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[108 Senate Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:98356.wais]
S. Hrg. 108-769
FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT FOR 2004
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED EIGHTH CONGRESS
SECOND SESSION
ON
OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU-
ANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978
__________
JULY 20, 2004
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
RICHARD C. SHELBY, Alabama, Chairman
ROBERT F. BENNETT, Utah PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky EVAN BAYH, Indiana
MIKE CRAPO, Idaho ZELL MILLER, Georgia
JOHN E. SUNUNU, New Hampshire THOMAS R. CARPER, Delaware
ELIZABETH DOLE, North Carolina DEBBIE STABENOW, Michigan
LINCOLN D. CHAFEE, Rhode Island JON S. CORZINE, New Jersey
Kathleen L. Casey, Staff Director and Counsel
Steven B. Harris, Democratic Staff Director and Chief Counsel
Peggy R. Kuhn, Senior Financial Economist
Martin J. Gruenberg, Democratic Senior Counsel
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
(ii)
C O N T E N T S
----------
TUESDAY, JULY 20, 2004
Page
Opening statement of Chairman Shelby............................. 1
Opening statements, comments, or prepared statements of:
Senator Dole................................................. 2
Senator Bunning.............................................. 2
Senator Carper............................................... 3
Senator Reed................................................. 4
Senator Crapo................................................ 4
Senator Bayh................................................. 4
Senator Sununu............................................... 5
Senator Sarbanes............................................. 5
Senator Hagel................................................ 6
Senator Dodd................................................. 6
Senator Allard............................................... 6
Prepared statement....................................... 36
Senator Schumer.............................................. 7
Senator Corzine.............................................. 7
Senator Bennett.............................................. 26
WITNESS
Alan Greenspan, Chairman, Board of Governors of the Federal
Reserve System, Washington, DC................................. 7
Prepared statement........................................... 36
Response to written questions of:
Senator Shelby........................................... 40
Senator Bunning.......................................... 42
Senator Crapo............................................ 43
Senator Sununu........................................... 44
Senator Stabenow......................................... 46
Additional Material Supplied for the Record
Foreign Official Assets in the United States chart, submitted by
Senator Paul S. Sarbanes....................................... 48
Monetary Policy Report to the Congress, July 20, 2004............ 49
(iii)
FEDERAL RESERVE'S SECOND MONETARY
POLICY REPORT FOR 2004
----------
TUESDAY, JULY 20, 2004
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met, at 2:31 p.m., in room SH-216 of the Hart
Senate Office Building, Senator Richard C. Shelby (Chairman of
the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY
Chairman Shelby. The hearing will come to order. I am very
pleased this afternoon to welcome Chairman Greenspan before the
Committee on Banking, Housing, and Urban Affairs, to testify on
the Federal Reserve's Semi-Annual Monetary Policy Report to the
Congress.
Chairman Greenspan, the U.S. economy is continuing its
expansion with real GDP increasing 3.9 percent in the first
quarter of 2004. I hope we can now also point to strong job
growth with payroll employment increasing for 10 straight
months with an average of 200,000 jobs per month in the first
half of this year. I think overall this is good news for the
American worker and we hope to see even better numbers on jobs
and wages in the months ahead.
When this Committee heard from you in February of this
year, the Federal Open Market Committee had just stated that
the Committee could be ``patient'' in changing its
accommodative monetary policy. The FOMC then indicated in May
that changes in its policy were ``likely to be measured.'' At
its June meeting, the Federal Open Market Committee raised its
target for the Federal funds rate by 25 basis points to 1\1/4\
percent--the first increase since May 2000. This move was
widely anticipated by financial markets, and I think overall it
has helped ease inflationary fears.
Some Fed watchers have expressed the concern that the FOMC
waited too long to increase its target Federal funds rate
target. However, last week's report on retail sales and
industrial production seemed to indicate that the Fed's actions
have been prudent. Also, since the FOMC's June action, the
markets have responded by a reduction, as you well know, in the
long-term interest rate.
This afternoon, I think we will have ample opportunity to
discuss the Federal Reserve's views on the economy and how we
might interpret the FOMC statement on changes in monetary
policy which are ``likely to be measured.'' And, perhaps we
will even garner some insight as to the FOMC's consideration at
its upcoming August meeting.
Mr. Chairman, as I had indicated to you a minute ago, there
is a vote going on. Some of us voted early, and we will have a
lot of Members to join us. We look forward to your remarks, but
first, Senator Dole, any statement?
STATEMENT OF SENATOR ELIZABETH DOLE
Senator Dole. Thank you, Chairman Shelby.
Today, we welcome Chairman Greenspan back to this Committee
for our fourth and final Semi-Annual Monetary Policy Report of
the Federal Reserve for this Congress. I appreciate the
Chairman's willingness to visit with us so often, and explore
areas of concerns with regard to our economy and monetary
policy.
Last month, Chairman Greenspan assured us that he has
observed real wages increasing for Americans in the past 4
months. This, in turn, has helped increase disposable income, a
trend that I understand Chairman Greenspan expects to continue
as the natural course of the recovery and growing strength of
our economy. I cannot overstate the importance of this trend
for our men and women in the workforce, and appreciate Chairman
Greenspan's continued optimism in the American economy. I was
very pleased with the release last week of the June industrial
production data, indicating the growing strength in the
manufacture of durable capital goods. North Carolina has been
hit very hard by the loss of manufacturing jobs over the past
years. Any reversal of this trend is indeed welcome news.
There have been some excellent numbers for North Carolina--
according to figures released today from the Bureau of Labor
Statistics--North Carolina has created 35,400 new jobs in the
month of June. This positive news highlights the transition
which is occurring in North Carolina with the loss of low-
skilled manufacturing jobs and the creation of jobs in service
sectors which require a good education with a demand on
computer skills. Continuing education must continue to be a top
priority for us to respond to this demand.
I have spoken before about the work that Senators Enzi,
Alexander, and I are undertaking to write the Higher Education
Access, Affordability, and Opportunity Act of 2004. It will
provide additional assistance to our community colleges and
other institutions of higher learning for training and
retraining students in high-growth job markets. We hope to
introduce this bill shortly.
In addition, I remain concerned about a number of factors
such as high energy prices, the rise in steel prices, and the
size of our trade deficit. Despite these concerns though, I am
confident that through increased trade, hard work, global
communications, and continuing education of our workforce, we
will achieve new levels of opportunity for all Americans and
global security.
I, again, thank Chairman Greenspan for joining us here
today, and I will look forward to his testimony.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Bunning.
STATEMENT OF SENATOR JIM BUNNING
Senator Bunning. Thank you, Mr. Chairman.
I am glad that we get you first this time, Chairman
Greenspan--the House usually shares that opportunity with us--
because given the June economic figures, especially the housing
figures that came out today, I know many want to know what you
make of these figures, and that is especially true of this
Committee.
When the FOMC raised rates 25 basis points on June 30, it
was a move that was largely expected. Many in the economic
talking heads class said the market had already built in this
rate adjustment. However, since that raise, as of last night's
close, the Nasdaq market has lost 164 points, and the Dow has
lost 341 points. It has not been a very good 3 weeks for our
stock markets. I am not sure the June economic figures were
what the FOMC had in mind when it made its decision to raise
rates. I do not think any of us like the figures we have seen.
We can do better on all fronts. We did have another jobs
increase, but I still think we can do better. We need to make
sure those who want a job can find one.
I am also concerned with some of the recent corporate
earnings that have been reported, especially in the airlines
industry. Delta Airlines has been a major presence in Northern
Kentucky and in Kentucky in general. Their Northern Kentucky
hub has been an economic engine for all of Kentucky. It is a
major reason why companies such as Toyota, Fidelity, Citigroup,
to name a few, have built facilities in Kentucky. Delta also
has a great many employees in my State, about 8,000 in the
Northern Kentucky area. Delta's health is a very large concern
to my State.
I do not know what the answer is, but I know other Members
of this Committee have similar concerns about airlines with
major operations in their States. I also think many are
concerned about the new housing starts figures that were
released today. As you know, the housing sector helped carry
our economy during the last recession. Obviously, at some point
this would have to cool down, just a little I hope, but it was
a pretty dramatic drop both in May and in June. That came as a
surprise to me. I would like to hear your take on this. Is this
so-called housing bubble bursting? Is it something we need to
be concerned with, or was it inevitable that the housing market
would have to slow some?
I am concerned with how our economy is faring right now,
especially with the June figures coming in. Energy prices were
falling, but they are back on the rise. The stock market is
down and housing is down. It seems that our recovery had a
definite hiccup in June. I guess the $64,000 question, was it a
hiccup or something that we should be more concerned about?
Also, as I mentioned earlier, most of the economic talking
heads stated that the FOMC rate raise was built into the
market. They seem to have been proven wrong. They also stated
that a second rate increase was pretty much a done deal for
August. I hope the Fed is not on automatic pilot. I would like
you to look closely at the June figures, and I know you will,
before a decision is made in August. I do not want a hiccup to
turn into the flu.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Carper.
COMMENT OF SENATOR THOMAS R. CARPER
Senator Carper. I have no prepared remarks, Mr. Chairman.
Chairman Greenspan, welcome. I look forward to hearing your
testimony.
Chairman Shelby. Senator Reed.
COMMENTS OF SENATOR JACK REED
Senator Reed. Thank you, Mr. Chairman.
Thank you, Chairman Greenspan, for attending.
It does look like we are recovering jobs, but those jobs
seem to not have the same wages and earnings of previous jobs
that were lost, and that is a significant issue. We have had a
chance to talk about this before, but until we can really
establish wage and earning growth among a broad sector of
American workers, I do not think we are going to see a robust
economic recovery, and we are going to continue to have
families that are trying to make ends meet by borrowing. And as
interest rates go up--and you have already raised them and you
might contemplate raising again--that will put additional
pressure on families. So there is perhaps some encouraging
news, but there is also a very different reality we have to
cope with, and I am looking forward to your testimony.
Thank you.
Chairman Shelby. Senator Crapo.
COMMENTS OF SENATOR MIKE CRAPO
Senator Crapo. Thank you very much, Mr. Chairman.
Chairman Greenspan, it is a pleasure to welcome you back
here.
I am going to say at the outset my duty is to preside over
the floor in about 18 minutes, so I will not be here too far
into your testimony. In fact, I may miss your testimony. I am
going to read it very carefully, however, and I do share some
of the questions that you have already heard. The main
question, of course, that we want to see, is whether the
expansion that we are now seeing is capable of sustaining
itself, what the numbers from June meant, and how we can look
forward now in terms of gauging the strength of the expansion
and what is going to happen with inflation. I do appreciate
your careful attention to the inflation in our economy.
I do want to pose one question for you to consider either
during your testimony or perhaps in follow up if it does not
come up there. That is, as you know, a divided SEC voted 3 to 2
last Wednesday to seek comments on a proposal for mandatory
registration of hedge funds advisers with the SEC. My question
is whether you are concerned with this SEC proposal for
mandatory registration of hedge fund advisers with the SEC, and
whether you think it would be advisable for the President's
Working Group on Financial Markets to become involved in issues
relating to the regulation of the hedge fund industry.
With that, again, I welcome you here, and I look forward to
your testimony.
Chairman Shelby. Senator Bayh.
COMMENT OF SENATOR EVAN BAYH
Senator Bayh. Thank you, Mr. Chairman. I look forward to
hearing from Chairman Greenspan, and I will reserve other
comments until the question period.
Chairman Shelby. Senator Sununu.
COMMENT OF SENATOR JOHN E. SUNUNU
Senator Sununu. I have no opening statement. Welcome, Mr.
Chairman.
Chairman Shelby. Senator Sarbanes.
STATEMENT OF SENATOR PAUL S. SARBANES
Senator Sarbanes. Mr. Chairman, thank you very much. I am
pleased to welcome Chairman Greenspan back before our Committee
to testify on the Federal Reserve's Semi-Annual Monetary Policy
Report to Congress.
This was a requirement put into law by this Committee with
actually the support of the Fed, and I think it has worked very
well over the years.
As we all know, of course, at the last meeting of the
Federal Open Market Committee, they decided to raise the target
for the Federal funds rate by 25 basis points to 1\1/4\
percent, the first change in interest rates by the Fed in about
a year's time.
In a statement released after the meeting--and I want to
commend Chairman Greenspan and his colleagues for this shift in
practice, whereby after the FOMC makes decisions, they seek to
explain them, however briefly, to the public. The FOMC said
they ``perceive the upside and downside risks to the attainment
of both sustainable growth and price stability for the next few
quarters are roughly equal. With underlying inflation still
expected to be relatively low, the Committee believes that
policy accommodation can be removed at a pace that is likely to
be measured. Nonetheless, the Committee will respond to changes
in economic prospects as needed to fulfill its obligation to
maintain price stability.''
The final sentence of that paragraph has generally been
read to suggest that the FOMC will take a more aggressive
stance toward monetary policy if economic conditions warrant.
But, I would just like to note, in light of the recent economic
indicators that have been released, that the sentence could
also be read to suggest that the FOMC may tilt in the other
direction if, in fact, it is necessary.
While the outlook for economic growth remains positive,
most forecasts are being revised downward. GDP growth for the
first quarter of the year was revised downward to 3.9 percent.
Last week, the Commerce Department reported an unexpectedly
large decline in retail sales for June of 1.1 percent. The Fed
reported a 0.3 percent decline in industrial production. And
just this morning, the Commerce Department reported that
housing construction fell 8\1/2\ percent in June, the sharpest
drop since February 2003.
While these are all just monthly numbers, they raise
questions about the strength of the economic outlook. That is
particularly true when taken together with a continuing
weakness in the labor market.
Job growth in May declined from the 300,000 figure of March
and April to 250,000, and in June was cut in half to 112,000.
As a result of the prolonged labor market weakness, the economy
remains 1.2 million jobs below the level when the recession
began 39 months ago. Compared to the average economic recovery
of the post-war era, today's economy is nearly 6 million jobs
short.
Further, in June, 1.7 million of the unemployed, 21.6
percent of the total, had been unemployed an average duration
of 20 weeks. The long-term unemployed have made up over 20
percent of the unemployed for the past 21 months, surpassing
the record set from 1982 to 1984.
As The New York Times reported on Sunday, the slack labor
market is resulting in the failure of hourly pay in the United
States to keep pace with inflation. The article points out that
the Bureau of Labor Statistics reported last Friday, that
hourly earnings of production workers fell 1.1 percent over the
past 12 months, after accounting for inflation. The decline is
the steepest since the recession of 1991.
And only this morning, The Wall Street Journal had an
article entitled, ``So Far, Economic Recovery Tilts to Highest-
Income Americans,'' and goes on to note that, ``The recovery's
primary beneficiaries have been upper-income households.''
Finally, Mr. Chairman, in closing I simply want to take
note that Virgil Mattingly, who had served as General Counsel
for the Federal Reserve Board and the Federal Open Market
Committee for the past 15 years, and who served a total of 30
years at the Federal Reserve, just retired on June 30.
Virgil Mattingly worked closely with the Members and staff
of this Committee on every major piece of banking legislation
enacted over the past 20 years. He always provided not only
exceptionally intelligent and competent technical assistance to
the work of this Committee, but also wise counsel and wise
advice. He was, in my view, an extraordinarily able and
dedicated public servant, and upheld, and indeed in some
measure helped to define, the tradition at the Federal Reserve
of an outstanding career of service. He made very significant
contributions to our Nation and to the formulation of public
policy. I simply wanted to take this opportunity to wish him
well in his retirement, and to express appreciation for the
fine work he did over the years.
I also want to take this opportunity to congratulate Scott
Alvarez, who has been Associate General Counsel for the Federal
Reserve, and has been appointed to succeed Virgil Mattingly as
the Fed's General Counsel. Scott Alvarez is also well known and
highly regarded by the Members and staff of this Committee, and
we look forward to continuing to work closely with him in his
new capacity.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Hagel.
COMMENT OF SENATOR CHUCK HAGEL
Senator Hagel. I have no statement, Mr. Chairman.
Chairman Shelby. Senator Dodd.
COMMENT OF SENATOR CHRISTOPHER J. DODD
Senator Dodd. Mr. Chairman, I will wait, and I will just
ask unanimous consent that my statement be included in the
record.
Chairman Shelby. Without objection, so ordered.
Chairman Shelby. Senator Allard.
COMMENT OF SENATOR WAYNE ALLARD
Senator Allard. Mr. Chairman, I would like to thank you for
holding this hearing, and I always look forward to hearing from
the Chairman, and I will submit my full statement to the
record.
Chairman Shelby. Without objection, it will be made part of
the record.
Chairman Shelby. Senator Schumer.
COMMENTS OF SENATOR CHARLES E. SCHUMER
Senator Schumer. Thank you, Mr. Chairman. I would ask that
my full statement be submitted to the record.
Chairman Shelby. Without objection, so ordered.
Senator Schumer. The only observation I would make is there
are two wings to our economic policy here. There is fiscal
policy and monetary policy. The thing you are here to report on
and the thing you are in charge of, monetary policy, I think
you are doing a superb job. I think the quarter-inch steps that
you have made is just about perfect for our situation. But I do
worry about our fiscal policy, and sometimes, as you well know,
much of the time, lower interest rates are better for the
economy than lower taxes, and that will be the line of my
questions.
Chairman Shelby. Thank you, Senator Schumer.
Senator Corzine.
COMMENTS OF SENATOR JON S. CORZINE
Senator Corzine. I will submit a statement for the record.
Chairman Shelby. Without objection, your opening statement
will be made part of the record.
Chairman Greenspan, if you will abide us a few minutes, we
have established a quorum and would like to move the Committee
to Executive Session and ask for a vote on our nomination for
the Department of the Treasury and the Department of Housing
and Urban Development.
Chairman Greenspan, you proceed as you wish. Thank you.
STATEMENT OF ALAN GREENSPAN, CHAIRMAN
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Chairman Greenspan. Mr. Chairman, if I may before I start,
I would like to thank the Senator for his very thoughtful
remarks with respect to Virgil Mattingly's tenure at the
Federal Reserve. We will miss him, and we certainly concur in
how you evaluated his service and his contributions, I must
say, to this Committee, and assisting in innumerable pieces of
legislation, for which, for some reason or other, he always had
the right balanced insight.
We know Scott Alvarez, who worked closely with him over the
years, will not become a Virgil clone, but we would not mind if
he did.
Mr. Chairman, with respect to Federal Reserve's Monetary
Policy Report to the Congress, I cannot remember how many times
I have been here, but it is always a fascinating experience
because it gives us a chance, in this requirement, to review
every 6 months what is going on in the economy and our
interfacing with it. As Senator Sarbanes said, it has probably
been a major element in our generalized communications policy,
and I know that we always look forward to meeting with this
Committee.
Economic developments in the United States have generally
been quite favorable in 2004, lending increasing support to the
view that the expansion is self-sustaining. Not only has
economic activity quickened, but the expansion also has become
more broad-based and has produced notable gains in employment.
The evident strengthening in demand that underlies this
improved performance doubtless has been a factor contributing
to the rise in inflation this year. But inflation also seems to
have been boosted by transitory factors such as the surge in
energy prices. Those higher prices, by eroding households'
disposable income, have accounted for at least some of the
observed softness in consumer spending of late, a softness
which should prove short-lived.
When I testified before this Committee in February, many of
the signs of the step-up in economic activity were already
evident. Capital spending had increased markedly in the second
half of last year, no doubt spurred by significantly improving
profits, a low cost of capital, and the investment tax
incentives enacted in 2002 and enhanced in 2003. The renewed
strength in capital spending
carried over into the first half of 2004. Orders and shipments
of nondefense capital goods have been on the rise, and backlogs
of unfilled orders for new equipment continue to build.
A key element of the expansion that was still lacking in
February, however, was evidence that businesses were willing to
ramp up hiring to meet the stepped-up pace of sales and
production. Businesses' ability to boost output without adding
appreciably to their workforces likely resulted from a backlog
of unexploited capabilities for enhancing productivity with
minimal capital investment, which was an apparent outgrowth of
the capital goods boom of the 1990's. Indeed, over much of the
previous 3 years, managers had seemed to pursue every avenue to
avoid new hiring despite rising business sales. Their hesitancy
to assume risks and expand employment was accentuated and
extended by the corporate accounting and governance scandals
that surfaced in the aftermath of the decline in stock prices
and also, of course, by the environment of heightened
geopolitical tensions. Even now, following the pattern of
recent quarters, corporate investment in fixed capital and
inventories apparently continues to fall short of cashflow. The
protracted nature of this shortfall is unprecedented over the
past three decades. Moreover, the proportion of temporary hires
relative to total employment continues to rise, underscoring
that business caution remains a feature of the economic
landscape.
That said, there have been much clearer indications over
recent months that conditions in the labor market are
improving. Most notably, gains in private nonfarm payroll
employment have averaged about 200,000 per month over the past
6 months, up sharply from the pace of roughly 60,000 per month
registered over the fourth quarter of 2003.
The improvements in labor market conditions will doubtless
have important follow-on effects for household spending.
Expanding
employment should provide a lift to personal disposable income,
adding to the cuts in personal income taxes over the past year.
In addition, the low interest rates of recent years have
allowed many households to lower the burdens of their financial
obligations. Although mortgage rates are up from recent lows,
they remain quite attractive from a longer-term perspective and
are providing solid support to home sales. Despite the softness
of recent retail sales, the combination of higher current and
anticipated future income, strengthened balance sheets, and
still-low interest rates, bodes well for consumer spending.
Consumer prices excluding food and energy, so-called core
prices, have been rising more rapidly this year than in 2003.
For example, the 12-month change in the core personal
consumption expenditures price index stood at 0.8 percent in
December of last year and climbed to 1.6 percent by May of this
year. Core inflation, of course, has been elevated by the
indirect effects of higher energy prices on business costs and
by increases in non-oil import prices that reflect past dollar
depreciation and the surge in global prices for primary
commodities. But the acceleration of core prices has been
augmented by a marked rise in profit margins, even excluding
domestic energy companies.
This surge in profits reflects, at least in part, the
recent recovery of demand after a couple of years during which
weak demand led to relatively heavy price discounting by
businesses. Profits of nonfinancial corporations, as a share of
sector output, after falling to 7 percent in the third quarter
of 2001, rebounded to 12 percent in the first quarter of 2004,
a pace of advance not experienced since 1983. Half of this rise
in profit share occurred between the first quarter of 2003 and
the first quarter of 2004, a period during which costs were
unusually subdued. In fact, consolidated unit costs of business
for the nonfinancial corporate business sector actually
declined during this period. The increase in output per hour in
the nonfinancial corporate business sector of more than 6
percent accounted for much of the net decline in unit costs.
The remainder was due to the effects of rising output in
reducing nonlabor fixed costs per unit of output. Hence, at
least from an accounting perspective, between the first quarter
of 2003 and the first quarter of 2004, all of the 1.1 percent
increase in prices of final goods and services produced in the
nonfinancial corporate sector can be attributed to a rise in
profit margins rather than rising cost pressures.
However, businesses are limited in the degree to which they
can raise margins by raising prices. An increase in margins
should affect mainly the level of prices associated with any
given level of unit costs but, by itself, should not prompt a
sustained pickup in the rate of inflation going forward. In a
market economy, any tendency for profit margins to continue to
rise is countered largely by the entry of new competitors
willing to undercut prices and by increased labor costs as more
firms attempt to exploit the opportunity for outsized profits
by expanding employment and output. That increase in
competitive pressure, as history has amply demonstrated, with
time, returns markups to more normal levels.
The profit share in the first quarter of this year, at
about 12 percent, was well above normal. The gap suggested that
the growth of unit profits would eventually slow relative to
increased unit costs. This outlook had accorded with analysts'
expectations for earnings growth over the next year, which are
substantially below the realized profit growth of profit in
recent quarters.
Indeed, some leveling or downward pressure on profit
margins may already be in train, owing to a pickup in unit
labor costs. And, although advances in productivity are
continuing at a rate above the long-term average, they have
slowed from the extraordinary pace of last summer and are now
running below increases in hourly compensation. The available
information suggests that hourly compensation has been
increasing at an annual rate of about 4\1/2\ percent in the
first half of the year. To be sure, the increases in average
hourly earnings of nonsupervisory workers have been subdued in
recent months and barely budged in June. But other compensation
has accelerated this year, reflecting continued sizable
increases in health insurance costs, a sharp increase in
business contributions to pension funds, and an apparently more
robust rate of growth of hourly earnings of supervisory
workers. The larger wage gains for supervisory workers together
with anecdotal reports of growing skill shortages are
consistent with earlier evidence of rising wage premiums for
skilled workers relative to less-skilled workers.
For the moment, the modest upward path of unit labor costs
does not appear to threaten longer-term price stability,
especially if current exceptionally high profit margins begin
to come under more intense competitive pressures at home and
from abroad. Although some signs of protectionist sentiment
have emerged, there is little evidence that the price-
containing forces of ever widening global competition have
ebbed. In addition, the economy is not yet operating at its
productive capacity, which should help to contain cost
pressures. But we cannot be certain that this benign
environment will persist and that there are not more deep-
seated forces emerging as a consequence of prolonged monetary
accommodation. Accordingly, in assessing the appropriateness of
the stance of policy, the Federal Reserve will pay close
attention to incoming data, especially on costs and prices.
As always, considerable uncertainties remain about the pace
of the expansion and the path of inflation. Some of those
uncertainties, especially ones associated with potential
terrorism, both here and abroad, are difficult to quantify.
Such possibilities have threatened the balance of world supply
and demand in oil markets in recent months, especially as
demand has risen with the pace of world economic growth. Yet
aside from energy, markets exhibit little evidence of
heightened perceptions of risk. Credit spreads remain low, and
market-based indicators of inflation expectations, after rising
earlier this year, have receded.
With growth of aggregate demand looking more sustainable
and with employment expanding broadly, the considerable
monetary accommodation put in place starting in 2001 is
becoming increasingly unnecessary.
If economic developments are such that monetary policy
neutrality can be restored at a measured pace, as the FOMC
expects, a relatively smooth adjustment of businesses and
households to a more typical level of interest rates seems
likely. Even if economic developments dictate that the stance
of policy must be adjusted in a less gradual manner to ensure
price stability, our economy appears to have prepared itself
for a more dynamic adjustment of interest rates. Of course,
considerably more uncertainty and hence risk surrounds the
behavior of an economy with a more rapid tightening of monetary
policy than is the case when tightening is more measured. In
either scenario, individual instances of financial strain
cannot be ruled out.
The protracted period of low interest rates has facilitated
a restructuring of household and business balance sheets.
Businesses have been able to fund longer-term debt at highly
favorable interest rates, and by extending the maturity of
their liabilities, have rendered net earnings and capital
values less exposed to destabilizing interest rate spikes.
Households have made similar adjustments.
Financial intermediaries are profitable, well-capitalized,
and appear to be well-positioned to manage in a rising rate
environment. In short, Mr. Chairman, financial markets along
with households and businesses seem to be reasonably well-
prepared to cope with a transition to a more neutral stance of
monetary policy. Some risks necessarily attend this transition,
but they are outweighed, in our judgment, by those that would
be associated with maintaining the existing degree of monetary
policy accommodation in the current environment. Although many
factors affect inflation in the short-run, inflation in the
long-run, it is important to remind ourselves, is a monetary
phenomenon.
As we attempt to assess and manage these risks, we need, as
always, to be prepared for the unexpected and to respond
promptly and flexibly as situations warrant. But although our
actions need to be flexible, our objectives are not. For 25
years, the Federal Reserve has worked to reestablish price
stability on a sustained basis. An environment of price
stability allows households and businesses to make decisions
that best promote the longer-term growth of our economy and
with it our Nation's continuing prosperity.
Thank you very much, Mr. Chairman. I have excerpted from my
prepared remarks and request that they be included in the
record in full, and I look forward to your questions.
Chairman Shelby. Without objection, it will be. Thank you,
Mr. Chairman.
Chairman Greenspan, your testimony, among other things,
indicates that the economic expansion is self-sustaining, and
that it has become broad based with strengthened demand and
employment gains. You also indicate that financial markets,
along with households and businesses, seem to be reasonably
well prepared to cope with a transition to a more neutral sense
of monetary policy.
Can we interpret those comments as indicating that the
Federal Open Market Committee, FOMC, will be inclined to raise
the Federal funds target by an additional 25 basis points in
August, and would this be a measured pace?
Chairman Greenspan. I think we have very purposely
refrained from defining what we mean by that term. Obviously, I
try to raise two general scenarios as to how we would
ultimately restore the Federal funds rate to neutrality, where
we believe it will need to go. One is measured, which I guess
the dictionary says means gradual; and the other is one which
we do not perceive is the most likely, but still we are
prepared for if necessary, if the economy shows signs of
exhibiting significant inflationary pressures, in order to
maintain the mandate which the Congress has given us to create
price stability mainly for the purpose of maintaining and
fostering maximum, sustainable long-term growth. Because that
is our objective, we will do what is required to achieve that
objective.
Chairman Shelby. In February, the Fed's forecast for growth
was between 4.5 and 5 percent for 2004. Today's forecast gives
a range of 4.5 to 4.75 percent, or a slight reduction. It is
close. At the same time we have seen evidence of higher
inflation in recent months.
Others argue that the economy does not have as much excess
capacity as utilization data would imply, with the implication
there that the inflation threat may be stronger in the Fed's
view.
What is your assessment, Mr. Chairman, of whether the
economy is in any danger of moving into a slowdown
characterized by higher inflation?
Chairman Greenspan. Mr. Chairman, this is always our
concern. I should say most of us lived through the stagflation
of the 1970's, and it was a very, I would say, disconcerting
experience.
Chairman Shelby. A bad situation.
Chairman Greenspan. And the concern that we have,
obviously, in this context, is something that obviously
occurred in that period, namely a sharp rise in oil prices.
Now, obviously, the levels of oil prices in real terms are
nowhere near today where they were back then. But we will
always be confronted with issues of trying to maintain an
economy in which low inflation exists in the context of strong
growth in the economy and in employment.
We try to calibrate our policies to achieve that end as
best we can. Sometimes the real world does not offer us the
opportunities that we would like, but we work as expeditiously
as we can to calibrate policy to achieve those ends.
Chairman Shelby. Chairman, how comfortable are you with the
data being gathered on production capacity, which seems to
imply that there is still room to absorb additional production
without generating significant inflation? You alluded to that
earlier.
Chairman Greenspan. Mr. Chairman, these data are collected
through surveys of plant managers who were asked at what level
in their judgment at a certain period of time their plant is
operating. And what we do is essentially collect, reweigh, and
process those data and make a judgment as to what the
facility's capacity and excess capacity is, recognizing that
this is not necessarily the same thing as saying, what is the
capability of these plants, because there may be shortages of
skilled workers or surpluses of skilled workers, and obviously,
capacity in any meaningful sense is an integration of the
physical facilities and a workforce capable of effectively
operating those facilities.
Chairman Shelby. Chairman Greenspan, the House has been
considering a bill that effectively blocks FASB from requiring
the expensing of all employee stock options. Some of us here
have grave concerns about the Congress becoming involved in
such technical accounting issues. What message would the
Congress send by intervening in FASB's rulemaking process? What
would the implications have for the current standard-setting
process?
Chairman Greenspan. I would be most concerned if the
Congress intervened. Accounting, remember, is for the purpose
of trying to get records which tell companies whether their
strategies for success are succeeding or not. Accounting is
difficult because a lot of it requires forecasts. FASB
endeavors to obtain all of the various differing views on the
way certain particular accounting procedures should be
implemented, and I think that they do a good job. It is a tough
job. And if the Congress dictates what they can do or should
do, I think it undercuts the ability of the business community
to effectively measure what it is doing.
Chairman Shelby. Thank you.
Senator Carper.
Senator Carper. Thank you, Mr. Chairman.
Chairman Greenspan, this past weekend I flew out to
Kentucky to visit my mother. Senator Bunning, she lives over in
Ashland, Kentucky, real close to Huntington, West Virginia.
While traveling there and back to Delaware I had some down time
because our planes were delayed, and I had a chance to catch up
on some of my reading.
Among the things that I read about were the competitive
disadvantage that a lot of our manufacturers face because of
the rising, still-high cost of natural gas compared with
natural gas costs for a lot of our competitors around the
world. I read about the competitive disadvantage that a number
of our employers face in this county--I will call them legacy
costs--which relate to pension costs for pensions that you are
attempting to fund, and pension costs for those that are
already retired. I read about the health care cost that we face
in this country, double digit increases again in health care
costs for employees and for those who are retired. And I read
about the disadvantages that we face with respect to legal
costs. We tried mightily earlier this month to pass class
action reform legislation in the Senate, have not yet been
successful, although I certainly hope we are not giving up. And
another is with respect to costs growing out of asbestos, and
the question whether or not we are going to be able to come to
grips with a more rational approach for compensating those who
have been damaged by exposure to asbestos.
I am going to ask you to maybe address a couple of those.
First of all, if you will, just maybe a minute or two with
respect to natural gas prices. I did not fully appreciate
earlier how much higher our natural gas prices are to those in
other parts of the world and how regionalized the prices are
and what that means to us. If you could just dwell on that a
little bit. As you know, we are supposed to be in conference
with the House on a FISC ETI bill, so-called the Jobs Bill or
Tax Bill. There are provisions in that legislation for energy
conservation and production. Just a thought, if you will, to
start off on natural gas prices and what these are doing to our
competitiveness.
Chairman Greenspan. Senator, I think you are raising a very
critical issue which I have addressed before this Committee in
the past, and regrettably, things have not changed or improved
much.
Our basic problem is that natural gas is essentially unlike
crude oil or all of the oil products, where because we have a
significant world trade, when we run into shortages here as we
do, and indeed we are always short in the sense we are
importing a very significant amount of our oil in this country,
we have the capability from almost any part of the world to
draw in additional supplies of crude oil and petroleum
products. As a consequence, our prices tend to be, at least
domestically, fairly close to those amongst our competitors
around the world.
That is not true, as you point out, with natural gas. The
basic reason is that as our demand for natural gas in this
country has increased year-by-year in part because it is
obviously the preferred fuel in so many applications, we have
begun to run out of the ability to supply that from domestic
sources or from Canada, which has historically supplied us with
about a sixth of our needs. Because trade in natural gas is
about half the size, relative to total consumption worldwide
that oil is, we have very considerable difficulty importing.
One of the reasons is that while we do import from Canada, we
can no longer expand Canadian imports. What we have to do is
very markedly increase our supplies of liquified natural gas,
which means what we have to do is get gas which is put in
liquified form for transport in a cryogenic state, and bring it
in to terminals in the United States. Our terminal capacity is
not at this stage large enough to fill our import needs, and I
trust we will be moving fairly rapidly to increase our capacity
to bring in foreign gas, but until that occurs, I am fearful,
as I suspect you are from the remarks you were making, that we
are going to erode our competitive advantage where natural gas
is a key input into the production process.
And I trust we can expedite our ability to raise our import
capabilities and bring gas prices, which now are close to $6
per million BTU, well above the world competitive level, back
to levels which enable our companies to be far more
competitive.
Senator Carper. Mr. Chairman, I mentioned earlier that we
have been unsuccessful, at least this month, in passing class
action reform legislation. Later today or maybe tomorrow
Senator Frist is expected to meet with Senator Daschle and make
a counter-proposal, if you will, to the offer Senator Daschle
made maybe 4 weeks ago on asbestos litigation reform. We have
about 70 to 75 companies that have gone bankrupt in this
country. A number of others are threatened at this point in
time. Could you take a minute and share with us your views of
the importance of our trying to reach an accommodation in this
area?
Chairman Greenspan. I am not someone who has looked at the
details of the legislation, or in fact, the depth of the
problem. In my early years, asbestos was something that was
considered an exceptionally valuable product and----
Senator Carper. Times have changed.
Chairman Greenspan. Times have definitely changed. And I
cannot add terribly much to this, but hope that the obvious
business uncertainty which the lack of a resolution of this
question is creating can be expeditiously resolved.
Senator Carper. Thank you, sir.
Chairman Shelby. Senator Dole.
Senator Dole. Mr. Chairman, I am concerned about how
movement in the Chinese economy could affect us, and I would
like to ask you about this. The Chinese, of course, have a very
weak banking sector. Half of their loans are bad. There are
signs of a growing bubble in their commercial real estate
sector, a growing U.S. currency reserve at $415 billion as of
January.
Chairman Greenspan, while the Chinese economy is small
compared to ours, how concerned are you about these and other
potential problems in the Chinese economy? Recently, China
appeared to have realized that their growth is not sustainable,
and have taken steps to slow down their rapid growth. One of
the areas where they have pulled back is with steel production.
Recently, I have been contacted by our transit authorities,
both in Charlotte and Raleigh, North Carolina, because they are
going to be starting soon on construction, and they have
expressed deep concern on how this rise in steel prices is
presenting real problems to their cost projections. I have to
imagine that commercial real estate and other industries will
be impacted and will suffer because of these cost increases.
Could these steps by the Chinese Government to slow down
their economy potentially trigger inflation in the United
States with continued globalization? Can China, in combination
with other countries with high growth, export inflation to the
United States, and if so, do we have any monetary tools to
combat such a problem?
Chairman Greenspan. Senator, the Chinese economy is slowing
down, and it is a deliberate effort on the part of what is a
partial, centrally planned economy with an ever-growing market
segment, and it is a very tricky policy that they have to
implement to get it right.
The rate of increase in investment has gone down very
materially on a year over year basis, and clearly through the
second quarter, where their quarter-by-quarter rate of growth
really slowed virtually to a halt, they exhibited considerable
removal of very major elements of growth. However, they do not
seem to be sinking much further. In fact, their exports look,
frankly, a little bit better in June, and overall, it is very
likely that, largely because of the nature of the central
planning, they will try to calibrate it in a way which improves
the outlook. But their economy, as you point out, is still
relatively small in the areas which impact directly on us. I
find it most unlikely that their contraction of steel product,
as large a producer as they are, will induce any significant
rise in steel prices.
There has been, as you know, some significant decline in
steel prices in the United States, but judging from the scrap
prices in recent weeks, it has come back a bit in part because
the demand is still reasonably strong. I do not believe that
the Chinese can export inflation to us. It is extremely
difficult to do that, and they are not the type of economy
which so interfaces with us that would create such a problem.
It is important that they move as quickly as they can to a
market economy, and I think that they are trying to move in
that direction. But until they have succeeded, they will still
have the types of problems that you suggest.
Senator Dole. The Bureau of Labor Statistics reported that
in June that the U.S. economy created about 112,000 new jobs
nationwide. I have been amazed that some have stated that since
this number was less than half of that projected for new jobs,
that somehow this is an indication that our economy is headed
back into recession again.
For the record, how do you view these lower-than-expected
job figures?
Chairman Greenspan. Senator, we have approximately 130
million people on payrolls in this country, and I am surprised
that we can estimate the change from month to month as
accurately as we do. The range is really quite large.
I know a number of people looked at those data and took it
as some indication that there is some significant weakness
developing. If that were the case, I think we would have seen
it in a marked pickup in initial claims for unemployment
insurance, which of course we have not, and all of the other
qualitative indicators we have currently in the third quarter
suggest that employment is continuing to expand. And indeed,
while there has been weakness in June, and a number of your
colleagues mentioned this, I might say that July seems to be
somewhat better, even though we are going through a soft patch.
Motor vehicle sales, which for example, were an important
part of the weakness in the June retail sales data, as least so
far as the first 10 days were concerned, shows a very
significant snap-back largely because discounts have been
expanded again. Our anecdotal data on new orders arriving
during the month of July showed that the system is holding up.
There is no real underlying evidence of any cumulative weakness
here.
It is nonetheless the case that the little bulge in
inflationary pressure seems to have created a soft patch here,
and it is something obviously we are watching very closely.
Senator Dole. Just one final question. Recently, some have
suggested that most of the new jobs being created in the last
year are paying an average $1,500 to $9,000 less than those
jobs lost over the past few years. Obviously, often an
unemployed person that finds a new job, they may be at a lower
salary for a short time. But does your analysis show that the
current jobs being created are basically lower-wage jobs with
little or no benefits?
Chairman Greenspan. The answer is no. But let me say that
there are several different statistics that I think are
important. The one that you cite is an important fact, namely,
that people who do lose their jobs tend to have difficulty
restoring the level of their original wage for quite a while.
And that is part of the process which goes on in the very
significant churning in the labor market.
We have looked at this question in the broader sense of are
we essentially downgrading the types of jobs that are being
created, say, over the past year, and the answer is we find
very little evidence of that.
There are essentially two ways to interpret how one should
evaluate this. One, is to look at the question as to whether
the growth in jobs is disproportionately in industries where
the average wage rate is higher than average for the economy as
a whole. There seems to be a slight indication of a decline in
that regard, meaning more workers going into industries with
slightly below nationwide average earnings.
And two, when we look at it in the context of occupation,
where clearly one gets a sense of what is happening to
particular types of job slots, the answer is exactly in the
opposite direction.
Now, these are not contradictory. In other words, you can
have an increasing spread within industries where there is a
greater skill dispersion while still having the average of the
industry go down. But the bottom line in all of this is these
data are so marginal that the conclusion that there is anything
going on other than just average expectation of changes in jobs
does not seem, in our judgment, to be supported by the
underlying data which is broadly available.
Senator Dole. Thank you, Mr. Chairman.
Chairman Shelby. Senator Sarbanes.
Senator Sarbanes. Thank you very much, Mr. Chairman.
Actually, Senator Dole touched on a couple of issues I
wanted to address. One is the current account deficit, which is
now at about 5.5 percent of GDP, the highest level, as I
understand it, in U.S. economic history, at least according to
Pete Peterson, who said in an article in The Washington Post on
Sunday, ``This deficit requires us Americans to borrow about $2
billion from foreigners every working day. No expert I know
believes that this is sustainable.'' And, Chairman Greenspan,
if I recall correctly, you have stated before this Committee in
the past that a current account deficit of this magnitude is
not sustainable, as I recall.
Chairman Greenspan. That is correct, Senator.
Senator Sarbanes. Now, I am concerned not only about the
deficit but that the source of the foreign borrowing has
shifted. In its February report, the Fed found, ``The financing
counterpart to the current account deficit experienced a
sizable shift in 2003 as net private inflows fell while foreign
official inflows increased. Foreign official purchases of U.S.
assets surged to record levels in 2003, with the accumulation
of dollar reserves particular high in China and Japan.''
I have a chart here that I want to show this surge and
which I think highlights that our dependence on foreign capital
has increasingly been supplied by foreign governments,
specifically, according to the Fed, China and Japan. And this
is the foreign official assets in the United States. This is
1976. This is 1993. And then we see the steady pace--and then
it is almost going up at a perpendicular rate now.
I find this troubling. I guess I find any chart that all of
a sudden seems to leap out in some different direction from
what we have generally been experiencing a matter of concern.
What is happening here and what are its implications? Are China
and Japan doing this to manipulate the currency in order to
gain a trade advantage and help their export position? And what
are the potential consequences for us in this scenario,
particularly assuming it might continue?
Chairman Greenspan. Well, let me answer the second part of
your question first. We have obviously been monitoring these
flows very closely for precisely the reasons that you indicate.
It is turning out that the impact on the international markets
on the value of the dollar and, hence, on the value of the
United States' internal economic system from these shifts
between foreign private funding of our current account deficit
to last year's very significant public funding, it is turning
out that in 2004 we are beginning to see a reversal of that
without any serious consequences, meaning that the shift
between foreign public financing of the deficit and private
financing is not a significantly large issue. The Japanese, for
example, stopped intervening to accumulate American dollars in
March of this year, after very heavy purchases earlier this
year, and the Chinese purchases have flattened out. We see very
little evidence that the shift of that official financing to
private financing is impacting on the economy in general.
Nonetheless, there is no question that, as I am sure you
are aware, almost half of Federal marketable debt outstanding
that we issue, is held abroad. And these trends are
significant, and they do raise serious questions. But so far,
the flexibility of our international financial system has been
such that we have had very little problem in financing these
very large deficits.
Now, as I have testified before this Committee on
innumerable occasions, this cannot go on indefinitely because
at some point we are going to reach a status where our net debt
to foreigners--currently a little under a fourth of GDP--will
get exceptionally large, and the holding of dollar assets as
reserves for both the private and public sectors abroad will
become abnormally large relative to their needs and they will
stop purchasing dollars. That will have an obvious significant
impact on us when it occurs.
I do not know when that date is. I know at some point in
the future something of that nature has to occur, unless there
are shifts in the world economy such that our trade deficit
and, therefore, our current account deficit falls measurably.
If that does not happen, then we are going to see a clear
indication on the part of foreign investors in the United
States to start to hold back and diversify, even if the rates
of return here remain high. Since we are at unprecedented
levels--and it could conceivably be higher, as I indicated in a
speech earlier this year--at some point it has to shift.
Senator Sarbanes. I want to touch on one other subject that
Senator Dole raised, and that is the weakness of the labor
market. The participation rate between the first quarter of
2001 and the second quarter of 2004 dropped to such an extent
that actually we would have 2.5 percent more people in the
labor force today if the participation rate was what it was
just 3 years ago.
In June, 21.6 percent of the total of unemployed have been
unemployed over 20 weeks. This is quite a change, as we can see
here, in terms of having crossed above the 20-percent line and
staying up there, which actually now it has been there for 21
months. It surpassed the record set from 1982 to 1984.
Finally, the job growth, although we have had some job
growth in recent months, we still remain below where we were in
the level of jobs 39 months ago when the recession began. In
every economic recovery since the Depression, the economy has
recaptured all of the jobs it lost well within the 39 months.
So this is the longest job loss recovery. And, in fact, there
is a very marked contrast between the current recovery and the
average of post-war recessions. If we just match the average,
we would have about 6 million more jobs currently.
Now, looking at all of this, and, of course, you know, we
are getting a lot of comment in the newspapers and in the
magazines about this very difficult problem, it seems to me we
have not been able to bring jobs back online in a way that
gives us encouragement in terms of putting people back to work.
We still have this job gap, this slack in the labor market. How
do we explain it? I mean, it is a very marked contrast----
Chairman Greenspan. It is.
Senator Sarbanes. --where we are today with previous
recoveries.
Chairman Greenspan. Senator, I think there are two basic
forces at play here. The first is that productivity growth over
this period has been extraordinarily large, far in excess of
the rate of increase in output per hour that was experienced
during other periods that you draw on the average of your
chart. And so as production picked up, we were not hiring,
basically for reasons which I indicate in my prepared remarks,
and that has continued, not to the extent that it existed last
year, but productivity is still running above the averages of a
goodly part of the period which you have on your chart.
Second, we have had an exceptionally shallow recession--in
fact, the shallowest recession in the post-World War II
period--so that the normal rebound that we experienced in a lot
of the recoveries which are part of the average that you show
on your chart was not possible.
If, as I suspect is the case, the growth rate of
productivity will slow down from the extraordinary levels of
last year, growth will continue in payrolls, and at a fairly
significant pace. I do not know that I can pinpoint the actual
number. It will depend crucially on every tenth of a percent in
the productivity numbers and obviously in the GDP. But it does
not look as though the growth in employment is stalling, though
there is no question that it is moving up at a pace far less
rapid than you point out has been our history.
Chairman Shelby. Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman.
Chairman Greenspan, how concerned should we be about the
June housing figures, 8.4-percent reduction following a 3.5-
percent reduction in May?
Chairman Greenspan. Senator, the figures for June came out
below where we would have expected them to be, but not
appreciably. The reason essentially is that as mortgage rates
began to move up several months ago, we began to see a
significant pick-up in housing sales, people endeavoring to get
in under the wire, so to speak. The result was clearly a
borrowing of housing starts from the future. And that I think
is part of the June experience.
If that is the case, then we would expect some short-term
recovery from the June decline, and, indeed, that is suggested
in the detail that we get along with housing starts, which
tries to measure the permit data that go along with the starts
data, coupled with backlogs of unused permits. And those data
indicate that a significant part of the drop, almost half, is
not reflected in the decline in so-called adjusted permits,
meaning for single-family dwellings it would be permits of
single-family dwellings plus the number of starts in
nonpermitted issuing areas. Those numbers are down roughly half
what the actual starts figure is.
So the number is weak, there is no question about that, and
definitely below where our expectations are. But we do not
believe it is a cause for concern. Our general forecast, as it
has been for quite a while, is that housing starts which have
come up at an extraordinary pace in recent years are very
likely to shade lower over the next couple of years. It is hard
to maintain the pace that we are maintaining, but we do not
expect that the fall-off will be abrupt or significant. And as
a consequence of that, we do not perceive the June figure to be
a harbinger of worse to come.
Senator Bunning. Does the June producer price index drop
make you feel better about inflation or not?
Chairman Greenspan. Obviously somewhat better, but still, a
number of the prices that are built into that index were rising
recently at a somewhat faster pace than we expect in the
context of maintaining long-term price stability. But it is the
case that the modest slowdown in the inflation rate was
welcome.
Senator Bunning. Let me ask you, you talked productivity
and how important it was for the job market and other things.
What is the Fed's view as far as additional productivity gains
as we look down through the third and fourth quarter of this
year? Do you see an average gain of productivity? Or where are
we?
Chairman Greenspan. It is one of the most difficult
statistics to forecast, Senator. We can forecast aggregative
demand reasonably well, plus or minus a half a percentage point
annual rate, most of the time. We know that when we have profit
margins at the levels they are now, there are very significant
incentives on the part of business to expand their workforces
and in the process be less focused on cost reduction, which is
the major component of productivity growth.
So it is difficult for us to make judgments as to the path
of productivity or exactly how the increase in the GDP will be
distributed between that produced by increased employment and
that produced by increased productivity. Our general judgment
is that it is probably going to be average, but the truth of
the matter is we have very little experience in dealing with
productivity numbers as high as they have been, and our
forecasting success in the last year or two in trying to judge
where these numbers were likely to go has been one of our
poorer set of projections.
Senator Bunning. The last question, and this has to do with
energy costs, the cost of crude oil, the cost of natural gas,
and everything. How much more cost increase can this economy
stand before it becomes a very significant factor in the
overall well-being of the economy?
Chairman Greenspan. Senator, that is one of the most
important questions that we focus on. It depends in part on
what these oil prices or gas prices are going to rise from
here. Their impact on the economy will depend on how fast they
are moving, because what our data show, especially for oil, is
that over the longer run, say a series of years, the elasticity
of demand for oil with respect to price is pretty high. In
other words, if prices stay high, after several years we will
shift the structure of our economy to less oil-intensive
structures. The nature of our light motor vehicle stock, for
example, will shift significantly to types of cars and trucks
which consume far less motor gasoline. And the same will hold
true in lots of other areas of the economy.
If, however, prices spike in the short run, where those
adjustments are not possible, then history tells us it has
significant impacts. And, indeed, that is what happened to us
in the latter part of the 1970's. So it depends very
critically, if we are to run into a problem, whether it is a
gradual change in price or whether it is a short-term change.
But as I indicated earlier, even though we are approaching
record nominal prices of crude oil in the world, we obviously
are well below where we were, for example, in 1979 in real
terms.
Senator Bunning. Thank you.
Chairman Shelby. Senator Reed.
Senator Reed. Thank you, Mr. Chairman.
Chairman Greenspan, one of the issues we have talked about
on several occasions is this lack of growth in wages and
earnings for workers, and that is a critical issue. Increases
are necessary to meet increased obligations of housing,
education, health care, but also there is a distributional
effect which you have pointed out, where higher-skilled workers
seem to do okay and lower-skilled workers seem to be falling
behind, creating social tensions.
Senator Reed. Looking at the numbers I have, over the last
year average hourly earnings decline 1.1 percent in real terms.
Average weekly earnings declined 1.4 percent. This is in a
situation where the economy is recovering. We are seeing GDP
growth and, as you point out, where productivity has been
growing significantly, allowing, one presumes, increases of
wages.
Can you explain the apparent contradiction between these
falling wages and increased productivity and expansion?
Chairman Greenspan. Senator, I believe--I think it was the
last time I was here--we had a fairly extensive discussion in
the question-and-answer period on the issue of education. I
believe you were participating in that.
Senator Reed. That is right, and can I say, I think this is
a slightly different question, because we are not talking about
people entering the workforce with different skills. We are
talking about apparently workers that are already employed
within a year. I would think that factor would not be the most
critical.
Chairman Greenspan. In a way it is, and the reason I say
that is that, as I tried to define the problem back then, what
has been happening to our labor force is that we have not been
able to keep up the average skill level in our workforce to
match the required increases of increasing technology. And what
that has meant has been that rather than getting an ever
increasing number of college graduates at a far faster rate
than we have been getting them and, hence, higher skills, to
create a surplus or at least a significantly large supply of
skilled workers relative to the demand in order to keep skilled
wages down and because you move up people from the lesser
skilled areas to the skilled, you lower the number of surplus
workers in those markets for lesser skilled and, hence, remove
the downside pressure on wages.
In other words, this is an issue which has been regrettably
going on for 15 years, or thereabouts, creating an ever
increasing opening up of the skilled versus lesser-skilled gap.
And as you point out, if you put the wage changes in nominal
terms, for the lesser-skilled they have been growing in many
parts of the last 15 years at less than the increase in the
Consumer Price Index. That is, of course, not true for wages
and salaries as a whole. Indeed, the ratio of average hourly
earnings for supervisory workers that one can infer from the
data systems that we have, have been rising relative to average
hourly earnings, which you cite, for quite a considerable
period of time, and they account for 40 percent of the
aggregate wage and salary totals. So we are getting a problem
here which I think has got to be addressed, and as I had
indicated last month, I think the effective increase in the
concentration of incomes here, which is implicit in this, is
not desirable in a democratic society.
Senator Reed. We have several problems. One problem is
training and retraining individuals and, you know, if you are
starting off with high school or elementary children, you maybe
can have an effect. That is 5 or 10 years out. The situation
is: What do we do in this year, next year, and the following
years to raise the wages of people whose skills cannot be----
Chairman Greenspan. I think the way you raise those wages
is you remove the large number of younger people whose skills
should be upgraded significantly from being an overhang on the
job markets in which we have got, from as best I can see, an
excess of supply over demand, and that has got to be changed.
Senator Reed. I do not see a ready policy there, but I see
a concept.
Chairman Greenspan. Whether you have a policy or not, I
think it is right to get the analysis right. Because if we do
not understand what is causing this, our policies are not going
to address what is a significant problem.
Senator Reed. What specific policies should we adopt today?
Chairman Greenspan. Well, I mean, if we can move----
Senator Reed. Because that helps us understand.
Chairman Greenspan. First of all, we know that from the
fourth grade to the twelth grade, our children somehow are
falling behind international standards.
Senator Reed. Mr. Chairman, I accept that, but policies
that are applied to people currently in the workforce today,
adults who are working hard, they are seeing corporate profits
go up dramatically. They are getting very little share of those
corporate profits as the data indicates.
Chairman Greenspan. I think what you are going to find is
that that share will now start to increase.
Senator Reed. Now, one of the places that this share
increases is labor costs, because employers will spend more for
health care and for other benefits, which workers appreciate.
That still does not increase the take-home.
Chairman Greenspan. I agree with that, and what I am saying
is that, as I indicated I think the last time I was here,
virtually all of the increase in productivity during the year
starting in the first quarter of 2003 shows up not as real
wages, but as increased profitability. That stopped some time
in the last several months, and what history tells us is that
the shift now goes in the other direction, and you get, with a
delayed effect, the increased productivity showing up as real
wages overall, and I would think that while certainly
supervisory workers are going to contribute or share
significantly, it will also be true of the 80 percent of
payrolls which are nonsupervisory workers as well.
Senator Reed. My time has expired. Thank you, Mr. Chairman.
Chairman Shelby. Senator Allard.
Senator Allard. Thank you, Mr. Chairman. I want to pose a
housing question to Chairman Greenspan.
Low mortgage rates I think for the last year have probably
contributed substantially to increased sales of existing
residences, helping to boost the national homeownership rate to
the highest level ever. Could you please discuss your views on
what lies in store for housing, particularly in terms of other
factors such as consumer confidence, unemployment rates, as
well as wage rate? And what trends do you see for the
homeownership rate?
Chairman Greenspan. Senator, as you know, the homeownership
rate in the United States has risen quite materially in the
last decade. We went from about 64 percent to probably around
69 percent now. We are seeing that household growth is holding
up reasonably, and indeed a significant part of that is
actually the result of immigration. And with household growth
holding up, and the inclination of renters to move into an
owner-occupied status, we still seem to be getting a fairly
pronounced growth in homeownership, and indeed the broad
policies and effectiveness of our mortgage markets are clearly
working in that direction.
To the extent, obviously, that homeownership becomes a
critical continuing factor, it creates big demand for single-
family dwellings, and that is the reason why we have had
approximately a million and a half plus single-family dwellings
annually for a number of years as homeownership has moved
forward.
Now, obviously, as we get into ever higher numbers, there
is some amount of desire to be a renter, not an owner. So at
some point we will slow down, but I see no evidence at this
stage that slowdown is occurring, and as a consequence I think
the underlying demand for housing is going to remain reasonably
solid, although presumably less than the peaks that we have
seen in recent months.
Senator Allard. I also understand that the number of jobs
coming from--to change the subject--other countries to the
United States is growing at a faster rate than jobs lost
overseas. According to the Organization for International
Investment over the last 15 years, the numbers of manufactured
jobs insourced, coming into the United States, have grown by 82
percent, while the number outsourced overseas grew by only 23
percent. This study indicated that these insourced jobs are
offering higher pay than those outsourced. Furthermore, last
month the Labor Department released the first official
Government study that revealed only 2.5 percent of the 182,456
workers who lost their jobs in the first quarter of this year
were due to jobs being sent abroad.
Would you please share your thoughts on these numbers, and
is outsourcing really taking away as many American jobs as
people are claiming it is?
Chairman Greenspan. Senator, I have not checked the
specific numbers, but it does not seem different from what I am
generally aware of, depending on how you define a lot of these
categories.
We are in a global economy, and increasingly so, and it has
been to the advantage of the United States to be in this global
economy, and indeed in the position of leadership, which we
have been in, and it has contributed, in my judgment, to a very
significant increase in standards of living of the average
American.
As the world becomes ever more complex and as we find we go
to ever increasingly more sophisticated levels of
specialization in the division of labor, it necessarily means
that we reach out to engage in trade with the rest of the world
at an increasing rate, and indeed, the aggregate amount of
trade worldwide has been growing almost every year relative to
world GDP for the last half century. This means that you are
getting imports as a share of domestic GNP's, on average,
rising. And as a consequence of this, we are engaged in ever
more insourcing and outsourcing, depending how you want to
define it, and while it is certainly the case that outsourcing
as estimated for the current period is quite small, I think it
is going to be rising, and I do not think that is bad. I think
that is going to be part of a broader expansion which will lead
to higher standards of living in this country and an ability
for our expertise to be most effectively applied in
international markets.
Senator Allard. Mr. Chairman, may I follow with a question
on protectionism?
Chairman Shelby. Go ahead.
Senator Allard. You have cautioned repeatedly about the
danger of protectionism, and that it could provide a barrier to
the economic growth that has picked up in recent months. Could
you elaborate on that for us, please?
Chairman Greenspan. Looking back at the post-World War II
period, this very expansion of globalization which I have
referred to is also capable of being viewed as an ever wider
degree of international stimulus to the United States, and
indeed, I think that our ability to engage the international
community has significantly enhanced our standard of living, as
I just indicated. But it depends on that expansion continuing,
because it is the rate of change in expansion which creates the
level of economic growth here, and I think that what one
requires to recognize is that if the Doha Round, for example,
fails to be completed--and there is some concern, as you know,
about how that is evolving, especially this month--I would have
a concern that we would find that losing this stimulus from the
international system will work negatively on economic growth in
the United States, and I, accordingly therefore, hope that we
can continue our efforts to make sure that globalization
continues if we are to reap the benefits of it.
Senator Allard. Thank you, Mr. Chairman.
Chairman Shelby. Senator Bayh.
Senator Bayh. Thank you, Mr. Chairman.
Chairman Greenspan, I would like to follow up on Senator
Sarbanes first line of questioning with regard to our growing
dependence upon foreign borrowing and the consequences for our
domestic economy. I think you indicated that at some point we
will reach a position where the rest of the world's appetite
for U.S. denominated assets has been satiated. We do not know
when that point will arrive. Are there any studies under way to
try and determine, using portfolio theory or other types of
analysis, when that point might be reached?
Chairman Greenspan. Senator, it is very interesting because
there has been a very considerable amount of work endeavoring
to unearth where those points are. We do know that in
developing countries in the past, as individual countries have
gotten up to ever higher current account deficits, they turned
around. In some cases they got to double digits before they
turned around. But they usually, if the economies were
flexible, adjusted without any real crisis occurring. But a
number of us have been trying to figure out whether there are
leading indicators as to when this type of thing turns. What
has been examined are all the various different types of flows,
private flows, equity flows, debt flows, flows of governments.
What we find is that none of them work.
What that says is that the markets internationally are so
efficient that the substitutability of various different
instruments to finance, for example, our current account
deficit, is extraordinarily high, and while it clearly affects
prices of bonds and stocks and exchange rates in the process,
the adjustments continue in a way which it is very difficult to
determine when certain types of flows are occurring and when
the aggregate deficit is about to turn around.
Senator Bayh. Let me follow up. I was concerned about part
of your response to Senator Sarbanes, where I believe you
indicated that when the satiation point arrives, that even a
higher rate of return on U.S. denominated assets would not lead
them to acquire more of our assets, which means that if the
deficit has to be financed entirely domestically, the increase
in interest rates and other adjustments that might flow from
that would have to be even more severe. I find that potential
to be rather alarming.
Chairman Greenspan. I think the way I put it, I said that
even if rates of return stay high. I did not say necessarily
``increase.'' The reason I put it that way, Senator, is that if
you think about rates of retutn being high in the United
States, and people therefore continually wish to invest here,
you can conceive of a situation in which even though the rate
of return does not change, they will eventually say, ``I am
over committed. I have too much. I want to diversify, even
though I will get a lower rate of return.''
Senator Bayh. Does that not imply more adverse consequences
for us domestically?
Chairman Greenspan. If we get to the point where there is a
cliff effect, obviously, it would, but I think we are so
flexible and the markets are so flexible, and I assume we will
keep them flexible, that the international system does not work
that way. It works incrementally. But you are quite right. I
mean ultimately if we cannot continue to attract investment at
current interest rates or current rates of return, and we still
are running very large trade, and therefore capital account
deficits, all economic theory says that rates have to rise.
I am a little suspicious of that conclusion largely because
of a lot of those conclusions are based on the way the markets
functioned 30, 40, 50 years ago, when remember, they were not
flexible. We had all sorts of capital controls and all sorts of
rigidities. But I do not think we can readily dismiss it out of
hand as a possibility.
Senator Bayh. Our focus as policymakers, when we are
concerned about this issue, should be on maintaining the
flexibility of the international financial system and hoping
there is not an exogenous shock of some kind that would lead to
a rapid readjustment.
Chairman Greenspan. Senator, I would generalize that. I say
the experience we have had in the last decade has indicated
that the most important thing we can do with respect to policy,
both domestically and internationally, is to create
flexibility, because it obviously is a factor in the resilience
of an economy to respond to shocks, and indeed, I do not think
that we could have successfully gotten through September 11,
for example, unless we had an exceptionally flexible financial
and economic system domestically.
Senator Bayh. My final question, Mr. Chairman, and thank
you for this discussion, it is something I am concerned about.
I hope that the flexible nature of the markets will enable us
to make a gradual adjustment but I am somewhat concerned.
I would like to just change the topic and ask my final
question. A recent Fed study entitled ``The Price and Quantity
of Residential Land in the United States'' was just completed,
and concluded that over the next 3 years in the aggregate,
housing prices on a cumulative basis, will go up, they predict,
2.6 percent, which is the lowest increase on record according
to the report. Given the role that real estate values played in
getting us through the recent softness and sustaining consumer
demand, is that not the source of some concern?
Chairman Greenspan. It would be if it were an abrupt
change. Remember that we have had a fairly significant rise in
real residential prices in recent years, and historically if
you look back, that is not unusual. But what does tend to
happen is that we go up for quite a while, and then we flatten
out, and I do not know what the actual number is. I have not
read the details of the study, nor do I know whether the data
are accurate in that regard, but I certainly do not----
Senator Bayh. If you are having a restless night and have
trouble nodding off, I recommend it.
Chairman Greenspan. I find the best thing to do if I run
into that occasion is to read some of my speeches.
[Laughter.]
Senator Bayh. Thank you, Mr. Chairman. The reason for my
question was simply--by the way, that has been said about mine
as well--is your sanguine view about the sustainability of the
recovery, and it seems one of the legs that we have relied upon
recently is--I may perhaps be ameliorating a little bit here
going forward, but you think that will be more than offset by
other things.
Chairman Greenspan. Yes, that is our forecast.
Senator Bayh. Thank you.
Chairman Shelby. Senator Bennett.
STATEMENT OF SENATOR ROBERT F. BENNETT
Senator Bennett. Thank you very much, Mr. Chairman.
One of the advantages of coming a little bit late is that
you get to hear all of your colleagues ask your own brilliant
questions before you can get to them, but you can also take
notes on the things that people say.
You said in response to Senator Shelby, when he was talking
about where interest rates should be, and you very
appropriately and predictably did not give us a number. But you
said you were hoping we could get back to neutrality. So let me
take one more stab at it and ask what number is neutrality?
Chairman Greenspan. I knew you were going to ask that
question, Senator. Actually, we do not know what neutrality is
until we get there. The reason I say that is the notion of
stability, or a state where the financial markets are in some
form of equilibrium, depends on a number of things. You can
tell whether you are below or above, but until you are there,
you are not quite sure you are there. We know at this stage
that at 1\1/4\ percent Federal funds rate, are below neutral.
When we arrive at neutral, we will know it, and we can take
whatever actions we consider desirable or not desirable at that
time, but I think that estimates that people try to make as to
where that so-called neutrality is, fall in a fairly broad
range, and I would just choose not to speculate where it is.
Senator Bennett. You said to Senator Allard that
outsourcing is rising and that is good.
Chairman Greenspan. It is very low at this stage, but what
I was saying is, as part of the globalization process, which I
think is good for the American economy, and probably an
inevitable component is increasing trade of all sorts, and
therefore, outsourcing both into the United States and out is
likely to rise. And as Senator Allard suggests, a number of
studies say at this stage that the outsourcing into the United
States may very well be larger than the outsourcing. I do not
think this is a critical issue. I am really quite surprised at
how big an issue this has become. I fully understand the real
and serious problems that individuals have who lose their jobs
in this process, and indeed, we should do whatever is required
to make their lives better, but shutting off international
trade as a means of doing that is essentially very
counterproductive to everybody's standard of living.
Senator Bennett. I happen to feel the same way. When you
made the statement ``that is good,'' I thought it is a good
thing he is not Chairman of the Council of Economic Advisers,
because if you were, tomorrow morning there would be calls for
his resignation and attempts on the part of the political arm
of White House to distance themselves from your testimony,
because that is exactly what Greg Mankiw said to the Joint
Economic Committee, and that is what happened when he said
that.
Chairman Greenspan. I think the response to Greg Mankiw's
remark was unfortunate.
Senator Bennett. Yes, and you are not going to be invited
to Lou Dobbs' show any time soon.
[Laughter.]
Let us talk for just a little bit about oil prices. Oil is
traded in dollars. The dollar is losing its value vis-a-vis the
euro, the British pound, and some other currencies. Is there a
temptation therefore on the part of OPEC to get their real
return back up to what it might have been by raising the
denomination of a barrel of oil in dollars? In other words, is
it in their interest to try to take the price of oil in dollars
up to the point where they are getting as much real income as
they used to get when the dollar and the euro were in parity?
Chairman Greenspan. Senator, I do not think that the
particular denomination in which oil is priced affects the
overall price. In other words, the way I would put it is we
could trace oil prices in euros, for example, or in dollars or
in yen, and while there are certain technical issues which are
a slight problem here, if we were to officially switch the unit
in which oil was denominated, I do not think it would change
the price patterns in dollars, yen or euros in any significant
manner.
Senator Bennett. I do not think it would either at the
moment the switch were made, but if a dollar is seen as
continuing to depreciate with respect to other world
currencies, is there an incentive over time for an OPEC
country----
Chairman Greenspan. Oh, I see. There obviously is a sense
in which if a dollar purchases less in other currencies, that
one could conceive that they might try to raise prices in order
to offset that.
Senator Bennett. Offset the declining value of the dollar.
Do you see that in OPEC strategy?
Chairman Greenspan. Well, they are certainly not doing it
now. They essentially have opened up the taps as best one can
judge. Supply is increasing, but demand overall is increasing
more, and that is what the difficulty is. I cannot say to you
that I see any evidence that OPEC is constraining production
for the purpose of raising price at this particular time.
Senator Bennett. My observation of the current increase of
the price of oil has more to do with uncertainty over the
situation in Russia than it does with OPEC strategy. Do you
have a reaction to that?
Chairman Greenspan. Let me say this. I am talking about
short-term strategy obviously. There is a long-term strategy
about the
capacity of crude oil in OPEC producing countries, which is a
different issue, but clearly, the problems in Russia involve a
significant concern about a curtailment of crude oil production
if Yukos went into bankruptcy and it was dismembered or
something like that. That was clearly in the marketplace.
But also in the marketplace is something which is
disturbing in the sense that the very long-term futures, that
is, those for 2010, for example, have risen very substantially
in recent years, which is unusual because in years past the so-
called long-term supply price of crude oil in dollars was about
$20 a barrel, and irrespective of what the spot price was, the
long-term price stabilized somewhere in that $20 area. In the
last several years, the long-term price has gone up very
substantially, and it is not because of cost. It is basically
fear of long-term supply in a number of the areas of the world
where geopolitical concerns have risen.
Senator Bennett. Thank you.
Chairman Shelby. Senator Dodd.
Senator Dodd. Thank you very much, Mr. Chairman.
Thank you, Mr. Chairman, for being here today. I was not
here for your confirmation hearing, but let me once again say I
think of how fortunate we are in this country that you are the
Chairman of the Federal Reserve, and you have done a tremendous
job over the past 16 years.
Chairman Greenspan. Thank you very much.
Senator Dodd. I suspect the next 16 years are going to be
difficult ones, and in your contribution to this discussion,
debate is very much appreciated. Let me begin with those
comments.
Senator Schumer, when he was speaking a little while ago,
mentioned that these two wings, like a wonderful physical
analogy, talking about monetary policy and fiscal policy. I
know you are here to give a monetary policy report, but I
cannot resist the opportunity to raise issues with you
involving fiscal policy. We are policy setters up here. We have
about 20 working days by my calculations, between now and the
adjournment of this Congress, which is not a great deal of time
left. Two issues that I would like to raise with you, both of
which you have commented on in the past. In fact, you did again
today in part. One has to do with the growing and dangerous gap
between those who are more affluent and those who are not in
the country. The second issue has to do with the Federal
deficit.
I recall sitting here, it was about 42 months ago, when you
were sitting in that very chair in January 2001, and we had
this incredible conversation, that is, you did with the
Committee, about the potential effects of eliminating the
national debt and how we should respond to it, a conversation I
suspect many of us only a few years earlier never would have
imagined occurring.
Chairman Greenspan. Nor I.
Senator Dodd. All of us have in our minds those clocks,
whether it was in New York or Washington, that would tick off
every nanosecond the accumulation of debt, and here we were,
only 42 months ago, literally talking about the implications of
eliminating the national debt. You spoke at that time about
realistically getting to the level of Federal debt that is an
effective irreducible minimum. I am quoting you from your
testimony on that day in January 2001.
Let me begin if I can with the gap question and wealth,
because some of the things we have heard today and some of the
statistics you point to, indicate that that is going on. I do
not know if you had the opportunity this morning to read an
article in The Wall Street Journal entitled ``So Far Economic
Recovery Tilts to the Highest-Income Americans.'' The article
quotes Dan Maki, M-a-k-i, a former member of the staff of the
Federal Reserve and currently an economist.
Chairman Greenspan. Dean Maki, I believe.
Senator Dodd. What is it?
Chairman Greenspan. Dean.
Senator Dodd. Dean, yes. He is an economist today with
JPMorgan. He says, ``Today the recovery's primary beneficiaries
have been upper-income households.'' Your own testimony of
course mentions a similar point when you find that increases in
average hourly earnings of nonsupervisory workers have been
subdued in recent months and barely budged in June, while also
find an apparently more robust rate of growth for hourly
earnings of supervisory workers. I wonder if I can conclude
from your testimony here today that you would in general agree
with Dean Maki's findings, that the primary beneficiaries of
this recovery have been upper-income households?
He goes on, by the way, in the article, to compare
purchases that are occurring in some of the high end value
stores. Nieman Marcus sales are up 13\1/2\ percent, whereas
Payless Shoe Stores have seen sales fall by 1 percent, of low
cost product. Putting that together, have we seen the wealthy,
who were given huge tax cuts over the past 3 years, turn around
and spend their tax cuts on these luxury items, while average
workers of course have seen their wages stagnate? What are the
implications? It worries me deeply. I think it does you as
well. If these trendlines continue, what happens to the social
fabric of a country where those kind of gaps exist?
Chairman Greenspan. I am not concerned about what people
spend money on. That is not an issue so much. But it is the
resource issue.
Senator Dodd. But as an evidentiary piece.
Chairman Greenspan. Yes. I agree with Dean Maki's
conclusions. That is what our data show as well. That is the
reason why I think, as I indicated earlier, that is very
important to understand the process that is going on here and
find a way to have public policy address it.
My own judgment, and I think the data strongly support the
underlying forces, is that the problem is essentially an
educational issue, plus I would suspect it may have something
to do with immigration policy as well. But we have been unable
to create a level of skills which would enable a significant
part of our population to earn skilled wages. Unless we can do
that, I am not sure how we get out of this bind.
Obviously, we could slow down the growth of the economy,
stabilize our technology, try not to be innovative, and that
will actually create a stabilization in the income shares. But
that is scarcely an acceptable way to come at this. Rather than
try to essentially curtail economic growth, we should determine
why it is that the skills of our schoolchildren, which in the
fourth grade internationally are above average, somehow
deteriorate by the time they get to the twelfth grade to well
in the lower echelons of children around the world.
It cannot be that our children are somehow inferior. The
fourth graders are not. And if they are not interior in the
fourth grade, I do not know how they become inferior
thereafter. So it is not the quality of the students. It is
something we do wrong. I am not knowledgeable enough to know,
but this is a crucial issue.
Senator Dodd. It would be worthwhile to have maybe a longer
conversation. One of the factors I think is we--I think the
high rate at one point in the Nixon Administration is we were
spending something close to 6 percent of the Federal budget on
secondary and elementary education in this country, the Federal
Government was. Today, I think the figure is less than 2
percent. And when you look at disparities that exist within
school systems, even adjoining ones or neighboring ones where I
think the average of a noncertified teacher in a poor rural and
urban school is hovering around 35 percent of the teachers not
certified to teach the classes they are teaching, class sizes
being huge, there are factors there that make it difficult for
students to learn.
I think we should look at our choices. We can come down to
where we allocate resources and how we make choices between the
issue of tax cuts for the top 1 percent of income earners
versus investing in a No Child Left Behind bill, or special
education funds and so forth that I think could contribute to
that. But it is an interesting point and I appreciation your
observation because I think it does contribute to it.
Let me jump to the deficit issue, because my colleague from
New York is here and I suspect he may want to talk about the
same subject matter. I want you to use a little bit if you can
here the bully pulpit of this chair have you. Again, we are
here from monetary policy. We have no budget. Not likely to get
one. Maybe we will, but I doubt it at this point. We are going
to be asked later this week to vote for a tax cut which we are
going to be asked not to pay for. No matter how much you may
find it attractive politically to be for it, there is no
provision apparently to accommodate for the cost of it. We may
be asked to vote for an omnibus appropriations bill, because we
have only passed one appropriations bills, the Department of
Defense appropriation bill. Otherwise, 12 appropriations bills
have not been enacted.
The House has done more, but nonetheless, not likely to
reach some common agreement between the two.
We are going to be asked to increase the debt ceiling by
some $680 billion, therefore getting near $8 trillion in debt
figures. That is in 42 months going from a projected, I think
it was in excess of $3 trillion, surplus over 10 years to now
$8 trillion in deficit. I know you feel strongly about this and
it just seems to me we need to hear your voice again on this
subject matter. That our fiscal policies are out of control
here and we need some voices of discipline warning members.
Again, I am not suggesting you come up with a policy
solution, but I think we need to hear from you as often as we
can. Along with the trend lines in the gap in wealth in this
country are disturbing, the trend lines on Federal deficits are
deeply alarming. And our inability or unwillingness to come to
terms with them is a growing concern, it should be to all of
us. I wonder if you might take a few minutes and express your
views on this subject matter once again.
Chairman Greenspan. Senator, let me just say that I think
we are, at the moment, reaping some of the consequence of the
failure to extend PAYGO and discretionary cap legislation in
September 2002. You are dealing with long-term budgets, which
has been something novel in this country in the last 20 years.
It was not all that long ago, in the 1960's and certainly in
the 1950's, that there were very few long-term programs. The F-
4, for example, was a project which took a number of years in
the military, and we had certain agricultural programs which
extended, but we did not have very long-term commitments as we
have today.
The problem is that our ability to forecast what the budget
will look like 15 years from today is extremely limited. We can
estimate within a reasonable degree of accuracy where, for
example, Social Security, a defined-benefit program, will
ultimately come out because it is a defined benefit and
forecasting only a limited number of variables will tell us
where we are going to be. In contrast, we have extraordinarily
limited understanding of the forces that are going to drive
Medicare 15 to 20 years from now. We know that the recipient
population is going to rise very sharply. But if we try to
determine what benefit outlay per recipient is going to be, we
would have a long list of things we needed to forecast. But the
variance in every one of them is very large. As a consequence,
the product of those variances creates huge uncertainty.
Unless we have a process which, for example, has a means to
control the long-term projections, for example, to have
triggers in the programs, both taxes and outlays, which go off,
so to speak, when a program is significantly off the originally
expected path. We clearly should be looking at the issue of
sunset legislation, automatically requiring reevaluations of
programs. The vast majority of programs will probably be
extended by voice vote on the floor. But there would be an
awfully large number of individual programs which really should
be looked at. And if you look at them, some of them require
major change, or elimination.
We at the Federal Reserve, for example, have a process
where every 5 years we scrub all of the regulations that we
have built up over the years to determine which of them still
are applicable. Had we not done that we would have had a huge
number of regulations.
So, I think what is wrong at the moment is that we do not
have process. It is very difficult to vote on individual bills
without the context of everything else. And 30, 40 years ago we
did not need triggers. We did not need PAYGO. We did not need
sunset legislation, largely because the vast majority of what
the Congress voted on was relatively short term and you could
make some reasonably good forecasts and reasonably good
judgments.
We can no longer do that. Unless we find that we can
address process first and get the Budget Committees back in
play and get the process by which the overall budget is
constructed in the way we did prior to September 2002, I do not
know how you figure out how to go forward. I do not think you
can construct a Medicare program, or any amendments to
Medicare, without some advertence to what the long-term fiscal
outlook is, and I do not know how you do it without process.
Senator Dodd. Thank you for that. I guess I can conclude,
at least in the short term here, your view would be that on the
various proposals we have before us in the budget that PAYGO at
the very least is something the Congress to endorse; is that
correct?
Chairman Greenspan. Indeed.
Senator Dodd. Thank you, Mr. Chairman.
Chairman Shelby. Thank you, Senator Dodd.
Senator Schumer.
Senator Schumer. Thank you, Mr. Chairman. And thank you,
Chairman Greenspan, as well.
Hearing the summary of your statement and your answers to
questions, I guess if I had to summarize it I would say, the
recovery is sustainable. That seems to be the tone. The
disparity I think some of us face as we go around our States
and our country is there does not seem to be a tremendous
amount of confidence about that. You can look at two measures.
One, consumer confidence has been relatively flat. We have the
oil prices, which you mentioned. And for the higher income
people, since we have talked a lot about disparities, the stock
market has actually gone down since the good numbers have
started going up.
I guess the question I have, the first question I have is,
why do you think that is? Does it have an effect on the
economy? You mentioned terrorism in your statement. Obviously,
that is something that is out there that is hard to quantify.
Do disparate incomes create that? Does the deficit help create
lower confidence? And how much effect, if this lower confidence
that is not as optimistic--it does not seem that average
people, the consumer end, whether it is higher end or lower end
seem to have that kind of confidence. Businesses seem to have a
little more confidence these days. But even they are saying
that profitability, which was enormously high in the last few
quarters, is going to decline some.
Could you just talk a little bit about this phenomenon
which is confusing in certain ways? Particularly the stock
market. I am puzzled how the stock market has gone down. The
Dow Jones has gone down 400 points as all these numbers are
good.
Chairman Greenspan. Senator, this is not atypical of a
recovery. If you go back historically and read the records of
the time when you know that subsequently things got
extraordinarily positive, people were glum. You have to put it
in context. With regard to today's environment, for example,
the June figures, and this soft patch we are going through, I
do not recall a recovery in which there were not several soft
patches. It's the way the markets work.
There is something different here, in a sense as you point
out, that the level of confidence is less. The way we know
that, or the way I would suggest is a indication of it, is we
have for the first time in a quarter-century, or more than that
I think, the aggregate of capital investment and inventory
investment running less than cashflow. The typical pattern is
that businesses when they are confident are expanding. They are
borrowing, and capital investment expands way beyond cashflow.
If you look at the debt markets, the corporate debt
markets, they are barely moving. In fact, I think in June, the
preliminary estimate is that corporate debt on balance
declined. In other words, repayments were greater than new
extensions because cashflow is so high. I think the reasons for
that are largely the aftermath of terrorism. I still think
there are concerns out there. Corporate scandals have created a
really serious issue of caution on the part of business who are
terribly fearful of doing things which are perceived to be
inappropriate. So that there is this sense of general lack of
charging ahead, which clearly was the case in the latter part
of the 1990's. It is likely that the mere aftermath of the
1990's themselves had some effect.
But it does not appear to be enough to hold back the
gradual broadening we perceive to be going on. Some things go
down, some things go up, but the markets and the economy
continues to grow.
The stock market does not always respond to good news
positively, and in fact in most instances where the perception
is that a rising economy or a booming economy will somehow
create increased interest rates in the context where long-term
or short-term profitability no longer has the upside to move as
fast as it has, markets will go down under those conditions.
So, I would say that the weakness in the stock market is a
perfectly typical type of pattern that one sees over the years,
and more generally that the way this economy is behaving with
its obvious idiosyncratic characteristics, as all recoveries
have, is nothing that we perceive at the Fed as particularly
surprising.
Senator Schumer. One more question, if I might, Mr.
Chairman.
Chairman Shelby. Go ahead.
Senator Schumer. Although I would just make a comment I
made in my opening statement, sometimes maybe for the stock
market and maybe for the economy, lower interest rates are
better than lower taxes. That is a debate on the fiscal side
that we have been having here, although it affects you. I take
it you would not disagree with that necessarily as long as
underline----
Chairman Greenspan. I can conceive of situations in which
you could be accurate.
Senator Schumer. How about now?
[Laughter.]
Here is my other question. This is a bit off the topic but
I had wanted to ask you this before. Last week, we had a very
interesting hearing that the Chairman led on hedge funds. It
was an interesting discussion and I, for one, have not made up
my mind on this thing. I have a bent that regulation, if it is
not heavy-handed, has been good for the markets. People
complain about it, but it works, and it has led people's view
that our markets are on the level.
The proposal made by Chairman Donaldson, who I know is your
friend and whom I know you disagree with on this issue, he made
a pretty good argument in saying, first of all, that 40 to 50
percent of the funds register now and there does not seem to be
too many complaints. In fact, they voluntarily register. That
he thought registration might increase because pension funds
and other types of funds that are dealing with consumers and
others might feel better with the registration. He mentioned
that the financial cost was quite low. I think he said it would
cost about $45,000 or $50,000 to do the registration, which for
a large pension fund is a drop in the bucket, particularly
given their profitability.
And he seemed to feel that the act of registering would not
create any kind of systemic risk--sorry, you said the systemic
risk. But he felt that the act of registering would not get in
the way of any kind of thing that a hedge fund wanted to do in
terms of its entrepreneurial zest, activity, risk taking, et
cetera.
I am wrestling with issue and I think some of us on the
Committee are, could you give us your views on this,
particularly on the aspect of, does required registration
cause--oh, one other point he mentioned, which made a
difference to me since hedge funds are based in New York and I
try to make sure businesses come to New York and not run away,
that you would not have people go overseas. I had heard from
some hedge funds, well, we will just go overseas. He said, it
does not matter. If they had U.S. investors they would still
have to be through the same--they would meet the same legal
requirements and have to register anyway.
Could you comment on the issue in general, and specifically
your view about how required registration would affect the
entrepreneurial zeal and zest, risk-taking of the hedge funds?
Chairman Greenspan. Senator, I actually was writing down a
few comments on this particular issue, not sure where I would
use it, just to get my own thoughts. It will take a couple of
minutes for me to read it. Let me read it to you, if you do not
mind.
Senator Schumer. That would be great.
Chairman Greenspan. If you do not mind, with the Chairman's
acceptance.
Chairman Shelby. Yes, sir, go ahead.
Chairman Greenspan. Hedge funds have become major
contributors to the flexibility of our financial system; an
issue I raised earlier. That development proved essential to
our ability to absorb so many economic shocks in recent years.
Hedge funds seek out the abnormal rates of profit often found
where markets are otherwise inefficient. Taking positions in
volume, as hedge funds do, tends to eliminate the abnormal
profits and the inefficiencies by aligning prices across
markets and provides liquidity to markets. Successful or not,
when those profit opportunities are perceived to be eliminated,
individual funds move on to address other inefficiencies.
But these above-normal profits have attracted a large
number of new entrants seeking to exploit a possibly narrowing
field of inefficiencies. Not surprising, the rate of return in
this activity is reportedly declining. I would not be surprised
if, with time, many of the new entrants exited, some presumably
following large losses.
Chairman Donaldson, who as you mentioned has been a good
friend of mine for 45 years, is certainly right in wanting to
eliminate fraud by hedge funds and other financial
institutions. Fraud undermines markets and the efficient
functioning of our economy.
My problem with the SEC's current initiative is that the
initiative cannot accomplish what it seeks to accomplish. Fraud
and market manipulation will be very difficult to detect from
the information provided by registration under the 1940 Act.
Fraud is almost always uncovered through complaints of
counterparties or by accident, such as our uncovering millions
of dollars of the new U.S. currency in Federal Reserve
wrappings in Iraq.
This is certainly true, namely the uncovering of fraud, in
banking as we experience it, and I assume is also true for
regulated broker-dealers as well. Even should SEC's proposed
risk evaluation surveillance of hedge funds detect possible
trading irregularities, which I doubt, those irregularities
will likely be idiosyncratic and of mainly historic interest
because by the time of detection hedge funds would have long
since moved on to different strategies.
Should the existing proposal fail in achieving its goal,
pressure will become irresistible to expand SEC's regulatory
reach in an endeavor to accomplish it set out to do. Hedge fund
arbitragers are required to move flexibly and expeditiously if
they are to succeed. If placed under increasing restrictions,
many will be leave the industry to the significant detriment of
our economy.
Senator Schumer. So in other words, if I might, and I
appreciate your statement. As I said, I am grappling with this
issue and have not made up my mind, but you are saying
registration in itself would not be detrimental. It might not
accomplish what its advocates say, but could leave to other
things that would become detrimental. Is that a fair summation?
Chairman Greenspan. That is correct.
Senator Schumer. Without the erudition that you have.
Thank you, Mr. Chairman.
Chairman Shelby. Chairman Greenspan, it has been a long
afternoon. I have a number of questions I am going to submit
for the record. We appreciate your candor, your appearance as
always, and we will be watching you and praying for our
economy. It is doing well. Thank you.
Chairman Greenspan. Thank you, sir.
Chairman Shelby. The hearing is adjourned.
[Whereupon, at 4:55 p.m., the hearing was adjourned.]
[Prepared statements, response to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF SENATOR WAYNE ALLARD
Thank you, Chairman Shelby, for convening this important hearing. I
always look forward to the opportunity to hear from Chairman Greenspan.
I believe that the U.S. economy is on the right track. The economy
is growing, payroll employment is up, and new and existing home sales
set new record highs in May. This is good news.
However, we cannot take the positive economic news for granted;
Congress needs to do more to continue to promote a healthy economy.
First, we need to address the looming problems in the various
entitlement programs.
Second, we need to continue to provide economic incentives through
tax cuts, including making the previous tax cuts permanent.
Finally, I believe the most important way that we can ensure the
long-term economic vitality of our country is to control Government
growth and spending. Congress will not spend the Nation into
prosperity. Chairman Greenspan, you and I have discussed this point a
number of times during your previous appearances before the Banking
Committee, and I have always appreciated your comments in favor of
Government restraint.
Chairman Greenspan, I know that you have a very busy schedule, so I
appreciate you taking the time to appear before the Committee today. I
look forward to your report and the opportunity to raise several
questions with you.
----------
PREPARED STATEMENT OF ALAN GREENSPAN
Chairman, Board of Governors of the Federal Reserve System
July 20, 2004
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.
Economic developments in the United States have generally been
quite favorable in 2004, lending increasing support to the view that
the expansion is self-sustaining. Not only has economic activity
quickened, but the expansion has also become more broad-based and has
produced notable gains in employment. The evident strengthening in
demand that underlies this improved performance doubtless has been a
factor contributing to the rise in inflation this year. But inflation
also seems to have been boosted by transitory factors such as the surge
in energy prices. Those higher prices, by eroding households'
disposable income, have accounted for at least some of the observed
softness in consumer spending of late, a softness which should prove
short-lived.
When I testified before this Committee in February, many of the
signs of the step-up in economic activity were already evident. Capital
spending had increased markedly in the second half of last year, no
doubt spurred by significantly improving profits, a low cost of
capital, and the investment tax incentives enacted in 2002 and enhanced
in 2003. The renewed strength in capital spending carried over into the
first half of 2004. Orders and shipments of nondefense capital goods
have been on the rise, and backlogs of unfilled orders for new
equipment continue to build.
A key element of the expansion that was still lacking in February,
however, was evidence that businesses were willing to ramp up hiring to
meet the stepped-up pace of sales and production. Businesses' ability
to boost output without adding
appreciably to their workforces likely resulted from a backlog of
unexploited capabilities for enhancing productivity with minimal
capital investment, which was an apparent outgrowth of the capital
goods boom of the 1990's. Indeed, over much of the previous 3 years,
managers had seemed to pursue every avenue to avoid new hiring despite
rising business sales. Their hesitancy to assume risks and expand
employment was accentuated and extended by the corporate accounting and
governance scandals that surfaced in the aftermath of the decline in
stock prices and also, of course, by the environment of heightened
geopolitical tensions. Even now, following the pattern of recent
quarters, corporate investment in fixed capital and inventories
apparently continues to fall short of cashflow. The protracted nature
of this shortfall is unprecedented over the past three decades.
Moreover, the proportion of temporary hires relative to total
employment continues to rise, underscoring that business caution
remains a feature of the economic landscape.
That said, there have been much clearer indications over recent
months that conditions in the labor market are improving. Most notably,
gains in private nonfarm payroll employment have averaged about 200,000
per month over the past 6 months, up sharply from the pace of roughly
60,000 per month registered over the fourth quarter of 2003.
The improvement in labor market conditions will doubtless have
important follow-on effects for household spending. Expanding
employment should provide a lift to personal disposable income, adding
to the support stemming from cuts in personal income taxes over the
past year. In addition, the low interest rates of recent years have
allowed many households to lower the burdens of their financial
obligations. Although mortgage rates are up from recent lows, they
remain quite attractive from a longer-run perspective and are providing
solid support to home sales. Despite the softness of recent retail
sales, the combination of higher current and anticipated future income,
strengthened balance sheets, and still-low interest rates bodes well
for consumer spending.
Consumer prices excluding food and energy--so-called core prices--
have been rising more rapidly this year than in 2003. For example, the
12-month change in the core personal consumption expenditures price
index stood at 0.8 percent in December of last year and climbed to 1.6
percent by May of this year. Core inflation, of course, has been
elevated by the indirect effects of higher energy prices on business
costs and by increases in non-oil import prices that reflect past
dollar depreciation and the surge in global prices for primary
commodities. But the acceleration of core prices has been augmented by
a marked rise in profit margins, even excluding domestic energy
corporations.
This surge in profits reflects, at least in part, the recent
recovery of demand after a couple of years during which weak demand led
to relatively heavy price discounting by businesses. Profits of
nonfinancial corporations as a share of sector output, after falling to
7 percent in the third quarter of 2001, rebounded to 12 percent in the
first quarter of 2004, a pace of advance not experienced since 1983.
Half of this rise in the profit share occurred between the first
quarter of 2003 and the first quarter of 2004, a period during which
business costs were unusually subdued. In fact, consolidated unit costs
for the nonfinancial corporate business sector actually declined during
this period. The increase in output per hour in the nonfinancial
corporate business sector of more than 6 percent accounted for much of
the net decline in unit costs. The remainder was due to the effects of
rising output in reducing nonlabor fixed costs per unit of output.
Hence, at least from an accounting perspective, between the first
quarter of 2003 and the first quarter of 2004, all of the 1.1 percent
increase in the prices of final goods and services produced in the
nonfinancial corporate sector can be attributed to a rise in profit
margins rather than rising cost pressures.
However, businesses are limited in the degree to which they can
raise margins by raising prices. An increase in margins should affect
mainly the level of prices
associated with any given level of unit costs but, by itself, should
not prompt a sustained pickup in the rate of inflation going forward.
In a market economy, any tendency for profit margins to continue to
rise is countered largely by the entry of new competitors willing to
undercut prices and by increased labor costs as more firms attempt to
exploit the opportunity for outsized profits by expanding employment
and output. That increase in competitive pressure, as history has amply
demonstrated, with time, returns markups to more normal levels.
Over the past three decades, the share of the profits of
nonfinancial corporations in the total nominal income of that sector
has fluctuated around a longer-run average of roughly 10\1/2\ percent.
The profit share in the first quarter of this year, at about 12
percent, was well above that level. The gap suggested that the growth
of unit profits would eventually slow relative to increases in unit
costs. This outlook had accorded with analysts' expectations for
earnings growth over the next year, which are substantially below the
realized growth of profits in recent quarters.
Indeed, some leveling or downward pressure on profit margins may
already be in train, owing to a pickup in unit labor costs. Although
advances in productivity are continuing at a rate above the long-term
average, they have slowed from the extraordinary pace of last summer
and are now running below increases in hourly compensation. The
available information suggests that hourly compensation has been
increasing at an annual rate of about 4\1/2\ percent in the first half
of the year. To be sure, the increases in average hourly earnings of
nonsupervisory workers have been subdued in recent months and barely
budged in June. But other compensation has accelerated this year,
reflecting continued sizable increases in health insurance costs, a
sharp increase in business contributions to pension funds, and an
apparently more robust rate of growth of hourly earnings of supervisory
workers. The larger wage gains for supervisory workers together with
anecdotal reports of growing skill shortages are consistent with
earlier evidence of rising wage premiums for skilled workers relative
to less-skilled workers.
For the moment, the modest upward path of unit labor costs does not
appear to threaten longer-term price stability, especially if current
exceptionally high profit margins begin to come under more intense
competitive pressures at home and from abroad. Although some signs of
protectionist sentiment have emerged, there is little evidence that the
price-containing forces of ever-widening global competition have ebbed.
In addition, the economy is not yet operating at its productive
capacity, which should help to contain cost pressures. But we cannot be
certain that this
benign environment will persist and that there are not more deep-seated
forces emerging as a consequence of prolonged monetary accommodation.
Accordingly, in assessing the appropriateness of the stance of policy,
the Federal Reserve will pay close attention to incoming data,
especially on costs and prices.
What does seem clear is that the concerns about the remote
possibility of deflation that had been critical in the deliberations of
the Federal Open Market Committee (FOMC) last year can now be safely
set aside. Those deflationary pressures were largely a consequence of
the stock market slump, the capital goods contraction that commenced in
2000, and, as I noted earlier, the extreme business caution that
followed from these events as well as from terrorist attacks, corporate
scandals, and the lead-up to the war in Iraq. Both equity prices and
capital goods spending have turned up over the past year, and the
probability that economic activity might stagnate has receded.
As always, considerable uncertainties remain about the pace of the
expansion and the path of inflation. Some of those uncertainties,
especially ones associated with potential terrorism both here and
abroad, are difficult to quantify. Such possibilities have threatened
the balance of world supply and demand in oil markets in recent months,
especially as demand has risen with the pace of world economic growth.
Yet aside from energy, markets exhibit little evidence of heightened
perceptions of risk. Credit spreads remain low, and market-based
indicators of inflation expectations, after rising earlier this year,
have receded.
With the growth of aggregate demand looking more sustainable and
with employment expanding broadly, the considerable monetary
accommodation put in place starting in 2001 is becoming increasingly
unnecessary. In May, the FOMC believed that policy accommodation needed
to be removed and that removal could be accomplished at a pace that is
likely to be measured. At our meeting last month, the FOMC raised the
target Federal funds rate from 1 percent to 1\1/4\ percent, and the
discount rate was raised commensurately. Policymakers reiterated that,
based on our current outlook, the removal of accommodation would likely
proceed at a measured pace. But in light of the considerable
uncertainty surrounding the anticipated evolution of price pressures,
the FOMC emphasized that it will respond to changes in economic
prospects as needed to fulfill its obligation to maintain price
stability.
If economic developments are such that monetary policy neutrality
can be restored at a measured pace, a relatively smooth adjustment of
businesses and households to a more typical level of interest rates
seems likely. Even if economic developments dictate that the stance of
policy must be adjusted in a less gradual manner to ensure price
stability, our economy appears to have prepared itself for a more
dynamic adjustment of interest rates. Of course, considerably more
uncertainty and hence risk surrounds the behavior of the economy with a
more rapid tightening of monetary policy than is the case when
tightening is more measured. In either scenario, individual instances
of financial strain cannot be ruled out.
The protracted period of low interest rates has facilitated a
restructuring of household and business balance sheets. Businesses have
been able to fund longer-term debt at highly favorable interest rates
and, by extending the maturity of their liabilities, have rendered net
earnings and capital values less exposed to destabilizing interest rate
spikes. Households have made similar adjustments. Between mid-2002 and
mid-2003, homeowners were able to refinance at lower interest rates
almost half of total outstanding home mortgage debt and thereby to
substantially reduce monthly debt service payments. Households also
substituted mortgage debt for more-expensive consumer credit. Moreover,
those households and businesses that held long-term investment-grade
bonds in that year accumulated realized and unrealized capital gains as
long-term rates declined.
The FOMC judged this extended period of exceptionally low interest
rates to have been helpful in assisting the economy in recovering from
a string of adverse shocks. But in the process of returning the stance
of policy to a more neutral setting, at least some of the capital gains
on debt instruments registered in recent years will inevitably be
reversed.
Prices in financial markets have already adjusted in anticipation
of a significant amount of policy tightening, engendering additional
alteration of balance sheets in recent months. An unwinding of carry
trades--that is, market positions premised on low short-term financing
costs--seems to be under way, at least judging from a pronounced shift
in the trading portfolios of primary dealers. In addition, investors
classified as noncommercial have established net short positions in 10-
year Treasury note futures in recent months. Indeed, the swing toward a
net short position on 10-year Treasury note futures has been the
largest since the inception of the contract in the 1980's, likely
offsetting a significant portion of the interest rate exposure of
previously established carry trade positions.
Moreover, the recent increase in market interest rates has slowed
the pace of mortgage refinancing and reportedly has precipitated some
winding down of leveraged positions among major mortgage market
participants. These circumstances are quite different from the
situation prevailing at this time last summer. Then, record levels of
refinancing in the second half of 2002 and the first half of 2003 had
pushed the duration of mortgage-backed securities (a measure of the
price sensitivity of fixed-income instruments to changes in interest
rates) to exceptionally low levels. As mortgage and other long-term
rates rebounded last summer, a consequence of rapidly improving
economic conditions and the fading of deflationary concerns,
refinancing fell sharply, removing most downward pressure on duration.
Holders of mortgage-backed securities endeavoring to hedge the
resulting shifts in interest rate gaps moved rapidly to shed Treasuries
and receive--fixed interest rate swaps, and these actions magnified
last summer's upturn in long-term interest rates. In the current
environment, by contrast, it appears that the scope for such mortgage
hedging effects to greatly amplify an increase in long-term rates is
much diminished given the decline in the pace of refinancing and the
associated increase in mortgage durations that have already occurred.
Last, very large fractions of the total outstanding obligations of
businesses and households are long-term, fixed-rate debt. As a result,
rising market interest rates will not have much immediate direct effect
on business and household debt service burdens. Indeed, from early 1999
through early 2000, a period when interest rates on new home mortgage
originations rose more than 150 basis points, the average interest rate
on the total of home mortgage debt outstanding barely moved.
Nonetheless, despite the lock-in of low interest rate costs on a
substantial share of household and business liabilities, recent higher
market interest rates will, in time, show through into increased
charges against household and business income. To be sure, financial
intermediaries and other creditors that extended loans or purchased
securities in recent years at relatively low long-term interest rates
will sustain capital losses as rates rise. In general, however,
financial intermediaries are profitable, well-capitalized, and appear
to be well-positioned to manage in a rising rate environment.
In short, financial markets along with households and businesses
seem to be reasonably well-prepared to cope with a transition to a more
neutral stance of monetary policy. Some risks necessarily attend this
transition, but they are outweighed in our judgment by those that would
be associated with maintaining the existing degree of monetary policy
accommodation in the current environment. Although many factors may
affect inflation in the short-run, inflation in the long-run, it is
important to remind ourselves, is a monetary phenomenon.
As we attempt to assess and manage these risks, we need, as always,
to be prepared for the unexpected and to respond promptly and flexibly
as situations warrant. But although our actions need to be flexible,
our objectives are not. For 25 years, the Federal Reserve has worked to
reestablish price stability on a sustained basis. An environment of
price stability allows households and businesses to make decisions that
best promote the longer-term growth of our economy and with it our
Nation's continuing prosperity.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM ALAN GREENSPAN
The Housing Sector
Q.1. The semi-annual written report refers to activity in the
housing sector remaining ``torrid'' in the first half of 2004.
There have been some concerns expressed about a potential
bubble in housing prices. Your report indicates that house
price increases have outstripped gains in incomes as well as
rents in recent years. In a recent speech, one member of the
Board of Governors, Governor Kohn, indicated that ``the odds
have risen that these prices could be out of line with
fundamentals.'' Governor Kohn also indicated that ``we still
cannot be very confident about whether a significant
misalignment exists, however.'' What is your assessment of the
continued rise in housing prices? Are there any particular
geographic sectors that you are more concerned about than
others?
A.1. As you note, the most recent Monetary Policy Report to the
Congress indicated that house price increases have outstripped
gains in income as well as rents in recent years. This
observation raises the possibility that real estate prices, at
least in some markets, could be out of alignment with the
fundamentals. But as
Governor Kohn notes, that conclusion cannot be reached with any
confidence. For example, the rise in house prices relative to
rents and incomes has, no doubt, been influenced by the low
level of mortgage interest rates in recent years in ways that
cannot be gauged precisely. Moreover, the available data are
not fully adequate for a complete analysis of the issue; house
prices are difficult to measure given the enormous
heterogeneity of the U.S. housing stock--both within and across
geographic regions--and available measures of residential rents
do not match precisely with the units for which we have prices.
Although taking a firm stand on the appropriateness of real
estate prices is not possible, policymakers do need to take
account of their influence on economic activity. As is the case
with other asset prices, we monitor real estate prices closely
in developing our economic outlook.
The data limitations that prevent a complete analysis of
housing price developments at the national level are even more
binding at the local level, making it especially difficult to
detect asset price misalignments for specific markets.
Improvements in the World Economy
Q.2. The semi-annual report comments on solid gains in U.S.
exports since mid-2003 due to the strong economic performance
of many of the major trading partners. What is your view as to
the continued economic strength of our trading partners? In
particular, do you believe the improvements in Japan will
continue?
A.2. Over the past year, the global economic recovery has
become both stronger and more sustainable. Growth has
strengthened in every major region compared with the sluggish
performance during the first half of 2003, and recent
indicators suggest that the foreign economies continue to put
in a favorable performance. To be sure, average growth in
emerging Asia appears to have braked sharply in recent months,
as policy measures muffled the boom in the Chinese economy.
However, continued strong export growth and recent signs of an
acceleration in consumer spending suggest that Chinese GDP
growth will rebound in the second half of this year. Recovery
in Canada and in Latin America also appears to be on track, and
economic expansion in the United Kingdom continues unabated.
The pace of recovery in the euro area has been sluggish,
however, with particularly weak activity in Germany.
In Japan, the rebound that began last year has continued to
broaden. Japanese exports have grown rapidly over the past
couple of years, as exports to China and other emerging Asian
economies have surged. The expansion in exports has contributed
to a snapback in corporate profits in the export-related
manufacturing sector, and the revival in profits appears to be
spreading to the more domestic-oriented nonmanufacturing
sector. Rising profitability along with improving conditions in
the corporate sector more generally have allowed investment to
rebound from its recent trough. Labor markets have also
revived, with employment rising and the unemployment rate
declining from a peak of 5.5 percent early last year to 4.6
percent at present. Against this backdrop of strengthening
activity, consumer price deflation has eased markedly since
early 2002.
These positive developments suggest that Japan may finally
be on its way to a self-sustaining recovery. However, there are
several risks to the outlook. In particular, the recent run-up
in oil prices, if sustained, may exert a significant drag on
Japanese economic activity. Moreover, Japanese consumption has
risen sharply over recent quarters, while employee compensation
has fallen. The result has been a marked decline in the
household saving rate. Most analysts expect the saving rate to
move up as economic conditions
improve. If this happens abruptly, consumption might lag the
recovery even if compensation begins to rise. Also, the
possibility of a hard landing in China carries significant
risks for Japan as well as for other Asian economies. Finally,
bank lending in Japan continues to contract, and more
aggressive financial sector restructuring remains important for
Japan's long-term growth prospects.
The President's Working Group & Hedge Funds
Q.3.a. In 1999, the President's Working Group concluded that
``requiring hedge fund managers to register as investment
advisers would not seem to be an appropriate method to monitor
hedge fund activity.'' In the intervening 5 years, have market
conditions changed in order to justify a different conclusion?
A.3.a. No. The Working Group's report made two arguments in
support of this conclusion. First, it argued that the provision
of the Investment Advisers Act that exempts hedge fund managers
from registration (Section 203(b)(3)) evidences a Congressional
determination that clients of an adviser that has relatively
few clients do not need the substantive protections of the
Investment Advisers Act. Congress has not repealed Section
203(b)(3). Second, it argued that the sophisticated investors
that typically invest in hedge funds are in a position to
protect their own interests. There is no evidence that
investors in hedge funds today are less sophisticated than they
were in 1999. Indeed, institutional investors have accounted
for a growing share of hedge fund investments, and they can and
should protect their own interests rather than rely on the
limited regulatory protections that would be provided as a
result of a registration requirement.
Q.3.b. What, if any, mechanism would be the appropriate method
for monitoring hedge fund activity in light of their growth in
recent years and the increased investor involvement while at
the same time being mindful of liquidity concerns?
A.3.b. The case for monitoring hedge fund activity has not been
made. Some have argued that monitoring of hedge funds is
necessary to detect and deter market manipulation. However, the
data collected from registered advisers is limited to total
assets under management, which would provide no insight into
any manipulative activities. Concerns about market
manipulation, whether by hedge funds or others, can best be
addressed by enhanced market surveillance. If there were a
public policy reason to monitor hedge fund activity, the best
method of doing so without raising liquidity concerns would be
indirectly through oversight of those broker-dealers (so-called
prime brokers) that clear, settle, and finance trades for hedge
funds. Although the use of multiple prime brokers by the
largest funds would complicate the monitoring of individual
funds by this method, such monitoring could provide much useful
information on the hedge fund sector as a whole.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING
FROM ALAN GREENSPAN
Q.1. The Securities and Exchange Commission (SEC) has recently
issued a proposed rule on the Gramm-Leach-Bliley push-outs
provisions governing bank securities activities. It is this
Senator's recollection that Congress intended to allow banks to
continue their
existing, limited securities activities that are part of their
banking business, such as trust, fiduciary, and custodial
activities. Do you believe that the SEC proposal accomplishes
Congressional intent? Also, do you believe that this SEC
proposal has complied with the intent of Congress not to impose
unnecessary regulatory burdens on banks?
A.1. Prior to the Gramm-Leach-Bliley Act of 1999 (GLB Act),
banks enjoyed a blanket exception from the definitions of
``broker'' and ``dealer'' in the Securities Exchange Act of
1934 (1934 Act). As part of the GLB Act, Congress replaced this
blanket exception for banks with a series of 15 exceptions
designed to allow banks to continue to conduct securities
activities that are part of normal bank activities. When these
activity-focused exceptions go into effect, a bank may avoid
registration as a broker-dealer under the 1934 Act only if the
bank limits its securities activities to those covered by one
or more of the new activity-focused exceptions. Because banks
cannot as a practical matter register as a broker-dealer,
securities brokerage and dealer activities that do not fit
within one of these
activity-focused exceptions would have to be ``pushed-out'' of
the bank to an SEC-registered broker-dealer.
The activity-focused exceptions that Congress adopted for
banks in the GLB Act are broad and were intended to allow banks
to continue to provide their customers securities services in
connection with their normal banking activities without
significant disruption. For example, Congress adopted important
statutory exceptions for the trust, fiduciary, and custodial
activities of banks. In adopting these exceptions, Congress
recognized that banks have long provided their customers
securities services in connection with their trust, fiduciary,
and custodial activities. Furthermore, Congress recognized that
banks had provided these services for decades prior to the GLB
Act without significant securities-related problems and under
the effective supervision of the Federal and State banking
agencies. The new activity focused exceptions were designed to
complement the new authority granted by the GLB Act, which
allowed banks to affiliate with full-service securities firms
without the restrictions embodied in the Glass-Steagall Act, by
restricting the ability of banks to significantly expand their
securities services. In particular, these targeted exceptions
were intended to prevent banks from operating a distinct retail
brokerage business within the bank.
The Board and the other Federal banking agencies previously
expressed concern that earlier SEC proposals to implement the
securities provisions of the GLB Act were not consistent with
the express terms or the Congressional purpose of the GLB Act.
In June, the SEC requested comment on new rules to implement
the ``broker'' exceptions for banks in the GLB Act, including
the important exceptions for bank trust, fiduciary, and
custodial activities. The public comment period on these rules
currently is scheduled to expire on September 1, 2004. Board
staff, in conjunction with the staffs of the other Federal
banking agencies, currently is reviewing and analyzing the
SEC's proposed rules to determine whether these rules,
consistent with Congress's intent, would permit banks to
continue to effect securities transactions in connection with
their traditional bank activities and without significant
disruption. The Board will provide you a copy of any comment
letter that the Board decides to file with the SEC on the
proposed rules.
RESPONSE TO A WRITTEN QUESTION OF SENATOR CRAPO
FROM ALAN GREENSPAN
Q.1. A divided SEC voted 3-2 last Wednesday to seek comments on
a proposal for mandatory registration of hedge fund advisers
with the SEC. Are you concerned with the divided SEC's proposal
for mandatory registration of hedge fund advisers with the SEC?
Do you think the President's Working Group on Financial Markets
should be involved in issues related to regulation of the hedge
fund industry?
A.1. I am concerned with the proposal. The proposal seeks to
deter fraud and market manipulation, but it is unlikely to
accomplish those objectives. The information reported to the
SEC by registered advisers is very limited and would be of
little value for these purposes. Nor are examinations of
advisers likely to uncover much fraud. Our experience with bank
examinations indicates that examiners have great difficulty
uncovering fraud. Most often it is uncovered through complaints
by customers or disaffected employees rather than through
exams. I believe this was also the case with the recent
scandals in the regulated mutual fund industry. Should
registration fail to achieve the intended objectives, pressure
may well become irresistible to expand the SEC's regulatory
reach from hedge fund advisers to hedge funds themselves. The
application of the Investment Company Act to hedge funds would
greatly impede their important contributions to the flexibility
and resiliency of our financial system.
Because of the critical role that hedge funds have come to
play in our financial system, all of the members of the
President's Working Group have an interest in what regulations,
if any, apply to their activities. It was this shared interest
that motivated the Working Group's April 1999 report on Hedge
Funds, Leverage, and the Lessons of Long-Term Capital
Management. More recently, it has motivated discussions within
the Working Group of the SEC's adviser registration proposal.
In that sense, the Working Group should be and has been
involved in issues related to the regulation of the hedge fund
industry. But decisions about the application of the Investment
Advisers Act to hedge fund advisers fall squarely within the
SEC's jurisdiction and must be made by the SEC.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SUNUNU
FROM ALAN GREENSPAN
Q.1. I understand that in August 2003, the Federal Reserve
proposed a rule to loosen the tying restrictions on bank
holding companies--the proposal and the subsequent supervisory
guidance would entail an interpretation of Section 106 of the
Bank Holding Company Act Amendments of 1970. Can you describe
the intent of the Fed proposal and comment on the status of the
rule? Also, does the Federal Reserve Board view tying as a
problem in large financial institutions?
A.1. The special antitying restrictions established by Section
106 of the Bank Holding Company Act Amendments of 1970 are
quite complex. For example, these restrictions apply only to
banks and do not apply to the nonbank affiliates of a bank or
other nonbank entities. In addition, while Section 106
prohibits banks from imposing certain types of tying
arrangements on their customers, there are several important
exceptions to the statute. These exceptions, among other
things, expressly allow a bank to condition the availability or
price of a product on a requirement that the customer also
obtain a ``loan, discount, deposit, or trust service'' from the
bank or an affiliate.
These exceptions and the statute's complex structure can
make applying the statute a challenging and fact-intensive
process. In
recent years, the Board has received a number of inquiries
concerning the antitying prohibitions in Section 106 and the
compliance of banking organizations with these restrictions.
These inquiries indicated that there was some uncertainty, both
among bankers and their customers, as to what types of bank
actions are prohibited by Section 106.
To help address this uncertainty, the Board in 2003
requested public comment on a formal interpretation of the
statute and
related supervisory guidance. The interpretation was intended
to provide banks and their customers a comprehensive guide to
the statute and, thus, improve the public's understanding of
the statute's restrictions. The proposed interpretation, for
example, discusses the necessary elements of a prohibited tying
arrangement, describes the statutory and regulatory exceptions
to the statute's prohibitions, and provides examples of the
types of bank actions that are prohibited and permissible under
the statute. The related supervisory guidance describes the
types of internal controls that should help banks comply with
the antitying restrictions in Section 106. The Board has
received approximately 40 comments on the proposed
interpretation and related supervisory guidance and we hope to
finalize these documents in the near future.
Federal Reserve examiners review the antitying programs of
bank holding companies and State member banks as part of the
regular compliance reviews of these organizations. In 2002,
examiners from the Federal Reserve and the Office of the
Comptroller of the Currency also conducted targeted antitying
examinations at several large banking organizations. The
targeted exams indicated that the banking organizations
reviewed generally have adequate policies and procedures to
ensure compliance with the antitying restrictions of Section
106, and the agencies generally did not uncover unlawful tying
arrangements in these examinations. The Government
Accountability Office also recently conducted a review of bank
compliance with Section 106 and found that the available
evidence does not substantiate claims that banks are tying the
availability or price of credit to the purchase of debt
underwriting services from a securities affiliate of the bank.
Based on our supervisory experience, it appears that
banking
organizations generally have adequate internal controls to help
prevent illegal tying. The Board, however, will take
appropriate supervisory action against a bank within our
supervisory jurisdiction if information developed through the
supervisory process or provided by a customer indicates that
the bank has imposed a tie on a customer in violation of
Section 106. For example, in 2003, the Board took enforcement
action against a foreign bank for violations of Section 106
after investigating a tying complaint received from one of the
bank's customers.
Q.2. In November 2003, the DOJ's Antitrust Division submitted a
comment letter to the Fed on its proposal to address tying. The
letter stated that the prohibitions on tying within Section 106
are much broader than those found in Federal antitrust laws and
that the Fed's proposed interpretation and supervisory guidance
might continue to prohibit some pro-competitive practices, such
as multiproduct discounting. The DOJ expressed concern that
Section 106 disadvantages banks as competitors in markets in
which banks and nonbanks compete--lessening competition and
ultimately harming consumers. The DOJ recommended that the
Fed's interpretation of Section 106 be consistent with, and not
broader than, the Federal antitrust laws.
It would appear that Section 106 was designed to protect
small business customers or individual consumers from being
forced to buy products they do not wish to purchase. The
Division's letter further recommends that, at a minimum,
Section 106 should be limited to ties involving small
businesses and individual consumers.
What are your views regarding the DOJ's Antitrust
Division's recommendations that Section 106 not be interpreted
to prohibit conduct that is not found to be anticompetitive
under the Federal antitrust laws? Also, what are your views on
applying general antitrust standards when banks are dealing
with large, sophisticated customers?
A.2. As you note, the Antitrust Division of the Department of
Justice has submitted a comment letter to the Board concerning
the Board's proposed interpretation of Section 106. In the
letter, the Antitrust Division supported the Board's efforts to
clarify that
Section 106 does not prohibit banks from entering into tying
arrangements with their customers when these arrangements are
voluntarily entered into or sought by the bank's customer (so-
called ``voluntary ties'').
The Division's letter also expressed concern that Section
106 may itself harm competition and consumers by limiting the
ability of banks to provide their customers discounts on
packaged offerings and by placing banks at a disadvantage in
markets where both banks and nonbank entities compete.
Accordingly, the Division recommended that the Board seek to
interpret the antitying restrictions in Section 106 in a manner
that is consistent with the tying restrictions that apply to
all companies, including banks, under the Sherman and Clayton
Acts. However, the Antitrust Division's letter also recognizes
that the courts historically have interpreted Section 106 as
imposing significantly more stringent antitying prohibitions on
banks than apply to companies generally under the Sherman and
Clayton Acts and that these precedents may constrain the
ability of the Board to interpret Section 106 to be coterminous
with the general antitrust laws.
The Board will carefully consider the views of the
Antitrust Division as the Board moves forward with the proposed
interpretation and related matters.
RESPONSE TO A WRITTEN QUESTION OF SENATOR STABENOW
FROM ALAN GREENSPAN
Currency Manipulation
Q.1. As you are aware, there has been a lot of concern in the
Senate with both China and Japan's monetary policy actions,
particularly related to Japan's huge interventions in
international
currency markets to maintain an artificially weak yen, as well
as China's dollar peg. The last time you and I discussed this,
you referred to it as a ``problem''--something the Bush
Administration has been unwilling to do. I would argue that it
has been an on-going problem and requires Government action to
end this unfair currency manipulation tax placed on American
products.
I believe that Japan's long-standing and successful efforts
in maintaining an artificially weak yen have been a major
factor in the ongoing weakness of our manufacturing sector. It
also has a very negative impact on the automotive sector.
Although, as you and I discussed recently, Japan had
stopped its interventions in the last several months after
spending over $138 billion in the first quarter of this year
and over $330 billion since 2003, I would note that significant
sums of money, perhaps as much as $50 billion per month, have
been budgeted for such future actions in Japan's current fiscal
year budget. Financial markets are also clearly wary of
statements from senior officials from Japan's Ministry of
Finance that the government is not ruling out intervening again
in massive amounts again if they so choose. And this threat
alone seems to be putting an artificial ceiling on the yen's
move toward its appropriate value.
Given on-going concerns over Japan's currency actions in
our last hearing and the ever-present threat of further massive
interventions, should the United States and the G-7 make very
clear to Japan that a resumption of such interventions would be
unwelcome and disruptive to the global economy?
Also, can you provide an analysis of the impact to our
economy of Japan's successful efforts to weaken its yen? Has it
undermined the Federal Reserve's efforts to stimulate U.S.
economic growth and create jobs, particularly in the
manufacturing sector?
A.1. U.S. policy regarding the foreign exchange value of the
dollar--against the yen or any other currency--is the province
of the Secretary of the Treasury, who is also the chief
spokesperson for the U.S. Government on these matters. I defer
to the Secretary on any official U.S. response to the concerns
you raise about Japanese policy operations with respect to the
dollar's exchange value against the yen. G-7 finance ministers,
central bank governors, and their respective deputies meet
frequently to discuss exchange rates and related foreign
exchange operations, such as those conducted earlier this year
by Japan.
Japan's official intervention operations, in which the
Japanese government purchased dollars in foreign exchange
markets and sold yen, may have influenced some U.S. asset
prices. One effect could have been on the foreign exchange
value of the dollar against the yen. In principle, the Japanese
operations would have weakened the yen against the dollar, and
it is possible that the operations did so, although the size
and persistence of any effects are difficult to judge. However,
one should keep in mind that, despite the large scale of the
Japanese operations in 2003 and 2004, the yen has strengthened
against the dollar on balance, rising roughly 20 percent from
its low point against the dollar in early 2002.
Because the Japanese authorities invested the proceeds of
their dollar purchases in interest-earning, dollar-denominated
assets, another effect of their operations on U.S. asset prices
could have come through the potential effect of these
operations on U.S. interest rates. In principle, the operations
would have resulted in increased demand for U.S. securities and
somewhat lower U.S. interest rates. While it is possible that
these operations did have such an effect, the magnitude of any
effect is likely to have been quite small. U.S. securities
markets are the deepest and most liquid of any in the world,
and the scale of the Japanese operations, while large by some
standards, was arguably too small to have had a substantial
effect on the general level of U.S. interest rates.
In any event, the operations of the Japanese have not
hampered the Federal Reserve in its efforts to conduct monetary
policy to achieve price stability and maximum sustainable
growth for the U.S. economy.
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