing steps to increase national saving and,
hence, future living standards.
As you know, the pay-as-you-go budget provisions of the
1990's required lawmakers to pay for any increases in
entitlement spending or decreases in revenues (that is, tax
cuts); such changes had to be offset either by equivalent
budget cuts or by revenue increases elsewhere. Since those
rules expired in 2002, Congress has strived and did enact a
variation on PAYGO that completely exempts taxes from the
equation: No tax cuts would require offsetting, and spending
increases could only be offset by entitlement cuts elsewhere--
never by tax increases. This despite the fact our Federal
budgets over the last few years have run recorded deficits.
This one-sided PAYGO passed despite the recommendations of
people like Federal Reserve Chairman Alan Greenspan,
Congressional Budget Office Director Douglas Holtz-Eakin, and
Government Accountability Office Comptroller General David
Walker, who all strongly and repeatedly urged Congress to adopt
full PAYGO rules.
Q.2.a. Chairman Bernanke, do you support full PAYGO rules over
spending-only ones?
A.2.a. As I noted in response to the previous question, I
believe reducing the Federal deficit is very important,
especially in light of the need to prepare for the retirement
of the baby-boom generation. I urge the Congress to proceed on
that effort in a timely manner and to pay particular attention
to how its decisions on spending and tax programs will affect
the U.S. economy over the long-term. However, I also believe
that in my role as head of the Federal Reserve, I should not be
involved in making specific recommendations about the internal
decisionmaking process of the Congress and the structure of its
budget procedures.
Q.2.b. The Treasury Department recently issued its first 30-
year bonds in over 4 years. Do you support this decision to
bring back the long bond?
A.2.b. The responsibility for Federal debt management, of
course, rests with the Treasury Department. However, I do
support the Treasury's decision to resume issuance of 30-year
bonds. Given the large current and prospective Federal
financing needs, it is prudent to distribute the Treasury's
borrowing across the yield curve. Moreover, long-term interest
rates are currently quite low, apparently reflecting in part
strong demand among investors for long-term issues. In these
circumstances, it is sensible for the Treasury to accommodate
this demand in part by issuing 30-year securities.
Last week, when the Treasury issued its first 30-year bond
since 2001, there was $28 billion in bids for $14 billion of
bonds being offered. This in turn made it cheaper for the
Treasury to borrow for 30 years than 6 months.
Q.3. Do you have any concern that this will contribute to the
creation of a bond market bubble, which has the potential
effect of lowering inflation-adjusted interest rates to
incredibly low levels?
A.3. I do not have any such concerns. I should note that I do
not see particular significance to the level of bids relative
to the size of the recent auction. I attribute the relatively
low level of long-term interest rates generally to several
factors, including a tendency in recent years for global saving
to exceed the amount of
potential capital investments, yielding historically normal
rates of return as well as relatively low-term premiums in
interest rates to compensate investors for interest rate risk.
In the unlikely event that any of these factors tended to push
real long-term yields to levels that appeared to be
incompatible with our macroeconomic objectives, the Federal
Reserve would respond by adjusting the stance of monetary
policy appropriately.
Q.4. What impacts could this have on our economy?
A.4. No significant adverse effects are likely.
Last week, the Commerce Department reported that our trade
deficit rose 17.5 percent to $725.8 billion in 2005, a new
record for the fourth consecutive year.
You have stated in the past your belief that what you call
a ``global savings glut'' is the main driver behind America's
record trade deficit, and that the ability to reduce our trade
deficit is largely beyond our control.
Q.5. Is there nothing we can do to alleviate the pressure
building up in the global financial system?
A.5. The emergence of large U.S. trade deficits and
corresponding surpluses on the part of our trading partners is,
to an important extent, the outcome of market forces. Several
factors, including the lingering effects of financial crises in
emerging market economies and concerns about the outlook for
growth in some industrial economies, have led saving abroad to
exceed investment. This excess saving has been attracted to the
United States by our favorable investment climate, strong
productivity growth, and deep
financial markets. Although the U.S. net external debt has been
growing as a consequence of these inflows, as a fraction of our
Nation's income it remains within international and historical
norms. Given the strength and flexibility of our economy, there
is every reason to believe that, if changes in the foreign
outlook or in the tone of financial markets were to cause a
reduction in capital inflows and the trade deficit, economic
activity, and employment would stay strong.
Q.6. Wouldn't reducing our budget deficit and getting tough on
currency manipulators help?
A.6. All that said, as our net external debt rises, the cost of
servicing that debt increasingly will subtract from U.S.
income. Accordingly, it would be helpful to raise our domestic
saving and reduce our trade deficit while maintaining an
environment conducive to investment and growth. Reducing the
budget deficit would release resources for private investment
and reduce the future burden of repaying the public debt,
although studies indicate a relatively modest effect of budget-
cutting on the trade deficit. Pro-growth policies among our
trading partners would also contribute to some adjustment of
external imbalances. Finally, more flexible exchange rate
regimes in some countries would provide greater scope for
market forces to reduce our trade deficit, and would be in the
interests of the countries implementing these regimes as well.
Nevertheless, in the absence of a shift in market perceptions
of the relative attractiveness of United States and foreign
assets, government policies would likely have only limited
effects on the trade balance.
Chairman Bernanke, under the fiscal year 2006 Congressional
budget resolution and the two related reconciliation bills,
Congress has cut Medicaid by $6.9 billion while spending up to
$70 billion over the next 5 years to repeal some of the sunsets
of President Bush's 2001 and 2003 tax cut packages. According
to the Urban-Brookings Tax Policy Center, more than 70 percent
of the benefits of those tax breaks have gone to the 20 percent
of taxpayers with the highest incomes, and more than 25 percent
of the benefits to the top 1 percent. Medicaid's benefits, by
contrast, go almost entirely to those at the bottom of the
income scale.
Q.7. Don't these additional tax breaks (from the fiscal 2006
reconciliation bills), when combined with the Medicaid cuts,
amount to a massive redistribution of income from those at the
bottom to those at the top?
A.7. As I stated in my testimony on the Monetary Policy Report,
the Federal Government has an important role to play in
boosting national saving as a share of national income over
time. Of particular concern to me is the mismatch between taxes
and spending in long-term budget projections. This mismatch
means that over time either taxes will have to be raised or the
spending increases embedded in current laws will need to be
scaled back, or some combination of the two. Deciding on the
mix of policy actions to be
implemented will require the difficult balancing of sometimes
conflicting goals regarding the provision of public services,
the effects on economic efficiency of increasing taxes, and the
distribution of fiscal burdens among various groups. The
judgments about how to balance these priorities are ultimately
political judgments and not ones that I believe I should
address in my role as Chairman of the Federal Reserve.
Chairman Bernanke, the 1991 edition of your Macroeconomics
textbook contains a policy debate on the minimum wage. At the
end of the debate, the textbook concludes: ``Therefore, the
total labor income of unskilled workers does increase when the
minimum wage rises . . . . Overall, taking these various
effects into account, a recent study finds that raising the
minimum wage from $3.35 per hour to $4.25 per hour [note: those
were the amounts under discussion at that time] could reduce
the number of families in poverty by about 6 percent, on
balance a reasonably substantial effect.'' The textbook goes on
to find: ``Thus, the inflationary effects of an increase in the
minimum wage are relatively small . . . As a result, an
increase in the minimum wage has negligible effects on
aggregate employment and output.''
Your textbook was written in 1991 when the minimum wage was
$4.25 an hour. Today, in real terms it is below that level
($4.25 in 1991 would be $5.89 today).
Q.8. Do you believe that increasing the minimum wage above its
current level of $5.15 an hour--where it has been stuck for
over 8 years--would be good economic policy, along the lines
that your textbook concluded?
A.8. I am reluctant to comment on specific proposals regarding
the minimum wage, but I can offer some general comments. In
particular, I would note that the minimum wage is a very
controversial issue among economists. Clearly, if the minimum
wage were raised, then those workers who retain their jobs will
benefit from the higher income associated with the higher
minimum wage. However, economists have raised two concerns
about minimum wages. The first is whether minimum wages have
adverse employment effects; that is, do higher wages lower
employment of low-skilled workers? The second is whether the
minimum wage is as well targeted as it could be; that is, to
what extent is the increase benefiting workers other than those
from low-income families?
My own view is that an increase in the minimum wage
probably does lower employment. However, I would note that
while this is the consensus view among economists, there is
some research indicating that any such disemployment effects
could be negligible. In any event, it does seem likely that the
employment losses from a modest increase in the minimum wage
would be relatively small from a macroeconomic standpoint and
thus, at the levels of the minimum wage prevailing in the
United States, a modest increase would not have sizable
negative effects on aggregate output.
The effect of a higher minimum wage on poverty is also a
hotly debated topic among economists. However, my reading of
the research that has become available over the past 10 years
or so is that if there is any reduction in poverty associated
with a higher minimum wage, it is likely to be quite small. In
this context, one might consider alternative ways of helping
low-income workers, such as the Earned Income Tax Credit, which
delivers money directly to working families and is thus better
targeted toward poverty reduction than is the minimum wage.
RESPONSE TO A WRITTEN QUESTION OF SENATOR CRAPO
FROM BEN S. BERNAKE
Q.1. I am very concerned about the potential efforts in this
Congress to change the manner in which we regulate derivatives
or to impact the manner in which derivatives operate in the
economy, and I would like to have your comments on the
importance of having a strong, stable, and dynamic derivatives
market in this country and what it means to our economy.
A.1. Derivatives markets have had important effects on two
dimensions of our economy. First, as is often noted,
derivatives enable financial risks to be unbundled and shifted
to those willing and able to bear them. The U.S. economy has
proven to be resilient in the face of shocks over the past
several years. Although no single factor accounts for this
favorable performance, derivative instruments undoubtedly have
contributed to this resilience because they offer firms means
for managing their risks. Second, derivatives have contributed
to our understanding of the measurement and management of risk.
Today's sophisticated risk management systems developed in
tandem with derivatives markets. When individual firms become
less vulnerable to shocks, the financial system as a whole
becomes more resilient. Certainly, derivative instruments pose
challenges to risk managers and to supervisors, but these risks
are manageable and thus far have generally been managed quite
well. Market discipline has provided strong incentives for
effective risk management, the key to ensuring that the
benefits of derivatives continue to be realized.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR ENZI
FROM BEN S. BERNAKE
Mr. Chairman, I noted in a press release dated November 10,
2005 that the Federal Reserve would cease publication of the M3
money aggregate, the broadest measure of the U.S. money supply.
I have carefully read your testimony in the House Financial
Services Committee on this topic. I have some follow-up
questions:
Q.1. You noted in your testimony to the House Financial
Services Committee that money aggregates are among the many
indicators that the Federal Reserve Board uses to determine
monetary policy. In your opinion, would discontinuing the M3
aggregate deprive the Board of information useful in the
formation of U.S. monetary policy? Has the M3 aggregate become
obsolete?
A.1. Over time, the Federal Reserve continuously assesses the
usefulness of the various statistics that it monitors in the
conduct of monetary policy. In cases in which the Federal
Reserve compiles and publishes the data, the Board seeks to
revise its statistical program appropriately, taking into
account ongoing developments in the economy and the financial
system as well as both the benefits and the costs of data
collection. For example, in the early 1980's the Federal
Reserve redefined the monetary aggregates to reflect changes in
the financial environment. Similarly, for a time research
suggested that a broad measure of nonfinancial sector debt
should receive considerable attention in monetary policymaking,
and the Board began to publish monthly data on such an
aggregate. Over subsequent years, policy experience and
accumulating empirical evidence indicated that some of these
aggregates--in particular, domestic nonfinancial sector debt at
a monthly frequency, and the broadest monetary aggregate--were
not particularly useful in the conduct of policy. Accordingly,
the publication of those aggregates was either scaled back or
dropped. Similarly, the Board over time recognized that M3 was
not providing information that was useful to policymakers.
Recently, the Board decided that discontinuing the compilation
of that aggregate would not deprive the Federal Reserve of
information useful in the formulation of U.S. monetary policy
and, given the costs involved in compiling the aggregate, it
decided to discontinue M3.
Q.2. Reducing regulatory burden for our Nation's banks is a
laudable goal and an effort I support. How many financial
institutions are currently required to provide data to the Fed
to calculate the M3? Do these same institutions report data to
calculate the M1 and M2 aggregates? Is there any quantitative
data on the savings achieved by reporting institutions once
publication of the M3 has ceased?
A.2. A complex system of reports is employed to collect the
data necessary to compile the monetary aggregates, and
discontinuing M3 will allow two reports--the FR 2415 and the FR
2050--to be dropped. The FR 2415 form (Report of Repurchase
Agreements [RP's] on U.S. Government and Federal Agency
Securities with Specified Holders) is reported by approximately
450 institutions (270 reporting annually, 90 quarterly, and 90
weekly). The FR 2050 form (Weekly Report of Eurodollar
Liabilities Held by Selected U.S. Addressees at Foreign Offices
of U.S. Banks) is reported by about 35 institutions. The
discontinuation of the FR 2415 and the FR 2050 is estimated to
reduce annual reporting burden by a total of 4,487 hours. These
reports are used to obtain data only for M3, not M1 or M2.
I should note that discontinuing M3 will also allow two of
our fellow central banks, the Bank of Canada and the Bank of
England, to stop collecting, editing, compiling, and
transmitting additional data on Eurodollars--a task that no
doubt involved the expenditure of significant resources for
which those institutions were not compensated. We do not have
estimates of the savings that will accrue to the Bank of Canada
and the Bank of England, or of any of the entities that report
to those central banks, as a result of the elimination of M3.
Q.3. Is there any indication of how useful the M3 aggregate is
to the U.S. public? How did the Fed determine the public's
demand for this data?
A.3. Federal Reserve staff conducted a search to determine the
extent to which M3 was used in the professional literature on
monetary economics. The staff found that the vast majority of
academic papers published between 1990 and 2000 that referenced
``M3'' actually referred to foreign versions of M3, which
correspond most closely to the Federal Reserve's M2 aggregate
rather than our M3 aggregate. The remaining papers, which
actually did use U.S. M3, fell into the following categories:
<bullet> Papers testing new methods of creating monetary
aggregates (for example, so-called ``Divisia monetary
aggregates''). These papers did not demonstrate any
important indicator properties of M3.
<bullet> Papers testing new methods of estimating long-run
econometric relationships. Some of these papers estimated
equations based on the quantity theory of money for a range
of monetary aggregates. Again, these papers suggested that
M3 played no particularly valuable role.
<bullet> Papers testing the forecasting properties of various
financial or other variables. M3 would be one of hundreds
of variables used in such tests.
In all cases, M3 was studied only in combination with M2
and other monetary aggregates. In summary, our review of the
academic literature revealed no evidence that M3 was
particularly useful in macroeconomic analysis or forecasting.
The Board believes that it has a responsibility to the
taxpayer to weigh carefully the costs and benefits of all of
the various activities of the Federal Reserve, including data
collection and publication, to determine whether the Federal
Reserve is performing its responsibilities most efficiently. In
the course of such a review, the Board recently judged that the
costs to the Federal Reserve of collecting and processing the
data necessary to publish M3 exceeded the benefits. Moreover,
discontinuing two of the reports that need to be filed in order
to construct M3 will permit a small reduction in the burden on
some depository institutions.
As the Nation's central bank, the Federal Reserve
recognizes the importance of carefully monitoring as well as
releasing to the public data on useful concepts of the money
supply, and the Board will continue to publish timely data on
the monetary aggregate M2. Of the various monetary and debt
aggregates, in our view M2 has exhibited the most stable,
explicable, and useful relationship with measures of nominal
spending and interest rates. In addition, the Board will
continue to publish the monetary aggregate M1, which is a
component of M2, as well as the other components of M2. The
Board will also continue to publish data on shares issued by
institution-only money market mutual funds, which are currently
included in the non-M2 component of M3.
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