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[Senate Hearing 107-]
[From the U.S. Government Publishing Office]

                                                       S. Hrg. 107- 132

        FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2001

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION

                                   ON

      OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU- 
       ANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978

                               __________

                           FEBRUARY 13, 2001

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs

                                _______

                  U.S. GOVERNMENT PRINTING OFFICE
75-191                     WASHINGTON : 2001

____________________________________________________________________________
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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                      PHIL GRAMM, Texas, Chairman

RICHARD C. SHELBY, Alabama           PAUL S. SARBANES, Maryland
ROBERT F. BENNETT, Utah              CHRISTOPHER J. DODD, Connecticut
WAYNE ALLARD, Colorado               TIM JOHNSON, South Dakota
MICHAEL B. ENZI, Wyoming             JACK REED, Rhode Island
CHUCK HAGEL, Nebraska                CHARLES E. SCHUMER, New York
RICK SANTORUM, Pennsylvania          EVAN BAYH, Indiana
JIM BUNNING, Kentucky                ZELL MILLER, Georgia
MIKE CRAPO, Idaho                    THOMAS R. CARPER, Delaware
JOHN ENSIGN, Nevada                  DEBBIE STABENOW, Michigan
                                     JON S. CORZINE, New Jersey

                   Wayne A. Abernathy, Staff Director

     Steven B. Harris, Democratic Staff Director and Chief Counsel

                      Linda L. Lord, Chief Counsel

             Martin J. Gruenberg, Democratic Senior Counsel

                       George E. Whittle, Editor

                                  (ii)

                            C O N T E N T S

                              ----------                              

                       TUESDAY, FEBRUARY 13, 2001

                                                                   Page

Opening statement of Chairman Gramm..............................     1

Opening statements, comments, or prepared statements of:
    Senator Sarbanes.............................................     2
    Senator Bennett..............................................     4
    Senator Miller...............................................     5
    Senator Ensign...............................................     5
    Senator Corzine..............................................     5
    Senator Hagel................................................     6
    Senator Stabenow.............................................     6
    Senator Allard...............................................     7
        Prepared statement.......................................    53
    Senator Johnson..............................................     7
    Senator Bayh.................................................     8
    Senator Dodd.................................................     8
    Senator Reed.................................................     9
    Senator Shelby...............................................    30
    Senator Carper...............................................    41
    Senator Schumer..............................................    44
    Senator Bunning..............................................    53

                                WITNESS

Alan Greenspan, Chairman, Board of Governors of the Federal 
  Reserve System, Washington, DC.................................    10
    Prepared statement...........................................    53
    Response to written questions of:
        Senator Bunning..........................................    58

              Additional Material Supplied for the Record

Monetary Policy Report to the Congress, February 13, 2001........    60
A New York Times Article by Robert Rubin, ``A Prosperity Easy to 
  Destroy,'' dated February 11, 2001.............................    92

                                 (iii)

 
  FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT TO CONGRESS FOR 2001

                              ----------                              

                       TUESDAY, FEBRUARY 13, 2001

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.

    The Committee met at 10:00 a.m., in room SH-216 of the Hart 

Senate Office Building, Senator Phil Gramm (Chairman of the 
Committee) presiding.

            OPENING STATEMENT OF SENATOR PHIL GRAMM

    Chairman Gramm. The Committee will come to order. Let me 
thank our Members for coming. This is an important hearing--The 
first of our new hearings on monetary policy under the Federal 
Reporting Act of 2000.
    As our colleagues and Chairman Greenspan will remember, for 
many years we had a semiannual report under the Humphrey-
Hawkins Act, which required the Fed to report on many economic 
factors that are no longer as relevant in the year 2001 as they 
were in the 1970's.
    We were able to work out a bipartisan agreement to change 
the focus of the report and, as a result of that bipartisan 
effort, today, we are holding our first hearing.
    I want to thank Senator Sarbanes for his leadership in 
helping us reach a bipartisan agreement that would allow these 
hearings to move forward. I am also glad that we have agreed--
except under circumstances where the Banking Committee in the 
house of Congress that does not hold a primary hearing feels 
that it is necessary to have the Federal Reserve Chairman 
present the whole thing again--that we will have reduced four 
hearings a year for Chairman Greenspan down to two.
    Knowing that he is a busy man, trying to keep the economy 
strong, doing God's work in that effort, I think that is an 
important achievement. So, we are here today to hear a report 
on the American economy.
    In my opinion, since roughly 1982, when the Reagan program 
became operational, we have been virtually in a 19-year golden 
era in America.
    Not only do we have higher real incomes, not only do we 
have an abundance of consumer goods at lower prices and higher 
quality than at any other time in history, but this expansion 
has been so strong that people who once were considered 
unemployable are now viable, functioning members of the labor 
force.
    In this environment, we were able to reform welfare and 
require that people leave welfare and go to work, and they have 
done it, and have not only benefited the taxpayer with lower 
welfare expenditures, but, most importantly, benefited 
themselves by earning the dignity that comes from being self-
supporting.
    It is hard to imagine anything more important than keeping 
this economic expansion going.
    Chairman Greenspan, as always, we look forward to hearing 
what you have to say and to working with you to do what we have 
to do to maximize the chances that this economic expansion will 
continue to create jobs and growth and opportunity for all of 
our people. And so, I want to welcome you to the Committee.
    Let me say to you and to our colleagues, I have to run 
downstairs around 10:30 to introduce a friend of mine from 
Texas who's been nominated to a high post.
    I will ask Senator Sarbanes to preside during my absence 
and, hopefully, by the time we allow everybody to give an 
opening statement, I will have had time to go down and do that 
and come back.
    But if I miss part of your statement, I will have trusty 
aides here listening.
    So let me welcome you today and recognize Senator Sarbanes.

         OPENING STATEMENT OF SENATOR PAUL S. SARBANES

    Senator Sarbanes. Well, thank you very much, Mr. Chairman.
    I join you in welcoming Alan Greenspan back before the 
Senate Banking Committee. We look forward to receiving the 
Federal Reserve's semiannual monetary policy report to Congress 
under the legislation that we were able to pass at the end of 
the last Congress, legislation which gave a permanent 
reauthorization to this semiannual monetary report, something 
which I understand the Fed was supportive of, and also 
reauthorize a number of other reports under the jurisdiction of 
this Committee.
    I want to express my appreciation to Senator Gramm for his 
cooperation in that effort that enabled us to resolve that 
issue, I think much to the advantage of everyone.
    These monetary policy reports and the public testimony 
before Congress by the Federal Reserve Board Chairman serve a 
critical oversight function and I am glad we are carrying it 
forward without interruption.
    Much has changed since Chairman Greenspan appeared before 
this Committee last July 20 to testify on the Fed's previous 
monetary policy report. Two months prior to that appearance, on 
May 16 of last year, not yet a year, the Fed completed the last 
and longest half-point of a series of six interest rate 
increases--increases--that have been initiated on June 30, 
1999. Between June 30, 1999 and May 16, 2000, the Fed took the 
interest rates up 6 times. While many of us were searching for 
some visible evidence of inflation in the economy to support 
such a move, the Fed said they were concerned about 
inflationary pressures developing as a result of strong 
consumer demand and tight labor markets.
    While the Fed's Open Market Committee did not raise rates 
again after May 16, it maintained a position through November 
15 of last year--in other words, just 3 months ago--that the 
economic risk continued to be weighted, and I quote them, 
mainly toward conditions that may generate heightened inflation 
pressures in the foreseeable future.
    It was not until the Federal Open Market Committee meeting 
on December 19, less than 2 months ago, that the FOMC shifted 
its position to the view that the economic risks were weighted, 
``mainly toward conditions that may generate economic weakness 
in the foreseeable future.'' And of course, as we all know, 
thereafter, the Fed lowered interest rates half a point on 
January 3 and lowered interest rates another half point again 
on January 31.
    In his testimony last July 20, Chairman Greenspan also 
emphasized the importance of not dissipating the budget 
surpluses of the Federal Government. He stated--``by 
substantially augmenting national saving, these budget 
surpluses have kept real interest rates at levels lower than 
they would have been otherwise. This development has helped 
foster the investment boom that in recent years has contributed 
greatly to the strengthening of U.S. productivity and economic 
growth. The Congress and the Administration have very wisely 
avoided steps that would materially reduce these budget 
surpluses. Continued fiscal discipline will contribute to 
maintaining robust expansion of the American economy in the 
future.''
    And Chairman Greenspan also stated--``I would say that 
anything, whether it is tax cuts or expenditure increases which 
significantly slows the rise in surpluses, or eventually 
eliminates them, will put the economy at greater risk than I 
would like to see it exposed to.''
    Now as we all know, in his testimony before the Senate 
Budget Committee on January 25, just a few weeks ago, the 
Chairman changed all of this.
    Business Week said, and I now quote them in their editorial 
on February 19--In his Senate testimony on January 25, Federal 
Reserve Chairman Alan Greenspan appeared to give his blessing 
to massive tax cuts that extend well into the decade.
    Despite his caution, the predictions of budget surpluses 
are subject to a relatively wide range of error. His 
benediction--Business Week's word--his benediction changed the 
political climate in Washington and set off a tax cut frenzy 
that is now veering out of control.
    And earlier, with reference to that very point in that 
editorial, Business Week had said: ``The great tax cut stampede 
is on, and two things could get trampled under foot--restraint 
and common sense.''
    Conservatives, liberals, the business roundtable and 
lobbyists of all kinds are demanding their fair share. A 
mindless, bloated, something-for-everyone tax cut may result. 
Before Washington gets swept away and does something that the 
country regrets for years to come, it might be wise to step 
back and consider a few simple truths. And some of those 
truths, I think, were outlined in a very pointed and succinct 
way by Alice Rivlin, the former Vice Chair of the Federal 
Reserve Board, as well as the former director of both CBO and 
OMB, who testified before the Senate Budget Committee and 
stated, and I quote her:
    I believe that the currently projected 10-year surpluses 
are good guesses, the best available guesses. But they are by 
no means guaranteed.
    Moreover, the 10-year horizon is too short. We need to 
respond now to the looming demographic pressures of the years 
beyond 2011.
    I believe committing to a massive tax cut now, especially 
one undertaken to counter a temporary downturn in the economy, 
would be short-sighted.
    We have time to see whether the surpluses turn out to be as 
large as currently projected and to debate whether public needs 
have priority over private spending.
    Ms. Rivlin also pointed out that:

    Since a tax reduction that overstimulates the economy is 
almost impossible to reverse, the likely result will be that 
the Federal Reserve will have to raise interest rates. If we 
want to promote economic growth, we would be better off with 
lower interest rates and tighter fiscal policy than with the 
opposite combination.

    In my view, we are at a crossroads in the conduct of fiscal 
policy. Over the past 8 years, the United States has maintained 
remarkably disciplined fiscal policy. That fiscal policy, in 
turn, has given the Federal Reserve the room to run an 
accommodating monetary policy that has allowed the economy to 
sustain the longest expansion in U.S. history. This economic 
expansion brought unemployment down to 4 percent, helped turn 
U.S. budget deficits into 
surpluses, produced an expansion in investment that has led to 
rising levels of productivity, which in turn has kept inflation 
at 
low levels.
    It is the reason the Fed had the flexibility to move 
quickly and aggressively last month to lower interest rates to 
respond to the economic slowdown. All of that could now be 
placed at risk.
    I hope we find it within ourselves to consider carefully 
the judgments we make in the coming months and act prudently to 
preserve the hard-won gains we have made over the past 8 years.
    Mr. Chairman, I look forward to hearing Chairman 
Greenspan's testimony this morning on this and other issues.
    Thank you very much.
    Chairman Gramm. Thank you, Senator Sarbanes.
    Senator Bennett.

         OPENING STATEMENT OF SENATOR ROBERT F. BENNETT

    Senator Bennett. Thank you, Mr. Chairman.
    I will try to be brief, but I could not resist noting an 
article that appeared today in The New York Times on the Op Ed 
page, that I think sounds a note that we ought to keep in mind 
as we get into this discussion of the economy. It is entitled, 
``An Irrational Case of Dread.'' And if I may, I would like to 
quote a little from it.
    My colleague from Maryland has quoted from Business Week, 
maybe an unusual source from a Democrat.
    I will quote from The New York Times, an unusual source for 
a Republican.
    [Laughter.]
    He says, ``It is very hard for outsiders to believe that 
the United States, with housing starts at over 1.5 million 
units and an unemployment rate at little more than 4 percent, 
is in trouble.''
    Why are Americans complaining about a broader economic 
outcome that in principle was strongly desired just a year ago?
    The steady drumbeat of worry over the past few months has 
come almost exclusively from economists who specialize in the 
stock market, especially the NASDAQ. There is far less gloom 
among the American corporate economists I speak to in 
nonfinancial companies, people whose main business is to advise 
top managers on longer-term trends that drive decisions like 
whether to build new factories or buy equipment.
    And finally, he says: Viewed from outside the country, 
there are a few signs of serious weakness in the American 
economy, just clear evidence that it has come back down to 
earth from a period of very fast growth before there could be 
real damage from a permanent rise in inflation.
    Only 6 months ago, most American economists still wanted to 
see the economy cool off. Because the Federal Reserve has done 
its job well by raising interest rates at the right time, there 
should be celebration, not trepidation.
    I think that is a very salutary way to greet the Chairman 
of the Federal Reserve Board, saying that, yes, things have 
slowed down a little.
    No, we are not going into the tank.
    And looking at it from the standpoint of Europe, and this 
particular byline is Frankfurt, U.S. economic worries look--
well, the quote is, from Europe: U.S. Economic Worries Are Hard 
To Fathom.
    Many times it is important for us when we look just at 
ourselves, to look around at others and see where we are in 
comparison to others and realize that confidence in the 
American economy is not a bad thing to have at this particular 
time.
    And I share that with you, Mr. Chairman, and look forward 
to the reactions and comments of Chairman Greenspan.
    Chairman Gramm. Thank you, Senator Bennett.
    Senator Miller.

                 COMMENT OF SENATOR ZELL MILLER

    Senator Miller. I don't have any comments at this time. 
Maybe some questions later.
    Chairman Gramm. Senator Ensign.

                 COMMENT OF SENATOR JOHN ENSIGN

    Senator Ensign. I will wait for questioning. Thank you.
    Chairman Gramm. Senator Corzine.

          OPENING STATEMENT OF SENATOR JON S. CORZINE

    Senator Corzine. Thank you, Mr. Chairman.
    I join my colleagues in welcoming Chairman Greenspan. I 
compliment you on your exceptional leadership over the years. 
As a former field hand in the financial services world and 
markets for 25 years, I could not respect your judgment, 
objectivity and the results more readily.
    But as Senator Sarbanes remarked in his opening comments, I 
am concerned about some of the interpretations that came out of 
the Budget Committee hearings. And I hope that we will have a 
chance today to have some clarification about some of those.
    As the most junior Member on this side of the aisle, I will 
keep my opening remarks to an irreducible minimum. But I do 
want to ask specific questions about specific tax cuts. 
Importantly, the size of those tax cuts within the fiscal 
framework that we face.
    Specifically, I hope to have some clarification whether you 
believe we should separate a stimulus-focused tax cut from 
structural tax adjustments. And under what circumstances you 
believe those should be scaled in, phased in, whatever term one 
would want to use, given the uncertainties that we may face in 
projecting a 10-year fiscal policy framework.
    But I am very, very pleased to be here and look forward to 
your comments.
    Chairman Gramm. Thank you, Senator Corzine.
    Senator Hagel.

            OPENING STATEMENT OF SENATOR CHUCK HAGEL

    Senator Hagel. Mr. Chairman, thank you.
    I would just note that, Mr. Chairman, even for your high 
standards, you have stimulated an unusually high degree of 
interest in the last few weeks, and an even more interesting 
degree of interpretation of what you have said.
    I look forward to some clarity and cogent interpretation of 
exactly what you said and what your intent was as you testified 
before our Budget Committee a couple of weeks ago.
    As always, we are glad you are here. Thank you.
    Thank you, Mr. Chairman.
    Chairman Gramm. Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman.

          OPENING STATEMENT OF SENATOR DEBBIE STABENOW

    Chairman Greenspan, it is a pleasure to hear your views on 
the economy and the budget for the second time since, as you 
know, I am a member of the Budget Committee and did have an 
opportunity to hear directly your comments just a number of 
days ago. As you said in your testimony before the Budget 
Committee, our economic performance of the past 5 to 7 years is 
without precedent, and I would agree.
    However, it is important to note, you admonished us to 
maintain fiscal responsibility and to pay down our national 
debt.
    I believe that somehow has gotten lost in other 
discussions.
    You also warned us about the uncertainty of a 10-year 
budget forecast. And while you did advocate some type of tax 
reduction, you also urged us to use some type of trigger 
mechanism to make sure that we actually pay down the national 
debt to its lowest possible level first. And I hope you will 
speak to that trigger mechanism today in your testimony.
    Overall, your Budget Committee testimony was balanced and 
prudent. But many advocates and those in elected office have 
highlighted only one side of your testimony, and as you know, 
are using it to promote a very large tax cut that would spend 
the entire surplus, rather than focusing on paying down the 
debt or other priorities, or even looking at the possibility of 
the slightest forecasting error.
    And I am looking forward to your addressing that today.
    I hope today's hearing will provide us an opportunity to 
clarify some of this confusion and to set the record straight 
on your message of fiscal responsibility and discipline and the 
importance of paying down the national debt.
    I think we very much need to hear your message in totality 
and I am looking forward to it.
    Thank you.
    Chairman Gramm. Thank you.
    Senator Allard.

                COMMENT OF SENATOR WAYNE ALLARD

    Senator Allard. Thank you, Mr. Chairman. I would like to 
make a brief comment. And I would like to just make my formal 
statement a part of the record.
    Chairman Gramm. It will be made a part of the record.
    Senator Allard. And just, again, welcome, Chairman 
Greenspan, to this Committee.
    I did hear your testimony before the Budget Committee. I 
thought it was pretty clear. I did not think there was any real 
confusion there. And I also found in your testimony, if you 
want to be vague, you can be decidedly vague and it is obvious 
that you are being vague.
    So I am looking forward to your testimony. You are going to 
be on a new format--focusing on monetary policy instead of the 
old Humphrey-Hawkins format, which, in my view, is a welcome 
change.
    Mr. Chairman, I am looking forward to your testimony.
    Thank you.
    Chairman Gramm. Thank you.
    Senator Johnson.

            OPENING STATEMENT OF SENATOR TIM JOHNSON

    Senator Johnson. Thank you, Mr. Chairman, and welcome to 
Chairman Greenspan.
    I will be very brief. Just a quick observation.
    One is that I did very much appreciate your testimony 
before the Budget Committee not long ago. And I would share 
some thoughts expressed by Senator Sarbanes and also by Senator 
Stabenow relative to the aftermath of your testimony before the 
Budget Committee.
    I think the message about tax reductions was heard loud and 
clear. The media has made much of it. And those words have been 
used for the promotion of that goal.
    I think your cautionary observations about the stimulating 
effect to the economy of tax cuts was not apparently heard 
terribly well.
    I think your cautionary remarks about fiscal responsibility 
and the uncertainty of 10-year projections on budget surpluses 
has not been discussed enough and it has not been heard as well 
as it ought to be.
    And I think that your observation about trigger mechanisms 
is something that we need to pursue further as well.
    I think that there is going to be a very significant tax 
cut enacted by this Congress. In fact, I believe that there is 
room within the budget for a larger tax cut for middle-class 
families than that which has been proposed by President Bush, 
but within parameters that involve less total cost for tax 
relief.
    It seems to me that it is incumbent on those of us who deal 
with the specifics of a budget that we use some prudence and 
some humility relative to the 10-year projections and that we 
take care to see to it that while tax relief is part of the 
total mix, that in fact there are adequate resources left over 
for education, debt reduction, defense, Social Security, 
Medicare, and so on, and that this be a properly balanced 
strategy that we embark upon here during this Congress.
    My fear, frankly, is that there is a greater risk of the 
Government backing into the bad old days of red ink--and we are 
not very far removed from those days--than there is of 
accumulating wildly excessive surpluses 10 years down the road.
    I believe that while both of those are legitimate concerns, 
as you have expressed to us, the balancing is something that 
has to be done by the policymakers. And I think that the 
policymakers need to listen a little more carefully to the full 
context of your statement than was necessarily the case 
following your testimony to the Budget Committee.
    So I look forward to further elaboration and your testimony 
today.
    Chairman Gramm. Senator Bayh.

             OPENING STATEMENT OF SENATOR EVAN BAYH

    Senator Bayh. Thank you, Mr. Chairman.
    Harboring no illusions that we have gathered here today to 
listen to me, I am going to wait for the question period to 
express my comments.
    It is my hope, however, Mr. Chairman, that either in your 
presentation or in response to questions, you can give us some 
guidance in how to make decisions of great consequence in an 
atmosphere of substantial uncertainty, and perhaps suggest some 
steps that can be taken to reduce the uncertainty, thereby 
increasing the prospect that our decisions will be prudent 
ones.
    Thank you.
    Chairman Gramm. Senator Dodd.

        OPENING STATEMENT OF SENATOR CHRISTOPHER J. DODD

    Senator Dodd. Thank you, Mr. Chairman, and welcome to you, 
Mr. Chairman, and to the Committee.
    And just to underscore, I would hope today, Mr. Chairman, 
you might take some time to offer some clarifications, to the 
Budget Committee testimony. I thought it was very good 
testimony. But you don't control how the media reports on your 
testimony and what the headlines may be or may not be.
    But, obviously, I think for many of us here, I don't know 
of anyone--maybe there are people who are just adamantly 
opposed to any tax cuts. I think most of us believe that there 
is plenty of room for a tax cut in the coming years, even where 
there is some doubt about the size of future surpluses, but 
with some degree of proportionality and where it would be 
targeted or how it would be paid for.
    I hope we can have some discussion on it.
    There is already--the 1.6 that has been introduced, and 
obviously, fiscal policy has a direct bearing on monetary 
policy. That number is moving up.
    You have already had Members of Congress talking about add-
ons to that that go between $500 billion and a trillion to what 
is already been proposed.
    Interest groups are lining up to express their concerns. We 
have watched this process over the years. It is not the first 
time we have been through it. And there are real dangers here 
that we could take what has been a very good economy--much of 
the responsibility for that goes to you.
    Your leadership over the past 8 years has been remarkable. 
And it is not without reason that most people attribute your 
leadership as the reason we have had an unprecedented economic 
growth and success in this country throughout its history. You 
really deserve a great deal of credit.
    And for those of us who have been around here for the past 
couple of decades and who have listened to the words of Yogi 
Berra with that deja vue all over again, there is some 
legitimate concern that we are back visiting the early 1980's, 
when similar remarks were being made about what tax cuts would 
do then, similar promises made about what happened on the 
spending side of the equation, and then to watch it all sort of 
evaporate, creating the mess that we saw in the late 1980's and 
very early 1990's.
    I just want to add my voice to the voices of Senators 
Sarbanes and Tim Johnson and others I think you will hear from 
today about this aspect.
    I know your responsibility is to talk about the overall 
economy. But this is such a big issue, it is so important. It 
has such long-term implications for our country.
    The opportunity to leave to the next generation a gift that 
none of us imagined we could ever give them, to virtually burn 
the national debt, the national mortgage.
    I cannot think of a greater gift that this generation could 
give to the next generation, as it grapples with the problems 
of the 21st Century. And we are very close to achieving that. 
My hope is that that would be very much on our minds as we 
weigh the pros and cons of the President's proposal on taxes.
    I thank you once again for being here and look forward to 
your testimony.
    Senator Sarbanes [presiding]. Senator Reed.

             OPENING STATEMENT OF SENATOR JACK REED

    Senator Reed. Thank you very much, Senator Sarbanes.
    Welcome, Chairman Greenspan.
    Your Budget testimony, either wittingly or unwittingly, 
advanced the case for a tax cut. The issue that confronts most 
of us today, and it is reflected in the comments of my 
colleagues, is the size of that tax cut. And I would hope that 
you could provide some specificity and some details with 
respect to your views in this regard.
    But, again, echoing my colleagues, your stewardship over 
the last several years has given us the opportunity to do many 
things, just one of which is a tax cut.
    We appreciate your comments on both priorities and size and 
other issues related to the policy choices we face ahead of us.
    Thank you, Mr. Chairman.
    Senator Sarbanes. Thank you, Senator Reed.
    Chairman Greenspan, we are happy to receive your statement 
now.

    OPENING STATEMENT OF ALAN GREENSPAN, CHAIRMAN, BOARD OF 
               GOVERNORS, FEDERAL RESERVE SYSTEM

    Chairman Greenspan. Thank you very much, Mr. Chairman.
    I appreciate the opportunity this morning to present the 
Federal Reserve's semiannual report on monetary policy.
    The past decade has been extraordinary for the American 
economy and monetary policy. The synergies of key technologies 
markedly elevated prospective rates of return on high-tech 
investments, led to a surge in business capital spending, and 
significantly increased the underlying growth rate of 
productivity. The capitalization of those higher expected 
returns boosted equity prices, contributing to a substantial 
pick up in household spending on new homes, durable goods, and 
other types of consumption generally, beyond even that implied 
by the enhanced rise in real incomes.
    When I last reported to you in July, economic growth was 
just exhibiting initial signs of slowing from what had been an 
exceptionally rapid and unsustainable rate of increase that 
began a year earlier.
    The surge in spending had lifted the growth of the stocks 
of many types of consumer durable goods and business capital 
equipment to rates that could not be continued. The elevated 
level of light vehicle sales, for example, implied a rate of 
increase in the number of vehicles on the road hardly 
sustainable for a mature industry. And even though demand for a 
number of high-tech products was doubling or tripling annually, 
in many cases new supply was coming on even faster. Overall, 
capacity in high-tech manufacturing industries rose nearly 50 
percent last year, well in excess of its rapid rate of increase 
over the previous 3 years. Hence, a temporary glut in these 
industries and falling prospective rates of return were 
inevitable at some point. Clearly, some slowing in the pace of 
spending was necessary and expected if the economy was to 
progress along a balanced and sustainable growth path.
    But the adjustment has occurred much faster than most 
businesses anticipated, with the process likely intensified by 
the rise in the cost of energy that has drained business and 
household purchasing power. Purchases of durable goods and 
investment in capital equipment declined in the fourth quarter. 
Because the extent of the slowdown was not anticipated by 
business, it induced some backup in inventories, despite the 
more advanced just-in-time technologies that have in recent 
years enabled firms to adjust production levels more rapidly to 
changes in demand. Inventory-sales ratios rose only moderately, 
but relative to the levels of these ratios implied by the 
downward trend over the past decade, the emerging imbalances 
appeared considerably larger. Reflecting these growing 
imbalances, manufacturing purchasing managers reported last 
month that inventories in the hands of their customers had 
risen to excessively high levels.
    As a result, a round of inventory rebalancing appears to be 
in process. Accordingly, the slowdown in the economy that began 
in the middle of 2000 intensified, perhaps even to the point of 
growth stalling out around the turn of the year. As the economy 
slowed, equity prices fell, especially in the high-tech sector, 
where previous high valuations and optimistic forecasts were 
being reevaluated, resulting in significant losses for some 
investors. In addition, lenders turned more cautious. This 
tightening of financial conditions, itself, contributed to 
restraint on spending.
    Against this background, the Federal Open Market Committee 
(FOMC) undertook a series of aggressive monetary policy steps. 
At its December meeting, the FOMC shifted its announced 
assessment of the balance of risks to express concern about 
economic weakness, which encouraged declines in market interest 
rates. Then on January 3, and again on January 31, the FOMC 
reduced its targeted Federal funds rate \1/2\ percentage point, 
to its current level of 5\1/2\ percent. An essential 
precondition for this type of response was that underlying cost 
and price pressures remained subdued, so that our front-loaded 
actions were unlikely to jeopardize the stable, low inflation 
environment necessary to foster investment and advances in 
productivity.
    The exceptional weakness so evident in a number of economic 
indicators toward the end of last year--perhaps in part the 
consequence of adverse weather--apparently did not continue in 
January. But with signs of softness still patently in evidence 
at the time of its January meeting, the FOMC retained its sense 
that the risks are weighted toward conditions that may generate 
economic weakness in the foreseeable future.
    Crucial to the assessment of the outlook and the 
understanding of recent policy actions is the role of 
technological change and productivity in shaping near-term 
cyclical forces as well as long-term sustainable growth.
    The prospects for sustaining strong advances in 
productivity in the years ahead remain favorable. As one would 
expect, productivity growth has slowed along with the economy. 
But what is notable is that, during the second half of 2000, 
output per hour advanced at a pace sufficiently impressive to 
provide strong support for the view that the rate of growth of 
structural productivity remains well above its pace of a decade 
ago.
    Moreover, although recent short-term business profits have 
softened considerably, most corporate managers appear not to 
have altered to any appreciable extent their long-standing 
optimism about the future returns from using new technology. A 
recent survey of purchasing managers suggests that the wave of 
new on-line business-to-business activities is far from 
cresting. Corporate managers more generally, rightly or 
wrongly, appear to remain remarkably sanguine about the 
potential for innovations to continue to enhance productivity 
and profits. At least this is what is gleaned from the 
projections of equity analysts, who, one must presume, obtain 
most of their insights from corporate managers. According to 
one prominent survey, the 3- to 5-year average earnings 
projections of more than a thousand analysts, though exhibiting 
some signs of diminishing in recent months, have generally held 
firm at a very high level. Such expectations, should they 
persist, bode well for continued strength in capital 
accumulation and sustained elevated growth of structural 
productivity over the longer term.
    The same forces that have been boosting growth in 
structural productivity seem also to have accelerated the 
process of cyclical adjustment. Extraordinary improvements in 
business-to-business communication have held unit costs in 
check, in part by greatly speeding up the flow of information. 
New technologies for supply-chain management and flexible 
manufacturing imply that businesses can perceive imbalances in 
inventories at a very early stage--virtually in real time--and 
can cut production promptly in response to the developing signs 
of unintended inventory building.
    Our most recent experience with some inventory backup, of 
course, suggests that surprises can still occur and that this 
process is still evolving. Nonetheless, compared with the past, 
much progress is evident. A couple of decades ago, inventory 
data would not have been available to most firms until weeks 
had elapsed, delaying a response and, hence, eventually 
requiring even deeper cuts in production. In addition, the 
foreshortening of lead times on delivery of capital equipment, 
a result of information and other newer technologies, has 
engendered a more rapid adjustment of capital goods production 
to shifts in demand that result from changes in firms' 
expectations of sales and profitability. A decade ago, extended 
backlogs on capital equipment meant a more stretched-out 
process of production adjustments. Even consumer spending 
decisions have become increasingly responsive to changes in the 
perceived profitability of firms through their effects on the 
value of households' holdings of equities. Stock market wealth 
has risen substantially relative to income in recent years--
itself a reflection of the extraordinary surge of innovation. 
As a consequence, changes in stock market wealth have become a 
more important determinant of shifts in consumer spending 
relative to changes in current household income than was the 
case just 5 to 7 years ago.
    The hastening of the adjustment to emerging imbalances is 
generally beneficial. It means that those imbalances are not 
allowed to build until they require very large corrections. But 
the faster adjustment process does raise some warning flags. 
Although the newer technologies have clearly allowed firms to 
make more informed decisions, business managers throughout the 
economy also are likely responding to much of the same enhanced 
body of information. As a consequence, firms appear to be 
acting in far closer alignment with one another than in decades 
past. The result is not only a faster adjustment, but one that 
is potentially more synchronized, compressing changes into an 
even shorter timeframe.
    This very rapidity with which the current adjustment is 
proceeding raises another concern, of a different nature. While 
technology has quickened production adjustments, human nature 
remains unaltered. We respond to a heightened pace of change 
and its associated uncertainty in the same way we always have. 
We withdraw from action, postpone decisions, and generally 
hunker down until a renewed, more comprehensive basis for 
acting emerges. In its extreme manifestation, many economic 
decisionmakers not only become risk adverse, but attempt to 
disengage from all risk. This precludes taking any initiative, 
because risk is inherent in every action. In the fall of 1998, 
for example, the desire for liquidity became so intense that 
financial markets seized up. Indeed, investors even tended to 
shun risk-free, previously issued Treasury securities in favor 
of highly liquid, recently issued Treasury securities.
    But even when decisionmakers are only somewhat more risk 
adverse, a process of retrenchment can occur. Thus, although 
prospective long-term returns on new high-tech investment may 
change little, increased uncertainty can induce a higher 
discount of those returns and, hence, a reduced willingness to 
commit liquid resources to illiquid capital investments.
    Such a process presumably is now under way and arguably, 
may take some time to run its course. It is not that underlying 
demand for Internet, networking, and communication services has 
become less keen. Indeed, as I noted earlier, some suppliers 
seem to have reacted late to accelerating demand, have 
overcompensated in response, and then have been forced to 
retrench--a not-unusual occurrence in business decisionmaking.
    A pace of change outstripping the ability to adjust is just 
as evident among consumers as among business decisionmakers. 
When consumers become less secure in their jobs and finances, 
they retrench as well.
    It is difficult for economic policy to deal with the 
abruptness of a break in confidence. There may not be a 
seamless transition from high to moderate to low confidence on 
the part of businesses, investors, and consumers. Looking back 
at recent cyclical episodes, we see that the change in 
attitudes has often been sudden. In earlier testimony, I 
likened this process to water backing up against a dam that is 
finally breached. The torrent carries with it most remnants of 
certainty and euphoria that built up in earlier periods.
    This unpredictable rending of confidence is the one reason 
that recessions are so difficult to forecast. They may not be 
just changes in degree from a period of economic expansion, but 
a different process engendered by fear. Our economic models 
have never been particularly successful in capturing a process 
driven in large part by nonrational behavior.
    Although consumer confidence has fallen, at least for now 
it remains at a level that in the past was consistent with 
economic growth. And as I pointed out earlier, expected 
earnings growth over the longer-run continues to be elevated. 
If the forces contributing to long-term productivity growth 
remain intact, the degree of retrenchment will presumably be 
limited. Prospects for high productivity growth should, with 
time, bolster both consumption and investment demand. Before 
long in this scenario, excess inventories would be run off to 
desired levels.
    Still, as the FOMC noted in its last announcement, for the 
period ahead, downside risks predominate. In addition to the 
possibility of a break in confidence, we don't know how far the 
adjustment of the stocks of consumer durables and business 
capital equipment has come. Also, foreign economies appear to 
be slowing, which could dampen demands for exports; and, 
although some sectors of the financial markets have improved in 
recent weeks, continued lender nervousness still is in evidence 
in other sectors.
    Because the advanced supply-chain management and flexible 
manufacturing technologies may have quickened the pace of 
adjustment in production and incomes and correspondingly 
increased the stress on confidence, the Federal Reserve has 
seen the need to respond more aggressively than had been our 
wont in earlier decades. Economic policymaking could not, and 
should not, remain unaltered in the face of major changes in 
the speed of economic processes. Fortunately, the very advances 
in technology that have quickened economic adjustments have 
also enhanced our capacity for real-time surveillance.
     As I pointed out earlier, demand has been depressed by the 
rise in energy prices as well as by the needed slowing in the 
pace of accumulation of business capital and consumer durable 
assets. The sharp rise in energy costs pressed down on profit 
margins still further in the fourth quarter. About a quarter of 
the rise in total unit costs of nonfinancial, nonenergy 
corporations reflected a rise in energy costs. The 12-percent 
rise in natural gas prices last quarter contributed directly, 
and indirectly through its effects on the cost of electrical 
power generation, about one-fourth of the rise in overall 
energy costs for nonfinancial, nonenergy corporations; 
increases in oil prices accounted for the remainder.
    In addition, a significant part of the margin squeeze not 
directly attributable to higher energy costs probably has 
reflected the effects of moderation in consumer outlays that, 
in turn, has been due in part to higher costs of energy, 
especially for natural gas. Hence, it is likely that energy 
cost increases contributed significantly more to the 
deteriorating profitability of nonfinancial, nonenergy 
corporations in the fourth quarter than is suggested by the 
energy-
related rise in total unit costs alone.
    To be sure, the higher energy expenses of households and 
most businesses represent a transfer of income to producers of 
energy. But the capital investment of domestic energy 
producers, and, very likely, consumption by their owners, have 
provided only a small offset to the constraining effects of 
higher energy costs on spending by most Americans. Moreover, a 
significant part of the extra expense is sent overseas to 
foreign energy producers, whose demand for exports from the 
United States is unlikely to rise enough to compensate for the 
reductions in domestic spending, especially in the short run. 
Thus, given the evident inability of energy users, constrained 
by intense competition for their own products, to pass on much 
of their cost increases, the effects of the rise in energy 
costs does not appear to have had broad inflationary effects, 
in contrast to some previous episodes when inflation 
expectations were not as well anchored. Rather, the most 
prominent effects have been to depress aggregate demand. The 
recent decline in energy prices and the further declines 
anticipated by futures markets, should 
they occur, would tend to boost purchasing power and be an 
impor-
tant factor supporting a recovery in demand growth over coming 
quarters.
    The members of the Board of Governors and the Reserve Bank 
presidents foresee an implicit strengthening of activity after 
the current rebalancing is over, although the central tendency 
of their individual forecasts for real GDP still shows a 
substantial slowdown, on balance, for the year as a whole. The 
central tendency for real GDP growth over the four quarters of 
this year is 2 to 2\1/2\ percent. Because this average pace is 
below the rise in the economy's potential, they see the 
unemployment rate increasing to about 4\1/2\ percent by the 
fourth quarter of this year. The central tendency of their 
forecasts for inflation, as measured by the prices for personal 
consumption expenditures, suggests an abatement to 1\3/4\ to 
2\1/4\ percent over this year, from 2\1/2\ percent over the 
year 2000.
    Mr. Chairman, I would appreciate the full comments that I 
have written appear in the record, and I look forward to your 
questions.
    Chairman Gramm. Mr. Chairman, thank you for your comments.
    I had the idea in listening to some of my colleagues that 
they at least perceived that you had been misquoted in your 
testimony before the Budget Committee. But I have noted in the 
past, when you thought people had misinterpretad your comment, 
you issued a clarification. I saw no clarification as a result 
of that testimony.
    In your opinion, were your views misconstrued?
    Chairman Greenspan. Mr. Chairman, I do think that because 
of the complexity of the issue which I addressed in the Senate 
Budget Committee--complex of necessity because things are 
changing in ways that we had not been required to evaluate 
previously--that a number of the reports that I saw were quite 
selective of the general position that I took. But I don't find 
that unusual. I find that sort of more general rather than 
otherwise.
    I don't know what to do about it. I just repeat myself, 
sometimes creating, I suspect, somewhat more complexity than is 
necessary. But I can only tell you what it is I believe when 
you ask me questions and hope for the best.
    Chairman Gramm. Well, let me ask you some of those 
questions.
    In listening to many people comment on where we are, I hear 
people talk about the need for prudence, the protection of 
Social 
Security and Medicare, uncertainty about projections.
    But as you are aware, last week on Thursday, the 
Congressional Budget Office issued their estimate as to what 
had happened to the 10-year projection of spending between 
August and January.
    And in that 6-month period, they concluded that Congress 
and the President had added $561 billion to the new projected 
10-year spending.
    Do you find that alarming?
    Chairman Greenspan. I do, Mr. Chairman, as indeed I 
indicated in the Senate Budget Committee hearing because while 
I have raised issues with respect to prudence in accumulating 
private assets in Federal Government accounts and, hence, to 
the need to be careful about creating very substantial 
surpluses after the debt has been eliminated, I indicated that 
we could very readily fall back into a very heavy set of 
deficits if all of the prudence which had been built up with 
great difficulty over the last decade or so, I must say, and 
with very considerable success, is dissipated.
    Chairman Gramm. Obviously, if we did the same thing in the 
next 12 months we did in the last 6 months, we would have spent 
the entire Bush tax cut.
    So it is fair to say that you are alarmed about the decline 
in fiscal discipline on the spending side.
    Chairman Greenspan. I said so in my prepared remarks before 
the Budget Committee and reiterated them during the question 
and answer period.
    Chairman Gramm. Let me ask another question.
    Continually, the point is made--in questioning the ability 
of the tax cut to stimulate the economy--that because the tax 
cut is phased in we wouldn't be putting much money into 
people's pockets immediately, even if the child exemption and 
rate cuts were retroactive.
    But it seems to me that what is missed in this analysis is 
an understanding that consumers are rational.
    You have talked now for several years about a wealth effect 
coming from the stock market. But the reality is that wealth 
effect is largely in IRA's, 401(k)'s, and mutual funds that 
people are not going to touch until they retire 20 and 30 years 
from now.
    Yet, each quarter, as people have gotten those statements--
I know because it is happened to me--each quarter, they have 
looked at those numbers and said, my God, I am much richer than 
I thought I was.
    And as a result, they responded to it.
    So is it not true that, just as if you and I have the same 
income and we are young workers, but you know that you are 
going to inherit $100 million and I know I am going to inherit 
nothing, based on rational expectations, with the same income, 
we have greatly different spending patterns?
    Is it not true that if you implement a tax cut, even if 
they don't have the money yet, we can expect people to respond 
to that in their behavior, both as consumers, investors, 
savers, et cetera?
    Chairman Greenspan. Mr. Chairman, I would suspect that that 
is in fact the case, though I am not aware of what the evidence 
is with respect to how predominant that particular phenomenon 
is.
    I do know it exists on the corporate side, where you get 
capital appropriations moving in advance of the enactment or 
the implementation of a tax cut because merely knowing what the 
schedule of rates of return are going to be after tax has a 
significant impact on what one does with respect to deciding to 
invest or not.
    I don't know of any particular studies, though they may 
very well exist, on the issue of how individuals respond in 
contemplation of a tax cut.
    Chairman Gramm. But you do believe, based on what you have 
observed in the last few years, that the run-up in equity 
values----
    Chairman Greenspan. Well, there is no question that that is 
indeed the case.
    Chairman Gramm [continuing]. Has clearly had an impact on 
consumption.
    Chairman Greenspan. But the run-up in equity values in real 
time actually produced a value which the individuals could see 
at that particular point and knew that they owned. And I am not 
sure how one necessarily translates that into expectations of 
particular tax cuts. But, obviously, when they are in place, 
and one contemplates their actual availability, I have no 
question that what you are saying is accurate.
    Chairman Gramm. One final question, and then I will move to 
my colleagues.
    You have not changed your position that, if we are going to 
do a tax cut, the most effective tax cut is an across-the-board 
cut, where the poorest worker and the richest worker all get a 
tax cut?
    Chairman Greenspan. Mr. Chairman, let me separate an issue 
here. In the Budget Committee hearings I indicated that I did 
not want, nor should I take a position on, any specific tax 
cut. And I am not and have not.
    It is certainly the case, as I have answered before this 
Committee in the past, that I think from the point of view of 
economic efficiency, recognizing there were other reasons to 
change taxes, that marginal tax rate reductions have always in 
my mind been the most effective way to enhance economic 
activity. But I was not in the Senate Budget Committee actually 
responding to a question which related to any particular tax 
recommendations that were currently in play.
    Chairman Gramm. Senator Sarbanes.
    Senator Sarbanes. Thank you very much, Mr. Chairman.
    Mr. Chairman, first I would like to have included in the 
Committee record the article by Robert Rubin that appeared in 
Sunday's New York Times, entitled, ``A Prosperity Easy To 
Destroy,'' and the first paragraph of which reads: I had not 
intended to get involved in the public debate on fiscal policy 
at this point. But I feel so strongly that a tax cut of the 
magnitude proposed is a serious error in economic policy that I 
felt a need to speak.
    And then goes on, I think, with a very penetrating analysis 
of this issue, and I commend this article to my colleagues.
    I think Rubin, more than any single person, is the one who 
helped to bring about fiscal discipline and bears a good deal 
of the credit for the prosperity that we have enjoyed during 
his tenure as the Secretary of the Treasury.
    Chairman Greenspan. I agree with that, Senator.
    Senator Sarbanes. Thank you. Chairman Greenspan.
    Second, I would like to quote from an article in Newsweek 
by their Wall Street editor, Alan Sloane, and I am just going 
to quote from it for a moment.
    A pie-in-the-sky policy. It is folly to slash taxes based 
on rosy budget projections that are certain to be wrong, why 
tax-cut fever needs to chill.
    And then he goes on to say--there are times when even the 
born contrarians among us wonder if we have taken leave of our 
senses or if the rest of the world has, which is how I feel 
about the bum's rush for getting to make huge tax right now 
based on iffy long-term budget projections, an economic 
slowdown and the supposed imprimatur of Federal Reserve Board 
Chairman Alan Greenspan.
    What is the hurry? Why not wait a while and see how the 
economy plays out?
    Treating long-term projections like they are facts is 
folly. For heaven's sakes, even the great Greenspan screwed up 
a short-term forecast last fall by not seeing that the economy 
was softening.
    That mistake is why he's cutting interest rates so sharply, 
an economic cardiologist trying to keep his patient from 
croaking.
    So answer me this.
    If the plugged-in, experienced Greenspan could not forecast 
the economy 4 months ahead, how can anyone think the 
Congressional Budget Office, or anyone, can foresee the economy 
10 years ahead? Especially when the CBO, whose surplus 
projections are the heart of Bush's tax-cut case, regularly 
devotes an entire chapter in its report to the uncertainty of 
budget projections?
    History makes my case for me.
    Until a few years ago, experts predicted huge deficits as 
far as the eye could see. Now they predict huge surpluses.
    A year ago, the CBO projected a $3.1 trillion, 10-year 
surplus. Six months ago, $4.6 trillion. Last month, $5.6 
trillion.
    Why should we treat today's numbers as right when 
yesterday's was so wrong?
    I think Senator Dodd stated this tax cut well. I think most 
Members of the Congress are open to doing some tax-cutting. But 
the question is, in what magnitude, and how is it distributed, 
which are obviously very, very basic questions.
    This tax cut now that the President has proposed, if you 
count in the interest cost of it, and the necessity to adjust 
the alternative minimum tax, is going to cost over $2 trillion.
    And of course, people want to add on to it, of course.
    Some of the leadership up here has said it should be even 
larger. All the interest groups are mobilizing.
    I used taking the cover off the punchbowl. I probably 
should have said, the maitre'd allowing the crowd to get at the 
buffet table because they all want to grab a piece of what is 
on the buffet table.
    So we are now talking of well in excess of $2 trillion.
    Now the Chairman asked you a question about $560 billion in 
spending.
    Chairman Gramm. In 6 months.
    Senator Sarbanes. I would like to ask you, don't you find a 
tax cut of well over $2 trillion and building all the time, do 
you find that alarming?
    Chairman Greenspan. As I said earlier, I am not going to 
comment on anybodys particular tax cut or structure of it. But 
let me just read the last paragraph of my Budget Committee 
testimony, which really relates to this issue. It said:

    But let me end on a cautionary note. With today's euphoria 
surrounding the surpluses, it is not difficult to imagine the 
hard-earned fiscal restraint developed in recent years rapidly 
dissipating. We need to resist those policies that could 
readily resurrect the deficits of the past and the fiscal 
imbalances that followed in their wake.

    I tried to stay with that position in my last testimony and 
trust I can maintain it today as well. I want to reemphasize as 
I did at the Budget Committee that I am speaking for myself on 
fiscal matters, except when these are cleared in detail with 
the Federal Open Market Committee. And the only thing that has 
been cleared are my monetary policy comments. So in all 
questions I have with respect to fiscal policy, I am on my own. 
I don't want to commit others. And even having said that, there 
is a very significant limit to which I think I ought to be 
engaged in.
    Senator Sarbanes. Do you think it is possible for the 
Chairman of the Federal Reserve, particularly one that has 
assumed kind of legendary dimensions now, to come in and make a 
statement and say, this is me as an individual?
    Chairman Greenspan. Yes, it is.
    Senator Sarbanes. If you weren't Chairman of the Fed and 
coming in as an individual, I don't know how much weight your 
comments would carry.
    But you come before us, you say--well, I am giving this as 
an individual. But I look at you and I see you as Alan 
Greenspan, an individual. But I also see you as the Chairman of 
the Federal Reserve and a distinguished Chairman of the Federal 
Reserve, who has held that position now for a great number of 
years. And obviously, your comments are going to be seized upon 
and interpreted.
    Someone said to me, well, maybe Alan Greenspan did not 
fully appreciate what the press would do with his comments.
    I said, you have to be kidding. Alan Greenspan is a very 
wily, experienced Washington hand and he obviously could 
anticipate what would be done with his comments, despite all 
the qualifiers and modifications and caveats that were in your 
statement.
    Chairman Greenspan. Senator, let me just say that I fully 
understand what you are saying and I don't disagree with it. 
But I do want to make the point because I think it is in all 
fairness that I am not speaking for a number of the people in 
the Federal Open Market Committee. I frankly do not know where 
they stand. But it is important for us to do that. Indeed, it 
is important for all of us to indicate when we are speaking for 
the Committee and when we are not.
    All of the members of the FOMC go out and make speeches and 
give their own views on a number of different issues. But they 
invariably say, ``I am speaking for myself.'' That is the only 
point I wish to make. I hope I succeed. If I failed, that is 
for you to judge.
    Chairman Gramm. Well, I think more people know Greenspan 
than know the Federal Reserve Board.
    So speaking for yourself does carry some weight.
    Senator Bennett.
    Senator Bennett. Thank you, Mr. Chairman.
    In my opening comment, I wanted to talk about confidence 
and I think the Chairman in his prepared remarks talked about 
the importance of confidence and why we can indeed have some 
confidence that even in this time of slowdown, the economy is 
not going into the tank. Therefore, it is clear we are going to 
turn 
this into a debate about taxes, and I cannot resist getting 
into the 
debate.
    Let me respond briefly to the article quoted where he said 
the projections are certain to be wrong.
    I will stipulate that they will be wrong. They always have 
been. They always will be. And there is no possible way of 
changing that.
    If I may be personal for just a moment, I made my mark in 
business with a reputation of being a good forecaster. And I 
could forecast what was going to happen in my business in my 
market with my customers with some certainty for about 3 months 
out.
    I was really good if I could get 6 months and, boy, if I 
hit it right for a year, I was a genuine hero. To forecast an 
$8-, $9-, $10-, 
$12-trillion economy 10 years in advance is beyond anybody's 
capability.
    But the point I think we have to recognize here is that 
just because I could not forecast accurately did not mean I did 
not have to make a decision.
    It did not mean I did not have to take a risk. It did not 
mean I did not have to lay out a strategic direction for the 
company that I headed with the best information that I had. And 
we as policymakers are faced with exactly the same challenge. 
Just because we know these forecasts are not going to be 
exactly right doesn't mean we must be paralyzed before our 
inability to make firm decisions.
    And the projections are certain to be wrong. They could be 
too high. They could be way too low.
    The Budget Committee has said that the surplus could be as 
high as $9 trillion, not $5.6. Or it could be as low as $1 
trillion.
    And tough as it is for a businessman to be facing his 
shareholders and bet the company on what is going to work or 
what is not, it is even worse if the businessman says, since I 
cannot know with certainty, I won't decide. I won't make any 
choice. And that is a guaranteed way to fly the company right 
into the sea.
    I think we have a responsibility here, given the likelihood 
of very substantial surpluses, to face the question of what is 
going to happen to that money.
    And I think Chairman Gramm has said, if we do not move 
ahead with the tax cut, the money is going to be spent by the 
government and we will see fiscal restraint disappear. And we 
have seen it disappear over the last 6 months, and I have been 
part of it, as one of the appropriators. I have seen it happen 
in the Appropriations Committee, and the stampede to spend was 
almost irresistible.
    Mr. Chairman, I would like your reaction to this. I think 
you are saying that a prudent thing for us to do would be to 
deal with that stampede to spend by returning some of the money 
to the source from whence it came. We can always go back to 
that source if we need the money and say, we made a mistake and 
we need to make a mid-course correction.
    We have had two major tax cuts with President Kennedy and 
President Reagan. And in that same period of time, we have had, 
what, 8, 9, 10 major tax increases, one of them under President 
Clinton.
    We have demonstrated as a Congress, we know how to raise 
taxes. We know how to raise taxes better than we know how to 
cut them.
    So aren't you saying----
    Chairman Gramm. Senator Bennett, the Democrats are 
disagreeing. They are saying they know how to raise them better 
than you do.
    [Laughter.]
    You had better put a caveat in there.
    [Laughter.]
    Senator Bennett. We won't get into that.
    Chairman Gramm. They are all yelling at me over here and 
saying, we, we, we.
    Senator Bennett. I will hear the heckling from the crowd 
and step down from my soapbox.
    Would you comment on that dichotomy of what happens to the 
surplus on the assumption from the very best sources we have 
that there will be a very significant one, and what it is we 
should be doing?
    Chairman Greenspan. Well, Senator, let me expand on some of 
the notions that you have put forth, which I think are really 
quite crucial to economic policy, specifically fiscal policy, 
and that is the fact that over the years, we have developed a 
budgetary process which requires us to make judgments of the 
future.
    I remember 30, 40 years ago when the so-called 
uncontrollables or entitlements were really very low. And the 
major problem that the budget process confronted was the spin-
out of various different military procurement items which often 
lasted 2 or 3 years. But it was extraordinarily rarely the case 
that what the economy was doing 3 or 4 years out was wholly 
relevant to the budget process.
    That has dramatically changed in recent years in which we 
are making judgments which have implications 10, 20 years out, 
and unless we are aware of what they are and try to handle 
them, we are setting up a projection of fiscal policy which 
could very readily go awry.
    I was particularly impressed with the implications of what 
would happen, not 10 years from now, but as early, under the 
current services budget, as 2006. Because in 2006, if indeed 
the current services budget functions as a projection of what 
is going on in the real world--and it is one of the best 
estimates we could make--fully granting the very wide range of 
error--then we run out of Federal debt to pay down. And we end 
up with a situation which, if you take their numbers literally, 
is we are in the year 2006 with a unified budget surplus of 
about $500 billion, or thereabouts.
    If--and I underline the word if--you believe as I do that 
it is not a good idea to have private assets accumulated in 
Federal Government accounts, then the problem arises that, as 
of that particular point, if you wait to address it, you have 
to reduce the surplus by half a trillion dollars. And we may at 
that particular point be in a significant upswing in economic 
activity and confronted with the need to create a huge stimulus 
to the economy which could very readily destabilize the system.
    It is those data which led me to conclude that the issue is 
not one that we can readily wait for a year or two to decide 
how one handles that. That does not mean that one needs to act 
today. But I would suggest to you that the Congress needs to 
think about this issue well in advance of the events that are 
materializing. And if we are to address what is really an 
extraordinary event--no one would have even credibly believed 5 
or 7 years ago that we would be at a point when we were running 
out of U.S. Treasury securities to buy back or to pay back on. 
We are ever more credibly moving in that direction.
    And the basic issue that I wished to put on the table in 
the Budget Committee hearing was to recognize that this is 
something new and it requires a wholly new set of views as to 
how fiscal policy is run. And the sooner it is addressed, the 
better. Waiting for 1 or 2 years I think is a mistake. That 
doesn't mean we need to do something right away with respect to 
it. But I do think that that issue has got to be addressed. It 
has very profound implications for the rest of this decade and 
into the next decade.
    And as you point out, we really have no choice but to make 
a forecast because not making a forecast is effectively trying 
to duck an issue for which we are making very major 
commitments. And implicit in any action that the Congress takes 
is a forecast. The only question is with all of its weaknesses, 
is it the best forecast that can be made? Or is it suboptimal, 
leading to suboptimal policy? And I would argue it is important 
that, as difficult as it is to forecast, we have no choice, as 
you point out, and we should do the best that we can.
    Senator Bennett. Thank you, Mr. Chairman.
    Chairman Gramm. Senator Miller.
    Senator Miller. Mr. Chairman, you have already answered and 
commented on most of the questions that I had. I would like to 
ask my question, though in a somewhat different way.
    It seems that all of us around this table are talking about 
fiscal restraint. We are all for fiscal restraint.
    But it seems to me like the definition of fiscal restraint 
is sort of like pornography--it is in the eye of the beholder.
    Some around this table see fiscal restraint as not cutting 
taxes too much. Others see fiscal restraint as not spending too 
much.
    And the fact of the matter is that if we have the last 4 
years to look at, Congress and the President both used various 
tactics--namely, advanced appropriations and obligations, 
payment delays and emergency designations and specific 
legislative direction, to significantly boost discretionary 
spending, while at the same time remaining statutorily 
compliant with the spending caps enacted by the Budget 
Enforcement Act of 1990.
    If we go over what we have done the last 4 years in 
discretionary spending--in other words, if the current trend in 
discretionary spending were to continue into the future, would 
this not cause significant budgetary problems?
    Chairman Greenspan. Well, that is an arithmetical question, 
Senator, and I think it is more of, if I may put it that way, a 
rhetorical question, because, obviously, if you take the 
numbers which were appropriated in the last two fiscal years, 
and you add them, then the concerns that I have about running a 
unified budget surplus, accumulating private assets in Federal 
Government accounts, is mispositioned, if I may put it that 
way.
    Senator Miller. Thank you.
    Chairman Gramm. Thank you, Senator Miller.
    Senator Ensign.
    Senator Ensign. Thank you, Mr. Chairman.
    Actually, I have several questions. I find it interesting, 
though, on some of your comments, I saw a movie recently called 
``Finding Forrester.'' It reminds me a little bit about when he 
wrote the book way in the past and then all of the people in 
the future tried to discern what he really meant when he said.
    And that seems to be what your comments always are. People 
try to discern what your comments truly meant when you said 
whatever you said.
    I always get a kick out of reading what people will say in 
tomorrow's papers about what you said today.
    I want to go to one question and it has to do with what 
Senator Miller talked about, about the way we all look at 
fiscal discipline.
    I thought that was very insightful. And it leads into one 
question that I had.
    Some have talked about triggers for, if we do have a tax 
cut now, that there would be some kind of trigger mechanism.
    When I was on the Ways and Means Committee, it seems to me 
that some of the trigger mechanisms that were talked about over 
there, some of them were destabilizing trigger mechanisms. And 
I would like you to address that.
    But also, the possibility of, if we are going to have 
trigger mechanisms on tax cuts, would trigger mechanisms on 
spending cuts also be in order?
    Chairman Greenspan. You know, it might not be a bad idea, 
Senator, if I answered your question by in fact reading what I 
actually said on this issue in the Budget Committee, which 
addresses specifically your question:

    In recognition of the uncertainties in the economic and 
budget outlook, it is important that any long-term tax plan or 
spending initiative for that matter, be phased in. Conceivably, 
it could include provisions that in some way would limit 
surplus-reducing actions if specified targets for the budget 
surplus and Federal debt were not satisfied.

    Now, what I am obviously referring to is the desirability 
of eliminating the Federal debt, which is still frankly, my 
first priority because I think that it has had an 
extraordinarily important impact on the economy, on the 
financial markets, on long-term interest rates, and on economic 
growth. The change that has occurred is we are running out of 
debt to retire. And if that is indeed the case, then 
priorities, of necessity, must shift. But if it is not going to 
be happening, then we shouldn't be shifting priorities.
    In effect, the terminology which I employed is essentially 
one which tries to look at, say, the net debt of the U.S. 
Government to the public, which is actually the unified public 
debt plus a few other accrual items minus tax and loan account 
deposits of the Treasury, the deposits at the Federal Reserve, 
and a number of other types of financial assets. That is the 
number we are trying to bring down effectively to absolute 
minimums.
    If there were a trigger which were built into both tax and 
spending programs, to the extent that they were phased, it 
ensures that we achieve what I think should be the first 
priority--namely, to eliminate the debt.
    Senator Ensign. Getting to your whole idea about the U.S. 
Government owning private assets, in the future, we have all of 

these various trust funds that we have as debt into the future 
generations.
    When we are looking--obviously, not the subject of the 
hearing today, but just something to think about for the future 
for us when we are talking about especially the biggest 
liability that we will have on our books will be Social 
Security.
    If in fact we don't want to have the money set aside and 
earning interest some place in some kind of Federal accounts, 
would that not then argue, if it is a bad idea for the Federal 
Government to own those assets, would it not be a good idea for 
individuals, private accounts, similar to the Thrift Savings 
Plan that Federal 
employees have, wouldn't that be, to make sure that we have 
those, we don't keep building up these huge debts because a 
debt 
is a debt, regardless--as long as it is a future obligation, it 
is 
still a debt.
    Would that not be a way to handle that?
    Chairman Greenspan. One of the reasons why I thought it is 
important to put this issue on the table is not strictly the 
immediate impacts that it has with respect to policy relevant 
to spending and receipts. But it also has some very profound 
implications depending on the way the Congress comes out, on 
such things as trust funds within the Federal Government. And 
it is fairly evident to me at least that we have been able, as 
a number of people have argued, when we have defined 
contribution plans, to have them in the government. Indeed, I 
have a piece of it in the sense of the thrift investment 
accounts that the Federal Reserve employees have.
    But I see what I own every month. And as a consequence of 
that, it would be almost impossible as far as I could see for 
there to be political maneuvering to get that fund to invest in 
some Congressman's or Senator's State where a company is in 
difficulty and they are seeking some form of support.
    I would suspect if that were the case and the company's 
name appeared on the form, there would be an awful lot of very 
negative comments. And I think that is the reason why we have 
been able to maintain the defined contribution plans 
effectively in place.
    If the Social Security trust fund or, more exactly, if 
Social Security were a defined contribution program, you could 
build up assets in the trust fund, private assets, without the 
political problems that I foresee would occur if that is not 
the case. But I might add, parenthetically, if you are going to 
do that, then the question of why not put it in the private 
sector obviously immediately emerges.
    The real difficulty arises when you have defined benefit 
obligations of the Federal Government in which they are 
guaranteed annuities to various individuals in our society 
whose availability is wholly independent of what assets are 
held in the trust fund. It is an unequivocal guarantee of the 
Federal Government. Social Security benefits do not depend on 
what the rate of return on that fund is. They are irrevocable 
obligations as far as I can judge, even though, legally, one 
can argue they are not. But I perceive of no credible 
possibility that they are not. If that is the case, then the 
question arises as to the assets that are built up in these 
funds indeed being subject to political manipulation.
    I indicated in my Senate testimony I saw very little 
possibility that we would be able to avoid fully the 
accumulation of private assets and hoped that they would be put 
in a fund in a manner in which, because the fund would 
ultimately reverse, it is not an irrevocable, long-term 
commitment. But the ideal would be to find ways to delimit the 
political exposure that I think private assets held by the 
Federal Government would create. And it is a major issue which 
I think that the Congress has got to address.
    I will say to you, you may agree or disagree that it is 
desirable to have private assets in Federal Government 
accounts. But I don't see how the issue can be avoided. If we 
are effectively going toward zero debt, there is no alternative 
with a unified budget surplus and effectively zero debt, to 
accumulating private assets, claims against the private sector. 
I said in the Budget Committee, I view budget deficits as a 
preemption of private capital and, hence, an undercutting of 
economic growth in a quite similar manner, although I grant it 
is not exactly the same as having claims on private assets in 
the Federal Government which are subject to political decisions 
as distinct from private market economic ones.
    Senator Ensign. Thank you, Mr. Chairman.
    Chairman Gramm. Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman.
    I have really two areas of questions that I would like to 
follow up with this discussion on investments.
    I think the whole debate about whether we have an 
irrevocable obligation in Social Security is a very profound 
debate that has to be addressed in the context of the 
demographic changes that are going to occur over the next few 
years.
    But cannot we eliminate some of that political exposure by 
investing in index funds and things that potentially would 
allow for a continuation of defined benefit effort, not unlike 
what we see in State pension funds and other methods around the 
country?
    Chairman Greenspan. Senator, I think it helps in part.
    But you have to be careful with index funds because, for 
example, you are dealing with to a very large extent, and 
almost of necessity, publicly traded securities. Even if you go 
from, say, the S&P 500 all the way to the Wilshire 5000, you 
are picking up publicly traded securities and essentially 
discriminating against those business investments which are not 
publicly traded.
    And so, while I would certainly grant you that it is far 
more difficult to manipulate in any way an indexed fund, the 
misallocation of capital that I think occurs as a consequence 
of that is something that would be very wise for us to try to 
avoid. If the numbers were small, obviously, it is not an 
issue. But we are not talking about small numbers. We are 
talking about extraordinarily large numbers--multitrillion 
dollars of accumulation. And having been in Washington on and 
off since the late 1960's, I have seen too many potential 
occasions where the political pressures to use governmental 
funds is virtually overwhelming.
    So I think it is worthwhile having a discussion to see 
whether in fact one can credibly insulate the markets from 
political manipulation. My own impression is that, at the end 
of the day, you will fail. That is, the pressures become 
overwhelming, at least in my judgment.
    Senator Corzine. My fear is that that would change the 
basic nature of Social Security in that irrevocable obligation, 
I think is the term you used.
    Let me ask, with regard to the Social Security trust funds 
and others, which I think really tie into this purchase of, 
buy-down of publicly-held debt, it strikes me that, like 
Senator Bennett, it is hard to predict how all this world is 
going to work.
    But it looks like out just beyond that 10-year cliff, we 
are going to have demands on the Social Security trust fund and 
Medicare trust fund that are going to put us back in the red.
    Again, making predictions 10 years out is pretty hard. But 
making them out 15--we can look at the demographics and we are 
going to see major changes.
    It seems to me we are letting sort of the tail wag the dog 
a little bit about this short-term intermediate period when we 
have an obvious major fiscal demand coming down the pike that 
everyone generally recognizes.
    And it seems to me that we ought to be very cautious about 
how we handle the intermediate fiscal period. And shouldn't we 
go slow at that, both whether it is through expenditures or on 
tax cuts?
    Chairman Greenspan. Senator, I think that with the change 
in the underlying productivity projections, a significant 
alteration in the post-2011 outlook occurs. If you take some of 
the implications of the CBO numbers and, indeed, what I suspect 
is going to be the Social Security trustees' report when it 
comes out in March, we are going to find that we get into the 
year 2011 when the baby boomers just start to come on, we will 
see two things.
    We will see, as you point out quite correctly, a very 
marked increase in the total number of retirees and a very 
substantial rise in benefits. But we start 2011 with a very 
large Social Security surplus, and the level of the assets in 
the Social Security trust fund at that point engenders a rate 
of interest which is quite substantial. And even though the 
actual receipts don't go up, the extensive rise in benefits is 
significantly offset by the rise in interest. So, the net 
increase in Social Security assets continues to rise in many 
different ways certainly through 2020 and beyond--which means, 
in effect, that we do not have in that context, if you believe 
the numbers, a Social Security deficit and therefore, not 
necessarily a unified budget deficit in that forecast.
    But I grant you, when you get out that far, it is a very 
loose set of circumstances. But the presumption that we all had 
that it was going to be inevitable when we started to get into 
the baby boom retirees, that we were going to run into a very 
significant financing problem, which I think was the most 
credible forecast even 6 months ago, is subject to question.
    I think that it all rests on what one perceives as the 
appropriate productivity rate of change, the type of 
technologies that we are going to have. And relatively small 
changes in that, as you well know, have very marked effects.
    So I would say, rather than indicate that this is an 
inevitable problem, as my good friend Alice Rivlin raised, I 
think it is now subject to significant question. It may at the 
end of the day turn out that, indeed, that is not precisely as 
you characterized it. But I do think that what we are learning 
with these changing productivity numbers is a major alteration; 
how we view our future, how we view Social Security, how we 
view our fiscal affairs, have to be readdressed in this 
context.
    The Congress is going to have to make very key judgments. 
And ultimately, there is no one else but the Congress to 
basically make those judgments. As difficult as they are and as 
prone to error as Senator Bennett has said, which I agree, we 
have no choice but to make these judgments. And implicit in a 
judgment is a forecast.
    Chairman Gramm. Senator Hagel.
    Senator Hagel. Thank you, Mr. Chairman.
    Chairman Greenspan, you alluded briefly in your testimony 
to the global economy.
    In your opinion, how captive is the continued, the 
sustained economic growth of this economy tied to the dynamics 
of the global economy?
    Chairman Greenspan. Well, Senator, there is just no 
question that one of the characteristics--I should say, one of 
the fallouts from the remarkable changes in information 
technology has been a very dramatic globalization of finance. 
And that in turn has created a very substantial integration of 
the economies of the United States, Europe, and Far East in 
ways that had never been perceived before. So we are all 
interrelated with one another. And to the extent that there is 
general weakness abroad, it does impact us. To the extent that 
we are in a weak state, it affects them. And there is a general 
interaction.
    So I do think that the extent of globalization which has 
proceeded in the last 10 or 15 years has essentially made a 
world economy a realistic notion. Senator Corzine was a big 
player in that before he, I think, demoted himself to the 
Senate of the United States.
    Senator Hagel. That is when he had a real job.
    [Laughter.]
    You know, Mr. Chairman, that we are going to be faced with 
a number of decisions here in this year regarding trade 
relationships.
    Any thoughts on, as we embark on that debate, that surely 
will be stimulating, on the trade issue and connecting that to 
your comments regarding the global economy?
    Chairman Greenspan. Senator, I think that one of the very 
few things that American, indeed, European and most Asian 
economists, agree on is that open markets and free trade 
enhance the standard of living of all participants. One can 
look at the really quite extraordinary rise in trade as a 
percent of GDP in the world which necessarily implies that, on 
average, the proportion of imports to domestic demand is rising 
all over the world. And I think we all see that as a process 
which has been a major factor in enhancing standards of living 
most everywhere. And increasing evidence demonstrates that 
those economies which open themselves up to competition 
prosper, those that do not fail.
    Senator Hagel. Thank you. I know you prefer not to get drug 
back into this tax cut swamp, but let me see if I can broaden 
this a bit.
    Your testimony today, as it was before the Budget Committee 
a couple of weeks ago, was very complete with the balanced 
approach of how we continue to grow and sustain this growth, 
anchored by productivity.
    The commitments that we are continuing to take on and those 
commitments will grow. The prescription drug benefit plan will 
most likely be incorporated into Medicare.
    As you add in responsible monetary fiscal policy, control 
of spending, do you see a place for significant tax cuts as 
part of that effort to sustain the kind of growth that we are 
going to have to sustain to make good on the commitments for 
these out-years for the programs that we have committed our 
country to?
    Chairman Greenspan. Senator, my focus on tax cuts as such 
in the Budget Committee discussion was related to the issue of 
returning monies to taxpayers because the alternative was to 
employ them as private assets held in Federal Government 
accounts.
    I was not addressing the issue of the economic 
effectiveness of tax cuts in promoting productivity and the 
like. There is a long discussion which one can have with 
respect to that, but I was not raising that as a reason for 
cutting taxes. I was basically indicating that the alternative 
of collecting the revenues and then employing them as claims 
against the private sector struck me as not something which is 
desirable if economic efficiency in this country is our goal.
    Senator Hagel. Thank you.
    Mr. Chairman, thank you.
    Chairman Gramm. Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman. Once again, we 
appreciate your being here today with us.
    If I might just talk more about the tax policies that you 
were suggesting in terms of a trigger so that we continue to 
reduce our debt to the lowest possible effective Federal debt.
    And in speaking about a trigger, I notice that you also 
spoke about phasing in paying down the debt and an effective 
trigger for the point at which we are phasing that in and 
making sure that we are not going back into debt at some later 
point.
    But I wonder if you could speak to the policy that some 
have suggested that we make the tax cut proposed by the 
Administration retroactive to the beginning of this year, and 
whether or not that was the type of phase-in that you were 
referring to.
    Chairman Greenspan. Senator, the only purpose of the phase-
in in the context of my testimony was to avoid doing nothing 
and then finding ourselves in, say, 2005 with the necessity of 
a huge reduction in a unified budget surplus, which could occur 
at a time when it would be wholly inappropriate to have a very 
large fiscal stimulus, especially of the size, the order of 
magnitude that we are talking about.
    So my notion about phasing in was to start taking actions 
now to endeavor to avoid having to act very abruptly in 3 or 4 
years from now. But in order to make certain that it was not 
actions which prevented the reduction in the debt from 
occurring, make them contingent. That is the full nature of my 
argument and my concerns.
    How that is done or by whatever means is not something 
which I think I have any particular knowledge of or expertise 
in. But I do know that from an economic policy point of view, 
if the decision is made not to accumulate very large amounts of 
private assets, then that issue of phase-in is crucial.
    Senator Stabenow. Would you want to speak directly to the 
notion of retroactive tax cuts?
    Chairman Greenspan. I think I answered that in the Senate 
Budget Committee. It is not an issue which I have views of 
strongly or otherwise. I did say in the Budget Committee that 
it is most unlikely that if we go through a regular recession, 
that any tax cut can be enacted sufficiently quickly to alter 
the probability of whether we will indeed find ourselves in a 
recession.
    But I also pointed out that in the event--and it is a low-
probability event--that we not only go into a recession, but 
stay there for an extended period of time, then it is better to 
have had lower taxes than otherwise. In short, it would be 
insurance against a low probability event which indeed is what 
insurance is essentially about. But the issue of retroactivity 
doesn't really phase into that period, as best I can see it.
    Senator Stabenow. Mr. Chairman, you spoke of 2006 as the 
point in which your estimation, we will have reached the 
effective----
    Chairman Greenspan. I am sorry. This is the estimation of 
both OMB and CBO.
    Senator Stabenow. Yes. Absolutely. And I have the CBO 
report with me now as we look at what we expect at that point 
in terms of that.
    And you were indicating in your testimony about $500 
billion that you believed would be available at that time.
    I am wondering if in fact that is the range that you 
believe that we have in which to look at tax cuts or spending 
or other policies of this Congress, if that number of $500 
billion was stated in that context?
    Chairman Greenspan. Senator, these are not my estimates. 
For example, CBO's baseline budget projection for the fiscal 
year 2006 is $505 billion. The number can be higher. It can be 
lower. The point that I think is important is that, unless you 
have productivity growth very significantly below what both the 
previous administration's OMB or currently CBO is using, you 
are going to get a number of that order of magnitude.
    Senator Stabenow. My reason for raising that is it is my 
understanding from your testimony that you are not retracting 
your feeling about paying down the national debt. You believe 
that we will pay it down sooner than originally anticipated--
2006 being the number.
    And that the question is, what will be available after that 
point? And what policies should we enact addressing that 
accumulation of surpluses?
    And I heard you indicate, as was done with CBO, that we 
have about $500 billion.
    I am assuming not to put us back into debt, that you would 
be suggesting that we look at that number in terms of the 
flexibility of our decisionmaking.
    Chairman Greenspan. Well, remember that $500 billion is for 
1 year only, and that the notion of a current services budget 
is not what is legally available to the Congress to 
appropriate. That number is actually a larger number.
    Senator Stabenow. I understand.
    Chairman Greenspan. In other words, at this particular 
point, you have discretionary spending which, by definition, 
means that the Congress has got to enact a law to instigate it. 
But because there is a general presumption that these types of 
outlays will continuously be forthcoming--you are not going to 
cut the Defense Department down. You are not going to cut the 
Postal Service--not the Postal Service. That is the wrong 
example.
    [Laughter.]
    Because they are part of the off-budget problem. But you 
cannot cut down a number of things. And so, we make a general 
judgment as to what these numbers are likely to be. And it 
gives you what is generally called the current services budget, 
which is what is available if you make the assumption that 
discretionary spending is going to rise at, say, the rate of 
inflation or the rate of population, and the entitlement 
programs are essentially continued.
    That is what is available to either cut taxes or institute 
new programs. And what these numbers are is basically the 
starting point. A lot of people have argued, well, you know, 
there are so many different commitments. We are not going to 
get to these budget surpluses. And the answer is very likely we 
are not because they will be partly reduced by tax cuts and/or 
spending increases.
    But in order to get a framework to know where to start and 
how to allocate various funds, there is really no alternative 
but to do something such as CBO has done or OMB does. We have 
long-term commitments. We have to meet them. We have to make 
rational judgments as best we can, with all of the errors that 
are involved. But the process which CBO and OMB have developed 
I think is by far the most sensible way of going at it.
    Senator Stabenow. I realize I am out of time, Mr. Chairman 
I would just hope that Chairman Greenspan, before you leave 
today, that you will reiterate those policies as you say in 
your last paragraph of your Budget Committee testimony, that we 
need to resist those policies that could readily resurrect the 
deficits of the past.
    And I hope you will take the opportunity today to speak 
again about what those policies are for us.
    Chairman Greenspan. If I could just say very quickly, it is 
not any individual policies. It is the sum of a lot of policies 
which lead in that direction.
    Chairman Gramm. Senators, let me say that I am going to 
leave Senator Allard in charge here. I am going to recognize 
Senator Shelby. And then we will just run down the list until 
we run out of people.
    If at any point, Mr. Chairman, you want to take a break for 
a moment, if you will let Senator Allard know.
    Senator Shelby.

         OPENING STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you.
    Mr. Chairman, a lot of people seem to be a little hesitant 
regarding the economy as a whole. And I know it depends on how 
they are looking at it.
    But consumer confidence is very important.
    Is it time to hunker down--I believe that was the phrase 
that was used earlier. Or is it a time to be a little cautious? 
Or is it time to be bullish? Or what?
    Because what you say today and how you say it, as you well 
know, is going to be interpreted many, many ways. And people 
are looking for everything in the world out of your utterances.
    What would you say to the American consumer looking at the 
economy today, seeing lay-offs here, lay-offs here. And not in 
every sector but in some.
    Chairman Greenspan. Senator, I think that it is always 
important to first start with what is the longer-term outlook.
    Senator Shelby. Absolutely.
    Chairman Greenspan. And the longer-term outlook, as I have 
reiterated many times, in my judgment, is undiminished in the 
sense that by any measure that I can see, we are only partway 
through one of the most remarkable periods of technological 
advance which is crucial to productivity growth and, indeed, to 
all of the deliberations we are having with respect to the 
budget. It really gets back to that question.
    What tends to happen, however, is that while the 
technologies change and create an accelerating environment for 
economic activity, as I point out in my prepared remarks we 
human beings react in a somewhat negative way to change when it 
occurs in a pronounced way.
    And so, it is perfectly credible to find, for example, as I 
think we see today, that there are a number of business people 
who fully perceive the longer-term profitability of these new 
high-tech investments as pretty much fairly accurate and 
achievable. But they are concerned about the uncertainty and 
they develop concerns about the immediate future. And even 
though they perceive the future in a very positive way, they 
tend to pull back. It is a wholly human, normal reaction. And 
what that does is it brings the economy down.
    But if indeed those underlying trends are still there, as I 
firmly believe, it is just a matter of time before that sort of 
malaise dissipates and the system comes back. If you look at 
American economic history, it always has those characteristics. 
And if we focus on the longer term, as a number of business 
people have and have continued to invest right through this 
period, it is my impression that it is they who will end up at 
the end of the day with the best positions in their markets to 
exploit over the longer run.
    Senator Shelby. Mr. Chairman, could you in a sense perhaps 
look at the economy like a long-distance race. The runners or 
some of the runners are going--if the economy is the runner--is 
going to get its second wind because they are trained for the 
long haul. We are in it for the long haul.
    And those that are in it for the long haul, which is all of 
us, we are going to be rewarded if we stay the course.
    Chairman Greenspan. I agree with that, Senator. I have no 
doubt that, at a minimum, the turgid economic growth which we 
experienced from the early 1970's through the, say, early 
1990's, is not something that we are about to replicate in any 
sense that I can envisage over the next 10 years.
    Senator Shelby. Mr. Chairman, have you thought about at 
all, and if you haven't, maybe we can talk about it some other 
time, the further reduction of the capital gains rate from 20 
percent to 10 percent, based on the holding period, like if you 
held an asset 1, 2, 3, 4, or up to 10 years, reduce it 
accordingly.
    Some economists believe that this would unburden the 
taxpayers who are holding onto as much as $7\1/2\ trillion in 
capital assets.
    Chairman Greenspan. Senator, that is something that this 
and the Finance Committee I guess are going to have to address. 
It is a complex issue.
    Senator Shelby. Very complex.
    Chairman Greenspan. Unlike other tax cuts, there is the 
obvious question of whether you lose revenue when you cut the 
capital gains tax. If indeed there is a capacity to unleash 
unrealized gains and hence to have them realized and the tax 
paid. There is that question, which is a crucial one because, 
in this particular context, where there is such a major debate 
with respect to fiscal responsibility, it is important to 
distinguish various different types of cuts and what their 
impact will be on revenues, as well as on the deficit or the 
surplus.
    Senator Shelby. Sure. We will talk about it again.
    Thank you.
    Senator Allard [presiding]. Senator Bayh.
    Senator Bayh. Thank you. And thank you, Mr. Chairman.
    I was struck by your dialogue with Senator Corzine that 
perhaps our focus on budget estimating is misplaced and instead 
we should focus upon the predictability and accuracy of 
productivity growth estimating, since that has such a profound 
impact upon the budget forecasts.
    But I suspect that may be a topic for another day.
    I want to just briefly go back to the comments that I made 
at the outset of the hearing.
    It seems to me that our challenge as public policymakers is 
to decide how best to make decisions of great consequence in an 
environment of inherent and substantial uncertainty.
    And it seems to me that the answer is to proceed with a 
fair amount of caution and an attempt to reduce the uncertainty 
in any way that we can.
    Senator Bennett used the analogy of a businessman making a 
decision and occasionally having to bet the company's future.
    Sometimes that is unavoidable. But when you do those kinds 
of things, I think you owe it to those interested in the 
success of the company to be as prudent as you possibly can be, 
and to do everything you can to make sure that your decisions 
are correct.
    You, Senator Sarbanes and others have both explicitly and 
implicitly mentioned the variability of the forecasts that we 
deal with.
    They varied greatly in the last 6 months. I notice that 
many States--and during my years as governor, we had biannual 
budgets. They were always inaccurate, on the upside or the 
downside.
    Many States are now going through that process.
    Ten-year estimating, it seems to many of us, is in reality 
guesswork disguised as science, it is so inherently unreliable.
    Considering that, it seems to me that we need to look for 
ways in which to reduce the uncertainty and ensure that we are 
making our decision based upon hard facts rather than unstable 
estimates.
    And given all that as prelude, I would like to dwell upon 
the idea of the trigger mechanism that has been raised by some 
others as perhaps one idea that can take some of the guesswork, 
some of the uncertainty out of our decisionmaking, and increase 
the probability that we are making prudent decisions.
    I would like to follow up on your budget testimony. You 
were kind enough to reread some of it here today.
    My understanding is that the trigger mechanism, as has been 
suggested, is one way to ensure that the budget will remain 
balanced, that we will place a premium upon paying down the 
debt, and therefore, increase the chances that we are being 
fiscally responsible.
    Is that your intent in floating the possibility of such an 
idea?
    Chairman Greenspan. Yes, Senator. Just remember that to the 
extent that the net debt goes down, that number is very close 
to what the unified budget surplus is.
    So, in a sense, you don't need to do both. In my judgment, 
it is far better to work off the debt numbers which are less 
capable of manipulation. And as a consequence of that, you get 
the full effect of the lower debt and the advantages of the 
lower debt and the savings that accrue as a consequence of the 
unified budget surplus.
    Senator Bayh. That was my understanding of the idea. I 
think it is commendable for those reasons.
    I see that Senator Ensign has reentered the room. I would 
just make a subsidiary point.
    The Senator raised the question about uncertainty, and I 
have occasionally heard this raised by others with regard to 
the trigger mechanism.
    I would only respond by saying that uncertainty is 
unavoidable and inherent in making some of these decisions.
    The question is not whether we will eliminate uncertainty, 
but whether a trigger mechanism will reduce the amount of 
uncertainty.
    And I believe that it will.
    My second question, Mr. Chairman, involves this.
    I approach the idea of a trigger mechanism as an attempt to 
reconcile two different strands of fiscal conservatism.
    The first strand believes in balancing budgets and avoiding 
deficits and public debt where possible.
    The second favors reducing taxes when the alternative to 
tax cuts is nonessential discretionary spending.
    Is my perception of the trigger mechanism as a way to 
reconcile these two different strands a good way to look at 
this?
    Chairman Greenspan. Well, I think the way you put it 
originally, Senator, is the correct one: Namely, what it tends 
to do is to reduce the uncertainty that is attendant upon 
making a decision irrevocably for an extended period of time.
    If you construct a mechanism which enforces an automatic 
revisiting of that initial decision, you effectively remove a 
very substantial amount of the uncertainty that is involved in 
it.
    But let me point out one issue that one must consider. 
Having contingent tax cuts or expenditure outlays has a 
downside, which is that it creates an element of uncertainty on 
those who are dependent on those programs, either the tax or 
the spending program. And what you have to do is to determine 
how one trades off the uncertainties that are engendered 
against for the people who are the recipients of those programs 
against the overall degree of uncertainty that is attendant 
upon making these types of budgetary projections.
    Senator Bayh. Yes. I understand we have to reconcile some 
of the macroeconomic uncertainty with the uncertainty created 
for individuals in their own decisionmaking.
    As someone else in the panel had previously mentioned after 
the tax reductions of the early 1980's, we then had nine tax 
increases.
    So it seems to me that there is some, again, inherent level 
of uncertainty. And what we are attempting to do is get the big 
picture right and then as best we can, try and limit the amount 
of individual uncertainty, any mechanism would create.
    Mr. Chairman, I just have one other question.
    Not surprisingly, the idea of a trigger mechanism has been 
the subject of some criticism.
    Interestingly enough, to me, it is been criticized from 
both those on the further left and those on the further right, 
suggesting that maybe we are right about where we ought to be 
from a public policy standpoint.
    Those on the left seem to be worried that a trigger would 
limit the ability to engage in discretionary spending in future 
years.
    Those on the right suggest that we would not get tax cuts 
because those on the left would engage in discretionary 
spending.
    Now, they both cannot be right. And it seems to me that in 
fact, what a trigger mechanism does is to establish what I 
would call a hierarchy of priorities.
    First, debt reduction, as you have pointed out.
    Second, a presumption that where surpluses did materialize, 
tax cuts could go into place.
    Third, that where a compelling case could be made for 
additional discretionary spending, such investments could be 
permissible.
    I view this as really both the left and the right being 
somewhat in error, that the tax cuts would go into place unless 
we returned to deficits and debt, which few would argue would 
be prudent.
    But that the left is also in error because spending could 
be considered if a compelling case could be made, as should be 
made to the taxpayers to justify the taking of their hard-
earned resources.
    Is that a good way to look at this?
    Chairman Greenspan. Senator, let me just add something 
which I think is important. In order to reduce the uncertainty 
that the recipients of either spending programs or tax cuts 
have, I would assume that you would not want to reverse 
previous decisions.
    In other words, if you have, for example, taxes going down, 
that once they are there, they are then irreversible, in a 
sense. It is only the next tranche that would be affected. It 
would be, I think, most difficult, if not wholly inappropriate, 
to find that if you ran into a problem with the trigger, that 
you rescind previously initiated tax cuts. That would be 
utterly inappropriate.
    Senator Bayh. I agree, Mr. Chairman. And my last comment 
would be, I thank you for making that.
    The way I had envisioned this is that the first phase of 
the tax cut would go into place immediately and be irrevocable. 
And that future phases of the tax cut would go into place 
depending upon the realization of the surplus. So even if you 
did not hit it in a particular year, and it was realized in a 
subsequent year, then the further tax reductions would go into 
place.
    I had not envisioned in fact rolling back previously-
enacted tax reductions, so thank you for raising that point and 
giving me the opportunity to clarify it.
    Thank you.
    Senator Allard [presiding]. Mr. Chairman, I will now take 
my time.
    I would just make an observation here at the start.
    Over the last two previous years, I have noticed that many 
of my colleagues in the Senate who feel like it is not 
appropriate to cut taxes, when we get toward the end of the 
spending year, more than willingly vote for increased spending. 
And that is usually in the discretionary area.
    I would just point out that this President here has 
indicated a willingness to try and reduce, hold down spending, 
as he moves forward, particularly the rate of growth in 
spending.
    And in recent years, discretionary spending has grown. 
Particularly when I look at the last budget year, last year, 
when we were debating this year's budget, we increased spending 
over a 10-year period over $500 billion.
    How important is it that we keep the growth of spending in 
line? And does rapid spending growth actually threaten any 
plans we may have to pay off the debt?
    And I may add, I think my position would be very parallel 
to what you are saying, is that my number-one priority is pay 
down the debt. Next would be cut taxes. But the least desirable 
would be an increase in spending.
    I wish you would comment on that, please.
    Chairman Greenspan. Senator, I think one of the really 
quite important advances in budgetary policy in this country 
occurred with the PAYGO and caps that we all early on thought 
were not really enforceable because a majority of both houses 
could basically overthrow them.
    The really remarkable sequence of events in the past decade 
or so in which those actual budgetary controls worked was a 
major element in restraining government outlays, producing the 
surpluses, and all of the great advantages that accrued from 
them.
    With the advent of surpluses, the budget controls broke 
down badly. And I think that if the Congress can put them back 
in place in an effective manner, it would be a very important 
public policy advance.
    It has only been 2 years when they have ceased to function 
in an effective way and hopefully, now confronted with longer-
term judgments which must be made, that as a part of any 
budgetary process which is resurrected for the 2002 budget, 
some form of budget controls can be put in place replicating as 
close as one can to those which were really quite so effective 
in years past.
    Senator Allard. Recent numbers show we have a negative 
savings rate in the United States.
    My question is, do you view this as a threat to our 
prosperity? And what actions might the Congress take to reverse 
this trend?
    Is it to cut taxes or is there some other approach?
    Chairman Greenspan. Senator, as best we can judge, if you 
took a survey of the average American household and asked 
whether they thought they were saving inappropriately low 
amounts, the answer would be no. And the reason is, quite 
appropriately, they are looking at their 401(k)'s and a variety 
of other assets, all of which have risen until very recently. 
And the consequence of that is that they perceive that they 
were saving and that they would therefore spend as necessary, 
maintaining what they perceived as necessary for their 
retirement or for their children's education, or whatever.
    Now that the rise in household wealth has turned down, one 
would expect the substitution of household wealth for savings 
out of income would now turn in the other direction. So that 
most people who look at this phenomenon would expect the 
savings rate to move from negative to positive as a consequence 
of the flattening out and slight decline in the equity holdings 
of households.
    So, I don't think that I would argue that any particular 
policies of government are required to address that issue until 
we see how it all works out after the so-called wealth effect 
adjustment is fully embodied in the savings rate and we 
actually see where it is, see, in effect, where households 
perceive their rates are, before any policies are initiated to 
try to change it in a significant way.
    Senator Allard. Mr. Chairman, my time is expiring here.
    I just would ask you to conclude with one brief comment on 
capital gains rates.
    Is it appropriate at this time to look at a reduction in 
capital gains rates in sort of economic growth or reduction?
    I would like to have you comment on it.
    Chairman Greenspan. Senator, I think that you will find 
that in my past discussions before this Committee on that 
issue, I have always argued that capital gains taxation is a 
poor means of raising revenue. I think that taxes on capital of 
the form which that is is not something which I would consider 
to be an appropriate economic form of taxation.
    To be sure, there are noneconomic reasons for putting such 
a tax on, according to the vast majority of people who support 
it. So I would merely say to you that if you eliminate it or 
move it down, keep the context of what the appropriate fiscal 
policy overall should be in the time ahead. And I would be 
careful about merely getting a list of various taxes which, in 
the abstract, would be very nice to have, without seeing what 
they are relative to the whole fiscal policy outlook.
    Senator Allard. Thank you, Mr. Chairman. I appreciate your 
comments.
    Senator Dodd.
    Senator Dodd. Thank you, Mr. Chairman. And thank you again, 
Chairman Greenspan. You are very patient once again with your 
time up here. And I will try and go through some of these 
rather quickly. A lot of the questions have been raised. 
Senator Corzine's questions I think went to the heart of that 
issue.
    I think the quote you gave is that at preemptive smoothing 
of the glide path to zero Federal debt, is really, as I read 
this, that is the core of your support for a tax cut.
    Chairman Greenspan. Correct.
    Senator Dodd. And so, when I read statements that the 
reason for this tax cut is necessary, is to kick-start the 
economy, that would be an improper and unwise policy. There is 
nothing in this to kick-start the economy in this particular 
tax package.
    Chairman Greenspan. The problem, basically, is not what is 
in the package. It is really the time it takes to implement the 
issue, which is I think the crucial----
    Senator Dodd. That is my point.
    Chairman Greenspan. Yes.
    Senator Dodd. There is nothing in the way that this is 
arranged that is going to kick start an economy based on--by 
the time it gets implemented, it is usually--it is outside the 
timeframe when such a kick-start might actually occur.
    Chairman Greenspan. Except for the low probability that any 
recession that might occur is prolonged. It is only under those 
conditions that I envisage it to be an insurance premium, in 
effect, because we use insurance for low probability events. 
And in that regard, it would act positively. But aside from 
that, I have not been able to find the useful means of 
employing it to fend off a recession.
    In other words, if a recession is going to happen--and I 
must say to you it is not happened yet--it is very unlikely to 
be affected one way or the other by what tax policy is going to 
be because the determination of a trigger as to when--I 
shouldn't use the word trigger--the determination of the point 
at which the markets determine whether we are flattening out or 
stabilizing or falling, that is way before the implementation 
of any tax cut that I can envisage happening.
    Senator Dodd. And you haven't changed--I mean, the 
definition of when a recession is occurring, is it still the 
classical definition of two quarters?
    Chairman Greenspan. It is roughly that. The only difficulty 
that you are going to have in these types of definitions is 
that when somebody examines when a recession begins, it is 
usually well before the economy actually breaks down. In other 
words, the economy will often start moving lower and a great 
deal of the time will then start back up. And so, that 
particular peak will never be discussed as the peak of the 
business cycle. But if it goes down and continues down, you 
only recognize that you are in a recession well off the peak. 
But in retrospect, it will always be that the beginning of the 
recession is supposedly at that peak.
    My argument is that, indeed, we really weren't in a 
recession in that short period. It is only when the break in 
confidence occurs that any meaningful definition of a recession 
is there. But that is not the usual definition. The usual 
definition, as you indicated, is any two quarters of negative 
economic growth.
    Senator Dodd. And we are not in a recession.
    Chairman Greenspan. At the moment we are not.
    Senator Dodd. And the likelihood of it is a very, very, 
very, very low probability.
    Chairman Greenspan. Well, I don't want to give 
probabilities. I will say, as I said at the Senate Budget 
Committee, that a breaking of consumer confidence or business 
confidence such that you get a significant erosion in economic 
activity is always a low-probability event. But it is of 
significant moment that we should take whatever actions we can 
to reduce the probability that it will occur.
    Senator Dodd. Just two quick points.
    I made the point at the outset of the hearing that I think 
virtually all the Democrats I know, and Republicans, believe 
that there is room in this surplus for a tax cut.
    Someone had the line, which I identify with, I am for as 
large a tax cut as we can afford, underscoring what we can 
afford. And that is how I feel. And I think others may share 
that view.
    I want to raise two points with you.
    One is, you have raised in your testimony the problems with 
energy, global energy issues which are looming on the horizon.
    Japan's economy is not recovering--you did not raise that 
in your testimony, at least indirectly, that that is still a 
serious issue given it is a major trading partner.
    There are issues involving global markets and how strong 
they will be down the road which you touched upon.
    The concern I have, obviously, and you raised this a bit 
with Senator Hagel, is there are some clouds on the horizon 
that raise some serious questions about the continued kind of 
growth of the economy?
    And I worry about that. I relate that to the second point, 
the one that my colleague from Indiana raised, the triggering 
mechanism.
    I have concerns about triggers because I think one of the 
values of tax cuts is to some degree the certainty of them, 
that there is an anticipation that occurs.
    And that if you start reining back in, your having trigger 
mechanisms, that in itself creates its own dynamic.
    Wouldn't it be wiser to try and come up with a tax cut 
proposal that was responsible and fit, rather than one that you 
built in a mechanism that would have to rein in, given the 
uncertainty that that creates in markets?
    Chairman Greenspan. Senator, let me just say with respect 
to the first part of your implied question, the very nature of 
the complexity of the world in which we are makes it very 
difficult, as I indicated in my prepared remarks, to forecast 
any particular recession. That does not mean that they don't 
happen. Obviously, they do happen. And what we try to do is, 
without trying to put a specific probability at any particular 
time, that from here forward, we are going to go into a 
recession. We tried that, but not with any great success.
    So I don't find the notion of trying to say what is the 
probability of a recession a terribly meaningful concept 
because the truth of the matter is we never really know for 
sure what that number is because we cannot see the process by 
which the system breaches.
    But because you have that particular problem, and indeed, 
the international circumstances which you suggest, it is 
important whenever addressing economic policy, whether fiscal 
or monetary, to try to reduce the levels of uncertainty in 
policymaking for precisely the reason that we do not know at 
any particular point what the probabilities of a recession over 
X number of months will be.
    And I would say for those reasons, if for no other reasons, 
it is important to find particular fiscal policy mechanisms, 
whether for initiated expenditure programs or tax cuts, to find 
vehicles which reduce the risks which are associated with them.
    I think triggers have advantages. They have disadvantages. 
And it is got to be for the Congress to make judgments as to 
which outweighs the other.
    Senator Dodd. Some of my friends are for A, some of my 
friends are for B.
    And I am for my friends.
    [Laughter.]
    Chairman Greenspan. I fully subscribe to that point of 
view.
    [Laughter.]
    Senator Sarbanes. We have come to realize that.
    [Laughter.]
    Senator Dodd. Thank you.
    Senator Allard. Senator Reed.
    Senator Reed. Thank you very much, Senator Allard.
    Thank you, Mr. Chairman, for your testimony.
    Let me take up the issue of this stampede to spending that 
we have been witnessing in the last several years.
    According to the Congressional Budget Office, Federal 
spending as a percentage of gross domestic product has declined 
since 1992, from a little over 22 percent to a little over 18 
percent, and that with their baseline figures, the projections 
for the economy and for spending, the decline is going to 
continue.
    Isn't that a more relevant way to look at the level of 
Federal spending than absolute increases year to year?
    Chairman Greenspan. Remember that goodly part of the fall 
in the ratio is a consequence of, one, defense expenditures 
coming down, two, the fact that the economy has risen so 
dramatically so that the denominator of the ratio has been 
really very impressive.
    But, certainly, yes, the notion of the impact of Federal 
spending on the economy is a function of what that ratio is. 
But the appropriations that one can make have very significant 
impacts on the forward levels of discretionary expenditures and 
it is quite conceivable that you can turn that ratio around 
quite quickly in a relatively short period of time.
    I think it is really quite important to think in terms of 
not only that ratio, but the underlying appropriations process, 
plus the denominator, merely what is going on in the economy, 
to come to conclusions on policy questions.
    Senator Reed. Well, I assume you are going to keep the 
denominator very robust. And you have done so far and we are 
very comfortable with that denominator.
    Chairman Greenspan. We certainly will endeavor to 
accommodate you.
    Senator Reed. Thank you, Mr. Chairman.
    Mr. Chairman, let me just take up another issue. Borrowing 
from Senator Dodd's phrase and your phrase, that preemptive 
smoothing of the glide path seems to be the operational 
emphasis behind your advice of cutting taxes to avoid a shock 
at 2005 or 2006 of a $500 billion stimulus.
    Chairman Greenspan. Yes.
    Senator Reed. There are several alternative glide paths. 
One is a tax cut. One is simply spending money over that time.
    From an economic standpoint, is there any difference?
    Chairman Greenspan. The only difference gets down to the 
question of how you view the effect of government expenditures 
on the economy versus tax cuts on the economy.
    Arithmetically, there is obviously no difference. Either 
one will affect it the same way. So the question really gets 
down to a judgment of the size of Government expenditures to 
the economy, coupled with the whole series of guarantees and 
economic preemptions which occur as a consequence of the 
regulatory system. In other words, there is a general sense of 
how much private sector resources are effectively preempted by 
the Federal sector, either through expenditures, guarantees, or 
regulatory actions. And you have to make a judgment as to 
whether the impact on the economy from tax cuts or Government 
expenditures is a plus or a minus, in addition to the 
noneconomic questions which obviously arise with respect to 
both of those issues.
    In other words, if you ask me from a strictly economic 
point of view, I have always argued and continue to argue that 
we are far better off when confronted with this type of 
situation to cut taxes rather than increase expenditures. I 
have always said in the next sentence that economics are not 
the only set, not the only criteria that are involved in making 
these judgments.
    But what I do think is required is to constrain 
expenditures because, in my judgment, it is very easy for 
expenditures to get out of hand and run up very rapidly. And 
that is a judgment which is based on observation on my part, as 
well as data. But there are others who could have different 
views.
    So I am really giving you my own point of view on that 
issue. But from the point of view of the question, the answer 
is it doesn't make any difference whether it is expenditures or 
taxes.
    Senator Reed. It seems, again, this is the difficulty you 
have as being both the Chairman of the Federal Reserve and 
being someone with very profound and insightful personal views, 
is that, oftentimes, your perspective is taken as sort of 
speaking ex cathedra about economics, when in fact, a lot of it 
is insights about congressional dynamics and the stickiness of 
cutting expenditures versus raising taxes.
    And I think that is sometimes confused.
    Chairman Greenspan. I try to make that distinction. 
Senator. I try to make that distinction as best I can. 
Sometimes I suspect I don't succeed, but I try.
    Senator Reed. But returning to your initial response, from 
a strictly tactical standpoint, tax cuts and increased 
expenditures will get you to that point where you do not have 
the fiscal shock in 2005 or 2006.
    Chairman Greenspan. That is correct, Senator.
    Senator Reed. Thank you. One of the other aspects of this 
debate about tax cuts is how you do it.
    And there has been a proposal about a rebate. In fact, if 
your goal is simply to eliminate the excess revenues for both 
economic reasons and public policy reasons, one approach is a 
rebate.
    Do you have any comments on a rebate approach, where 
everyone will receive a certain amount of money?
    Chairman Greenspan. Not really, Senator. We have had 
rebates in the past. Indeed, when I was chairman of the Council 
of Economic Advisers in 1975, we did initiate a rebate. And the 
purpose was to address the recession that was developing in 
that particular period. I don't have any comment on the 
appropriateness of it. The pros and cons I think are reasonably 
self-evident.
    Senator Reed. There was a suggestion by the Chairman that 
you were in favor of across-the-board income tax cuts.
    Do you have a position? Is that an accurate assessment of 
your view?
    Chairman Greenspan. It is, in the sense that I have often 
been asked in this Committee, when confronted with the desire 
to cut taxes from an economic point of view, what do I view as 
the most efficient means to come at the tax cuts? I have always 
argued that from what I can gather, marginal tax rate cuts are 
the superior way to come at that issue.
    Senator Reed. In order to ensure that the poorest workers 
receive the benefit as well as the richest workers, should that 
tax cut be refundable?
    Otherwise, there is a whole class of very poor workers who 
pay no taxes, receive no benefits, and there is equally a 
number of high-income taxpayers who don't work in the 
conventional sense.
    Chairman Greenspan. Well, it is a question of how you view 
refundable tax credits, which will often appear on the 
expenditure side as an outlay. As you know, the earned income 
tax credit, where it is unrelated to the actual tax form, is on 
the expenditure side. So you really cannot make the 
distinction. And that is a judgment that you have to make.
    Senator Reed. Thank you, Mr. Chairman.
    Senator Allard. In the Committee, where we are right now, 
it looks like we have Senator Carper and then Senator Schumer 
has just walked in.
    And then we will draw it to a close.
    Senator Sarbanes. Are we going to have a second round?
    Senator Allard. The Chairman had laid out earlier that he 
just wanted to go ahead and complete this round and then we 
would go ahead--I think Chairman Greenspan has a schedule and 
what not, that we would go ahead and adjourn.
    Senator Sarbanes. Well, if we have time, Mr. Chairman, I 
have just a couple of questions I would like to put to the 
Chairman before he gets away.
    We don't get him here that often and we would like to--I 
guess the phrase is, milk him for all he's worth while we have 
him here.
    [Laughter.]
    Senator Allard. I think if you have a couple of questions, 
I think that is acceptable.
    Senator Carper.

         OPENING STATEMENT OF SENATOR THOMAS R. CARPER

    Senator Carper. Thank you, Mr. Chairman.
    Chairman Greenspan, as we come to the end of this hearing, 
first of all, let me just thank you for being here today, for 
your testimony again.
    And maybe more important, thank you for your service to the 
people of our country.
    One of the values for me of a hearing of this nature is to 
find some areas where we agree on some things. And I just want 
to kind of go back over what I have gleaned from your testimony 
today and see if I have gotten it right.
    One of the things that I have understood you to say is that 
the direction of our Nation's debt and turning deficits into 
surpluses is something that has been a real positive for 
economic growth in this country.
    I understand you to say that economic growth in this 
country has slowed, but it has not tanked.
    And I think, to quote you, you said that the central 
tendency for real gross domestic product growth over the four 
quarters of this year is 2 to 2\1/2\ percent.
    I can remember a time not that long ago when 2 to 2\1/2\ 
percent GDP growth was actually considered pretty darn good.
    I have gleaned from your testimony that productivity growth 
continues, albeit, at a somewhat slower rate than it did over 
the last several years.
    And that the long-term prospects for economic growth over 
the next decade or so are actually quite encouraging.
    I have sensed from your testimony today that you believe 
inflation remains at bay. And while we always want to be 
cognizant of it, mindful of it, it is not now an imminent 
threat to our economy.
    I understand from your testimony today that the surplus 
forecasts, while they are robust in the years to come, are not 
always written in stone. And I think you mentioned at one point 
that the difference between what was forecast for deficits in 
1995 and what we actually realized in surpluses in 2000, I 
think, the swing was about $500 billion.
    Chairman Greenspan. That is what I commented on at the 
Budget Committee, that is correct.
    Senator Carper. Okay. And I think I have understood you to 
say that, given the fact that we have some extra money on the 
table, extra revenues on the table, that one of the good ways 
to make sure that we spend the money prudently, which is left 
for spending, is to return some of it to the taxpayers of this 
country.
    Those are very helpful things for us to know, as we in this 
Committee and the Congress and the President attempt to fashion 
a budget, a fiscal policy for our country, budget policy for 
our country, and adopt changes in taxes.
    Where we don't agree is in the following area.
    If you could give me a little bit of further guidance on 
this, it would be helpful.
    First of all, if real GDP growth for the year actually 
turns out to be 2 or 2\1/2\ percent, the issue of whether or 
not we need to cut taxes at this point in time in order to 
stimulate the economy, or whether or not the Fed, the Federal 
Open Market Committee, is perfectly capable of using monetary 
policy, interest rate cuts, to help us ease through this 
slowdown and to return to a stronger growth, that question is 
before us.
    And we are going to go from here, and the Democrats, we are 
going to meet over lunch and try to figure out which way to go.
    There is some who say, no, we ought to cut taxes now. It 
should be retroactive.
    There are others who say, no, that is not appropriate. 
Let's let the monetary policy work and make the tax cuts phase 
in a bit further down the line.
    Any help you can give us on that point?
    Chairman Greenspan. Well, Senator, the position I have 
taken, on the basis of the experiences I have had over the 
years, is that recessions, when they occur, tend to more often 
than not be over reasonably quickly, and that the timeframe for 
enacting tax legislation almost invariably is longer than that. 
But there are some cases in which, when recessions take hold, 
they extend themselves. They sit there for a while and are more 
prolonged than you anticipate. Under that condition, which I 
submit is a relatively low probability, a tax cut having been 
in place for a period of time is good rather than bad.
    So what it is, as I indicated before, is it is an insurance 
policy. It is basically doing something against a relatively 
low probability outcome--that is, the protracted nature of a 
recession. And the usefulness of that will basically depend on 
what is the size of the tax cut, where is it located, and what 
the economic outlook is.
    I haven't raised that as a crucial issue because I think 
that the particular point that I was raising as to why I 
believe tax cuts are important, is to address this technical 
problem with respect to the accumulation of assets in the 
Federal government. So my argument is really quite independent 
of the issue of economic stimulus, though I recognize that it 
has certain obvious relationships to it.
    Senator Carper. Thank you. My only other question is this.
    In my little State of Delaware, we cut taxes 7 years in a 
row during my time as Governor, sometimes rates at the top, 
sometimes rates at the bottom, sometimes in between. We cut 
taxes for businesses and individuals.
    We had a four-part litmus test for tax cuts that we 
adopted.
    One of the things that we are wrestling with within our own 
caucus, and I presume my Republican friends are as well, is a 
set of core principles on which tax cuts should be based.
    If you will, a litmus test.
    The four that we used in my State were the following:
    One, the cuts should be fair; Two, they should promote or 
enhance economic growth; Three, to the extent that they can, we 
should simplify the Tax Code, not make it more complex; And the 
fourth is that the cuts should be consistent with the balanced 
budget and sustainable throughout the full business cycle.
    But those four things--fairness, promoting economic growth, 
simplicity, and sustainability throughout the full business 
cycle and consistent with a balanced budget.
    Really, the litmus test that we used.
    Can you just give us a little guidance, I know my time is 
expired, but just a little guidance on the kind of principles, 
whether Democrats or Republicans, that our tax cut policy 
should be based on?
    Chairman Greenspan. Well, I think in a very interesting 
way, it depends on where one starts.
    Going back from, say, the purview of 1995, for example, 
with what appeared at that point to be about a 1\1/2\ percent 
trend growth rate in productivity, it appeared as though the 
level of taxation was essentially consistent with a balanced 
budget over the longer run at full employment.
    And what has happened is that productivity growth has 
accelerated quite significantly, and so, the existing set of 
tax rates has engendered a very much more rapid rise in 
revenues. As I said at the Senate Budget Committee, that 
productivity over the past 5 to 7 years has risen at about a 3-
percent rate, which is twice what it had been previously, and 
revenues have gone up 2\1/2\ times, the difference being that 
the rise in the productivity has elevated earnings, 
expectations, and created a permanent, higher level of asset 
values, which spilled over into tax liabilities when realized 
gains were involved, or even when they weren't.
    And so that what you have got at this point is, as a 
consequence of the acceleration in productivity, a much higher 
rate of receipts than one had anticipated. And so, I think the 
Congress is confronted with the choice of whether in fact you 
give back what in retrospect turned out to be an unintended 
excessive level of receipts, or whether those are employed for 
other purposes these are the key judgments which I think in 
this particular debate are critical, and these are political 
judgments. These are judgments which only the Congress can 
make.
    Senator Carper. Thank you so much.
    Senator Allard. The Senator from New York, Senator Schumer.

             COMMENTS OF SENATOR CHARLES E. SCHUMER

    Senator Schumer. Thank you, Mr. Chairman. And thank you, 
Mr. Greenspan, for your patience, as well as all your other 
great attributes.
    I would like to ask a few questions.
    One is, how big a tax cut is too big?
    One of the worries that many of us have is that we will 
repeat 1981. People start off with a good plan and it just 
snowballs.
    I think the way things work in Washington, when Republicans 
propose $2 trillion in tax cuts, and Democrats propose $1 
trillion in tax cuts, you don't end up with $1.5. You end up 
with $3 trillion in tax cuts.
    I am just worried. I support deficit reduction above tax 
cuts.
    I take it you would say that that priority is reasonable.
    Chairman Greenspan. I would say, Senator, that we do not 
wish to go back into unified budget deficits.
    Senator Schumer. Right. So the question is, given the 
numbers that you have been talking about, when do we get to a 
level where it is too high?
    Chairman Greenspan. I repeat--if we project our way back 
into a deficit, I think it would be a mistake.
    Senator Schumer. And let me just ask you another question 
because I think there has been some miscalculation here.
    When you do a tax cut, is it not fair to add into that tax 
cut, the amount of the debt payment that will have to increase 
because the Government has less revenues?
    Chairman Greenspan. Yes. In other words, all calculations 
with respect to the issue of what the level of the debt will 
be, indeed whether you have a surplus or a deficit, has in it 
implicitly the level of the debt and the interest payments.
    Senator Schumer. Right.
    Chairman Greenspan. Clearly, if you alter the timeframe of 
any particular expenditure or tax program, it is going to 
affect all of those items.
    Senator Schumer. So just to take a hypothetical, if someone 
were to propose a $1.6 trillion tax cut--I don't want you to 
comment on a specific plan--with the decline in marginal rates, 
the CBO and others would say that that would increase debt 
service over the 10 years by $400 billion, then the fair number 
that the tax cut would cause would not be 1.6, but would be 2.
    And we can change the numbers. I just wanted to be accurate 
in the ratios.
    Chairman Greenspan. Yes. Obviously, in order to get the 
full accounting of any particular initiative, whether it is a 
tax cut or expenditure increase--what in effect you do is you 
take the impact of that cut or the expenditure increase and try 
to infer what the total effect on the budget is, including 
interest and debt.
    Senator Schumer. Right.
    Chairman Greenspan. But there is also a very debatable 
issue, which now gets to the question of whether you are doing 
a static estimate or a dynamic estimate.
    Senator Schumer. Right.
    Chairman Greenspan. There are going to be those who argue 
that those actions will impact on the tax base itself and there 
will be a feedback effect. And having been involved in those 
debates now for too many decades, it is a very difficult issue 
to resolve. But I think what is important is not what numbers 
you put on a particular program, but what are its implications.
    Senator Schumer. Right.
    Chairman Greenspan. For example, there are a lot of people 
who would argue that because of doing a dynamic evaluation of a 
tax cut, the actual net reduction will be less.
    Senator Schumer. Right. Although the dynamic argument in 
1981 did not serve us very well.
    Chairman Greenspan. Dynamic arguments presupposed that 
expenditure cuts were to occur, which did not, plus the tax 
effects which you referred to. So that those projections were 
really off by very substantial amounts.
    Senator Schumer. You see, I am someone who would support a 
significant tax cut, but the way I look at the Bush tax cut, we 
are almost already in that unified deficit because it is $1.6 
trillion of cuts. It is $400 billion of deficit--increased debt 
spending. There is $100 billion of extenders which everyone 
believes we are going to renew. And there is the fix of the 
AMT, which is $200 billion, which, again, everybody thinks we 
have to do. Otherwise 25 or 30 percent--this is the individual 
AMT.
    So then, if you do what the President has talked about and 
moved it up to March of this year because of the stimulus, you 
are at 2.7.
    Well, if the surplus is 2.6, and those things which almost 
everyone thinks either have to be added in by the inexorable 
numbers of math or just the political realities, you are 
already perilously close to putting us back into debt before we 
spend another nickel on anything else.
    And nobody believes--the President just called for an 
increase in military spending, which I think everybody would 
support--that we are not going to be there.
    I am not asking you to comment on the specifics. I know 
those are the ground rules.
    But could you comment on--is it fair for any of us to be 
worried that a large sweeping proposal at the beginning, 
without all the ramifications counted, that we get back into 
the debt cycle that we were in.
    You must have thought about that a lot. You have been one 
of the architects, publicly, as well as, privately, of helping 
us bring the debt down and to turn the deficit into surplus.
    And to me, you make a distinction between tax cuts and 
spending. I think both of those are downhill. Those are easy. 
Those are the id of budget politics. The superego of budget 
politics, the hard thing, is debt reduction.
    I just worry that we are going to lose that very, very 
quickly, as all these other factors are added in.
    Could you just comment on whether my worries are well-
founded? What do you think about them?
    Chairman Greenspan. Well, Senator, if we had the ideal way 
to evaluate budgets and tax and expenditure programs, we would 
do it in what economists call a dynamic model, in which you not 
only calculate all the effects that you are referring to, but 
the interaction of all the tax and expenditure programs on what 
is going on in the economy as a whole and therefore, by 
altering the tax base, you are going to alter both expenditures 
and tax receipts from the initial conditions. Ideally, that is 
what we would like to do. Regrettably, our models have not been 
sufficient----
    Senator Schumer. You don't have very good dynamic models.
    Chairman Greenspan. We don't. But the point at issue is 
that most dynamic models will indicate that tax cuts will 
engender a larger tax base. The orders of magnitude will differ 
and they depend very much on the specification of the model 
itself.
    But, ideally, if you took the standard which I just put 
forth, in which whatever is done does not engender a budget 
deficit, a unified budget deficit, then the question is, what 
is the outcome of that evaluation? And I think it is a very 
difficult one. It raises difficult questions.
    I think the issues you raise are very much appropriate and 
to the point. The issue of static versus dynamic evaluation is 
really much to the point. And hopefully, over the years, we 
have learned a little, we have learned some, but we haven't 
learned enough. And I trust that in the future, we will be able 
to handle these issues far more facilely.
    But I would certainly not want to argue that the issues you 
are raising are inappropriate. And indeed, they are.
    Senator Allard. The Senator's time has expired.
    Senator Schumer. Thank you, Mr. Chairman.
    Senator Allard. And Senator Sarbanes had asked for the 
opportunity to ask a couple more questions, then I want to draw 
this to a close.
    Senator do you have one or two?
    If we are going to drag this one, maybe we would better 
give the Chairman an opportunity to stretch or whatever.
    Are you okay? Okay. Very good.
    Senator Sarbanes.
    Senator Sarbanes. The Chairman has done enough of this to 
know that if he stretches and comes back----
    [Laughter.]
    You had the latter part of your statement simply included 
in the record and did not present it to the Committee this 
morning.
    That is the part that deals with government debt repayment 
and the implementation of monetary policy.
    I gather the conclusion I am to draw out of that section, 
though, is the very last sentence, which says:
    In summary, although a reduced availability of Treasury 
securities will require adjustments, in the particular form of 
our open market operations, there is no reason to believe that 
we will be unable to implement policy as required.
    Is that correct?
    Chairman Greenspan. That is correct, Senator.
    Senator Sarbanes. So we don't have a major worry on that 
score.
    Chairman Greenspan. We have been working on this problem 
for quite a while. The alternatives available to us should 
Treasury debt effectively go to zero, are quite numerous and we 
do not see any technical problems in being able to implement 
monetary policy.
    Senator Sarbanes. Now I want to ask a bit about monetary 
policy and fiscal policy.
    The Fed itself is giving us the central tendency for real 
GDP growth this year of 2 to 2\1/2\ percent.
    The blue chip economic indicators recently released a 
survey. They said 1 percent in the first quarter, 2 percent in 
the second, three percent in the third, 3\1/2\ percent in the 
fourth, which comes out to essentially where the Fed seems to 
be.
    Now, a tax cut, of course, would hit later. It is not going 
to hit right away.
    How much thinking is there at the Fed that it may be 
necessary in the future to raise interest rates in order to 
slow down an economy which has been overly stimulated by tax 
cuts?
    Chairman Greenspan. As I said before, Senator, what we must 
do is respond to the economy as it evolved. We are confronted 
with far more than tax cuts or tax increases or expenditure 
changes in endeavoring to get a view of the economy against 
which policy would be implemented. In a technical sense, other 
things equal--and I emphasize, other things equal--the greater 
the budget surplus, the lower interest rates would be, which is 
what I testified many times before this Committee, and would 
just repeat it.
    There are, however, innumerable other things going on in 
the economy--namely the energy difficulties, which I address in 
my prepared remarks, and this extraordinary change in just-in-
time inventorying and the adjustment process itself, which we 
have to address. But before we address, we have to understand.
    And in that regard, the tax cut question is not a major 
issue, largely because its order of magnitude is not a very 
substantial one--it is an average tax cut.
    And therefore----
    Senator Sarbanes. It depends on which one you are talking 
about. We don't know where it is going yet.
    Chairman Greenspan. To be sure.
    Senator Sarbanes. Yes.
    Chairman Greenspan. Of the various different tax proposals 
which I have heard, none of them go outside a certain range 
where considerations----
    Senator Sarbanes. Now let me ask you because I don't want 
to impose on my colleagues.
    In early January, you took the Fed funds rate down without 
a meeting of the Federal Open Market Committee, as I recall.
    Is that correct?
    Chairman Greenspan. No, it is not, Senator. We actually did 
have a telephone conference. And we had a regular meeting and 
voted on the change.
    Senator Sarbanes. On the Federal funds, as well as the 
discount window, which you did a few days later?
    Chairman Greenspan. Correct, Senator.
    Senator Sarbanes. Okay. So that was not a Chairman's action 
under some previous authority.
    Chairman Greenspan. It was not.
    Senator Sarbanes. Now the next regularly scheduled meeting 
is for March 20.
    Chairman Greenspan. That is correct.
    Senator Sarbanes. But you leave open, then, I guess, on the 
basis of the January precedent, acting in the period between 
now and March 20, before a Federal Open Market Committee 
meeting.
    Chairman Greenspan. We will always have that prerogative, 
Senator.
    Senator Sarbanes. Thank you, Mr. Chairman.
    Senator Allard. The Senator from Connecticut.
    Senator Sarbanes. Can I close with just one observation?
    I have to put this in the record. Mr. Chairman, I am not 
going to ask you to answer it. But I really want to present it 
to you.
    You have argued that one reason that you have done this 
change in position on how high you put the priority of the debt 
reduction, that you see it going down to a minimum level and 
that this has caused you some concern.
    But CBO's projections last July, before you made the 
statements that had you on the same path as in the past, showed 
the public debt going to its irreducible minimum level in mid-
2007 and net debt going to zero in early 2009.
    Their new projections show it going to its irreducible 
level in late 2006 and net debt going to zero in early 2008.
    So the point hasn't changed very much.
    Chairman Greenspan. That point hasn't. But what has changed 
is the credibility of the productivity numbers which, as I 
indicated in the Budget Committee hearing and, indeed, 
reiterated this morning, we did not have a true test of 
structural productivity growth throughout this expansion period 
because even though we could statistically make reasonably good 
judgments, at the end of the day, you could not really be 
certain until you had a weakening in the economy and then were 
able to observe what happened to productivity.
    And so, it is the last 6 months of the year 2000 in which 
productivity held up far higher than any of the models based on 
the previous data would have indicated. It was only on seeing 
that that the whole notion that we were really going to reduce 
the debt effectively to zero became credible. Prior to then, we 
were dealing with projections with much larger ranges of error 
than we have today.
    Senator Allard. Senator Sarbanes.
    Senator Sarbanes. The 6 month period of a slowing economy 
is adequate to reach a conclusion that the productivity 
performance will track what it was in a growing and expanding 
economy.
    Is that correct?
    Chairman Greenspan. Obviously, it is not conclusive. It 
adds a very major element of evidence to the marketplace.
    Senator Allard. Senator Dodd.
    Senator Dodd. Let me just pick up on that. That is a 
critical point.
    The points that Senator Corzine raised about what happens 
with Social Security after the year 2010 is a legitimate issue 
in terms of whether or not we are actually going to be at that 
accumulating private assets at the Federal level, at the 
national level.
    And the second issue was the issue of productivity rates 
and the miracle of this new productivity.
    And the Economist has a piece in this February issue which 
I think gets to the point that Senator Sarbanes was raising.
    It goes on--the only possible economic justification for 
Mr. Greenspan's views is that the new economy has produced a 
productivity miracle, a permanent increase in the underlying 
rate of productivity, growth that is capable of being sustained 
through a downturn.
    If that were true, the public debt might indeed be paid off 
early and the Social Security and Medicare costs more 
manageable.
    Such a miracle may be occurring, it says, but no one is 
sure, and given that the downturn is only just begun, there is 
no strong evidence yet to justify 10 years' worth of huge tax 
cuts on the basis of a guess about productivity growth derived 
from a few quarters' figures, can only be considered, in their 
words, a reckless gamble.
    And since the tax cuts needs not be so vast, an unnecessary 
one.
    Chairman Greenspan. You want me to respond to that?
    Senator Dodd. Yes.
    Chairman Greenspan. Okay. I am not going to argue for any 
particular tax cut.
    Senator Dodd. I understand that.
    Chairman Greenspan. But what I do argue is that these last 
6 months have been quite important because had we not gotten 
the type of response that we have got, then it would have 
raised very serious questions about the extent to which what we 
were dealing with was cyclical productivity and not structural.
    Prior to the last 6 months, to be sure, our underlying 
statistical evaluations lent great credibility to the notion 
that productivity growth had indeed accelerated from the 
earlier period.
    The last 6 months are a different type of evidence. Now I 
don't deny that in the event the economy weakens, that 
productivity could temporarily turn negative. That is not what 
the issue is.
    The issue is, granted the history of the last 10 or 15 
years, what type of productivity change would you expect if 
there was not structural change of moment in productivity and 
what would you expect in the event that there was? And what I 
am saying is that the numbers, as crude as they are, are 
sufficiently persuasive that something different has happened.
    Now that is not the same thing as saying that we are going 
to get X percent of productivity for the next 10 years. That is 
not what I am arguing. I am just saying that if the underlying 
evidence is accurate, it means that the capital investments 
which we have put into our system over the last 7, 8 years, 
those capital investments have created an underlying capital 
stock which we now see as quite productive. And the only way 
you can determine that is what is the productivity of that 
stock.
    You can invest an awful lot of money irresponsibly, or 
whatever, and you will not be getting a return from it. What I 
am saying is we are now seeing that there is a return and it is 
suggestive of the fact that that capital stock is indeed as 
efficient as we suspected it was.
    If that is the case, then the probability of productivity 
growth being in excess of where it was from say, 1973 to 1995, 
is increasing and increasing sufficiently substantially that 
has made my concern about these surpluses just disappearing 
moot.
    And if you want to trace where my arguments have come from 
with myself, if you want to put it that way, it is trying to 
answer the question of can we depend upon productivity growth 
to generate surpluses which we don't have yet. They are on 
paper. And I have concluded that the changes that we have seen 
to date raise a sufficiently high degree of credibility without 
arguing it is certain, to address public policy in a different 
way.
    Senator Allard. Senator Reed.
    Senator Reed. Just one follow-up. Again, I am told that the 
Fed really relies on OMB and CBO. Do you have a different 
surplus number over the next 10 years that you are relying on 
as a result of your last statement than CBO and OMB?
    Chairman Greenspan. Let me put it to you this way: The 
numbers that I am relying on publicly are CBO and OMB. I 
wouldn't be had we not scrubbed the numbers ourselves and taken 
a close look. We get somewhat different numbers. But the point 
is that the numbers that OMB--this is, remember, the last 
administration's OMB, and current CBO--the underlying 
assumptions that are being employed are credible.
    Senator Dodd. And I assume your numbers, the Fed numbers, 
are higher than the 5.6.
    Chairman Greenspan. I don't wish to say.
    Senator Dodd. I have one more question, Mr. Chairman. I 
don't know whether my colleagues will let me address it.
    Senator Allard. If Senator Schumer would like to yield some 
time to the Senator from Connecticut.
    Senator Dodd. Just a quick one. I really should have raised 
this earlier.
    There was this piece--I don't know. I have so many papers 
in front of me here--on the bond investors who focus on 
Treasury auctions with the possible ending of the 30-year 
issuance question.
    I gather that the Treasury borrowing advisory committee has 
supported the idea of discontinuing the 30-year bonds.
    What effect is this going to have on the bond markets?
    Chairman Greenspan. We have had the 30-year bond for a long 
period of time and it is been a remarkable anchor in the long-
term bond market and been especially important for holdings 
overseas as well as in the United States.
    In recent years, as the probability that the outstanding 
debt would decline rose, the 30-year bond took on a scarcity 
premium. And as you may recall, the interest rates came down 
quite appreciably. That induced significant problems with 
respect to the underlying benchmark status of that particular 
issue. Indeed if I were to think about this question, I would 
call Senator Corzine and ask him how he would view the 
particular problem because he had to deal with the particular 
issue of whether you are working off a 10-year benchmark or a 
30-year benchmark.
    I think the reason why his former colleagues were 
advocating the elimination of the 30-year bond is that, with 
the reductions that have occurred, we are in a position where 
it no longer serves the use that it did, that the 10-year 
Treasury is becoming increasingly the benchmark. And there is a 
general presumption that if dollar- denominated issues of more 
than 10 years are required, that the private sector is very 
likely to create them.
    So there is no doubt that, other things equal, it would be 
better to have a large Treasury debt outstanding so that those 
of us who deal in the financial markets have easy benchmarks 
and easy means of pricing and funding, but, in my judgment, the 
value of reducing the debt to zero is so great that the costs 
involved to the bond community or to the Federal Open Market 
Committee and our System Open Market Account that the trade-off 
very clearly says by far the most important thing is to get the 
debt down, and we will handle the problem as best we can.
    Senator Dodd. I appreciate that. And I thank you once again 
for reiterating what you have now on two or three occasions 
this morning, this afternoon, that the primary goal is still to 
get that national debt down to zero.
    Chairman Greenspan. I have not changed my view on that in 
the slightest.
    Senator Dodd. No, I know you haven't.
    Chairman Greenspan. As soon as we can get it to zero, the 
better. And the great advantages that we have achieved as a 
consequence of that over the years have been really quite 
remarkable.
    Senator Dodd. I agree with you. As I said earlier, I cannot 
think of a better gift that we could give to a younger 
generation than to burn that national mortgage.
    Senator Allard. I would just observe at this time, for 
those people who are so against the debt, is running a deficit 
on time.
    Senator Schumer.
    Senator Schumer. I just have one final question that hasn't 
been asked. And I just want to get the Chairman's opinion on 
it, although I certainly am glad like the others to hear that 
debt is number one.
    I am worried that we are going to get away from that, as my 
questions before indicated, reducing debt.
    Credit crunch. In New York, we hear a lot of talk now about 
a credit crunch in various phases of the market, not just in 
high-yield bonds, but in other places, too.
    What is the outlook for credit quality and availability? 
Should we be concerned?
    What should we do?
    Chairman Greenspan. Senator, there were difficulties at the 
beginning of the year as a consequence of a very significant 
erosion in the latter part of December. We had problems with 
so-called secondary commercial paper, the so-called A2/P2 
paper. We had difficulties with so-called junk bonds and the 
spreads were very wide. They have since come down quite 
appreciably.
    We have had, as you know, evidence of tightening credit 
conditions by our commercial banks. They are tightened.
    They have put some pressure on some borrowers. But, 
overall, the quality of credit is easing, if anything. And I 
don't consider that there are serious problems out there.
    There are the usual credit quality problems you have when 
the rates of growth fall down. But, again, we are not in a 
position where anything terribly worrisome is occurring. And we 
hope that, as this pall of uncertainty which has gripped the 
economy gradually dissipates, as it will eventually--I don't 
know when, but I know that it always has--then the markets ease 
up and we are back to normal. But we are nowhere near where we 
were at some point in 1998, which was really marginally scary.
    Senator Schumer. Thank you, Mr. Chairman.
    Senator Allard. Senator Corzine.
    Senator Corzine. Yes, thank you, Mr. Chairman.
    Remarkable display of objectivity and, I think, acumen, 
even on the 30-year bond, Mr. Chairman.
    There was one clarification that I would love to hear you 
comment on that you mentioned a number of times.
    The preference for tax cuts versus expenditures is clearly 
a priority that you talk about. But, certainly, there must be 
some expenditures--FAA computers, computer systems for wire 
transfers that the Fed might want at some point in time.
    There are instances where expenditures produce productivity 
that I think some clarification on how you look at that as 
opposed to a black and white statement.
    Chairman Greenspan. I think that is a very good point. I am 
very glad you raise it, Senator. Obviously, there are 
innumerable types of activities which you can engage in in 
which expenditure projects do have a very clear rate of return 
in the sense of what they can do to the economy, leaving aside 
the secondary issues of the broader indirect relationships like 
education and all of that.
    I would just say that it is important to scrub all 
expenditure programs to be sure that they are efficient, 
effective, and they work. There is, regrettably, too little of 
that in my experience. And rather than draw the line 
unequivocally, I do think that the weight of the evidence is 
very heavy on giving back taxes that you don't need rather than 
spend them. Having said that, there is no question that there 
are a lot of projects which very readily are quite desirable.
    The Defense budget is a crucial issue in which those types 
of evaluations are very important and very difficult.
    Senator Corzine. Thank you.
    Senator Allard. Okay. We will go ahead and call it to a 
close.
    I would just make the comment that it seems like we have 
two sets of standards--one that gets applied to tax cuts and a 
different standard that gets applied to spending.
    It will be interesting to see how our budget deliberations 
go as we move through the year. So we will go ahead and call 
the hearing to a close.
    [Whereupon, at 1:16 p.m., the hearing was adjourned.]
    [Prepared statements, response to written questions, and 
additional material for the record follow:]
               PREPARED STATEMENT OF SENATOR WAYNE ALLARD
    I want to welcome Chairman Greenspan. It is a pleasure to serve on 
both the Banking and Budget Committees where I get the opportunity to 
frequently hear from the Chairman.
    We operate today under a new format, with the Fed Chairman focusing 
on a report on monetary policy. This makes more sense than the old 
Humphrey-Hawkins format, and is a welcome change.
    I expect that in addition to a thorough review of monetary policy, 
we will also have a heated discussion of tax and budget policy.
    As I have stated repeatedly in these forums, I support a plan to 
use the surplus to pay off the national debt. However, as the Chairman 
pointed out during his recent Budget Committee testimony, we now have a 
projected surplus over the next decade that will accommodate both debt 
reduction and tax relief.
    With a nearly $6 trillion surplus, there is certainly room for a 
$1.6 trillion tax cut. This assumes of course that we keep Federal 
spending growth in check.
    I look forward to Chairman Greenspan's testimony.
                               ----------
               PREPARED STATEMENT OF SENATOR JIM BUNNING
    Mr. Chairman, I appreciate your calling this hearing and I 
appreciate Chairman Greenspan's willingness to come before the 
committee to testify today.
    While I am relieved Chairman Greenspan finally lowered lending 
rates in January, I am very concerned that the Fed's action has come 
too late. I believe the Nation's economy showed signs of slowing 
throughout the fourth quarter of last year, and I was absolutely 
flabbergasted the FOMC did not lower rates in December. Now we are in a 
period of economic slowdown that looks more and more like a recession. 
I do not believe this slowdown was inevitable. I do believe that the 
FOMC's actions can only be classified as too little, too late.
    I have made no secret of my concerns that the FMOC, and especially 
the Chairman, seems to be focusing on inflation fires that do not 
exist. I fear that the Chairman's preoccupation with inflation has 
caused the FMOC to get behind the curve.
    Chairman Greenspan, I realize the job you have is a very difficult 
one, we essentially ask you to predict the future by watching the 
present and researching the past. Your track record, although I have 
not agreed with every decision the Fed has made, is generally sound. 
But I believe you missed the boat on this current economic slowdown; 
quicker action by the FOMC may have prevented it.
    I believe the FOMC should drop rates further. Banks are tightening 
credit standards because of the fear of a worsening economy. In fact, 
on February 5, 2001, the Federal Reserve Board said in its January 2001 
Senior Loan Officer Opinion Survey on Bank Lending Practices, ``In 
general, banks indicated that the most important reason for tightening 
standards and terms were a worse economic outlook and a reduced 
tolerance for risk.'' The Fed should drop rates further to pump new 
capital into the economy. There is no threat of inflation on the 
horizon; it is way past time to jumpstart the economy.
    As the Chairman of the Subcommittee on Economic Policy, I would 
like to invite the Chairman to come before our subcommittee soon to 
testify about the Fed's policies. I hope that you will be able to find 
time in your schedule to come talk to us.
    Once again, Mr. Chairman, I thank you for holding this hearing and 
I thank Chairman Greenspan for testifying. I have submitted a few 
questions for the record. I look forward to the Chairman's answers.
    Thank you Mr. Chairman.
                               ----------
                  PREPARED STATEMENT OF ALAN GREENSPAN
       Chairman, Board of Governors of the Federal Reserve System
                           February 13, 2001
    I appreciate the opportunity this morning to present the Federal 
Reserve's semiannual report on monetary policy.
    The past decade has been extraordinary for the American economy and 
monetary policy. The synergies of key technologies markedly elevated 
prospective rates of return on high-tech investments, led to a surge in 
business capital spending, and significantly increased the underlying 
growth rate of productivity. The capitalization of those higher 
expected returns boosted equity prices, contributing to a substantial 
pickup in household spending on new homes, durable goods, and other 
types of consumption generally, beyond even that implied by the 
enhanced rise in real incomes.
    When I last reported to you in July, economic growth was just 
exhibiting initial signs of slowing from what had been an exceptionally 
rapid and unsustainable rate of increase that began a year earlier.
    The surge in spending had lifted the growth of the stocks of many 
types of consumer durable goods and business capital equipment to rates 
that could not be 
continued. The elevated level of light vehicle sales, for example, 
implied a rate of increase in the number of vehicles on the road hardly 
sustainable for a mature 
industry. And even though demand for a number of high-tech products was 
doubling or tripling annually, in many cases new supply was coming on 
even faster. Overall, capacity in high-tech manufacturing industries 
rose nearly 50 percent last year, 
well in excess of its rapid rate of increase over the previous 3 years. 
Hence, a temporary glut in these industries and falling prospective 
rates of return were inevitable at some point. Clearly, some slowing in 
the pace of spending was necessary and expected if the economy was to 
progress along a balanced and sustainable growth path.
    But the adjustment has occurred much faster than most businesses 
anticipated, with the process likely intensified by the rise in the 
cost of energy that has drained business and household purchasing 
power. Purchases of durable goods and investment in capital equipment 
declined in the fourth quarter. Because the extent of the slowdown was 
not anticipated by businesses, it induced some backup in inventories, 
despite the more advanced just-in-time technologies that have in recent 
years 
enabled firms to adjust production levels more rapidly to changes in 
demand. Inventory-sales ratios rose only moderately; but relative to 
the levels of these ratios implied by their downtrend over the past 
decade, the emerging imbalances appeared considerably larger. 
Reflecting these growing imbalances, manufacturing purchasing managers 
reported last month that inventories in the hands of their customers 
had risen to excessively high levels.
    As a result, a round of inventory rebalancing appears to be in 
progress. Accordingly, the slowdown in the economy that began in the 
middle of 2000 intensified, perhaps even to the point of growth 
stalling out around the turn of the year. As the economy slowed, equity 
prices fell, especially in the high-tech sector, where previous high 
valuations and optimistic forecasts were being reevaluated, resulting 
in significant losses for some investors. In addition, lenders turned 
more cautious. This tightening of financial conditions, itself, 
contributed to restraint on spending.
    Against this background, the Federal Open Market Committee (FOMC) 
undertook a series of aggressive monetary policy steps. At its December 
meeting, the FOMC shifted its announced assessment of the balance of 
risks to express concern about economic weakness, which encouraged 
declines in market interest rates. Then on January 3, and again on 
January 31, the FOMC reduced its targeted Federal funds rate \1/2\ 
percentage point, to its current level of 5\1/2\ percent. An essential 
precondition for this type of response was that underlying cost and 
price pressures remained subdued, so that our front-loaded actions were 
unlikely to jeopardize the stable, low inflation environment necessary 
to foster investment and advances in productivity.
    The exceptional weakness so evident in a number of economic 
indicators toward the end of last year (perhaps in part the consequence 
of adverse weather) apparently did not continue in January. But with 
signs of softness still patently in evidence at the time of its January 
meeting, the FOMC retained its sense that the risks are weighted toward 
conditions that may generate economic weakness in the foreseeable 
future.
    Crucial to the assessment of the outlook and the understanding of 
recent policy actions is the role of technological change and 
productivity in shaping near-term cyclical forces as well as long-term 
sustainable growth.
    The prospects for sustaining strong advances in productivity in the 
years ahead remain favorable. As one would expect, productivity growth 
has slowed along with the economy. But what is notable is that, during 
the second half of 2000, output per hour advanced at a pace 
sufficiently impressive to provide strong support for the view that the 
rate of growth of structural productivity remains well above its pace 
of a decade ago.
    Moreover, although recent short-term business profits have softened 
considerably, most corporate managers appear not to have altered to any 
appreciable extent their long-standing optimism about the future 
returns from using new technology. A 
recent survey of purchasing managers suggests that the wave of new on-
line 
business-to-business activities is far from cresting. Corporate 
managers more generally, rightly or wrongly, appear to remain 
remarkably sanguine about the potential for innovations to continue to 
enhance productivity and profits. At least this is what is gleaned from 
the projections of equity analysts, who, one must presume, obtain most 
of their insights from corporate managers. According to one prominent 
survey, the 3- to 5-year average earnings projections of more than a 
thousand analysts, though exhibiting some signs of diminishing in 
recent months, have generally held firm at a very high level. Such 
expectations, should they persist, bode well for continued strength in 
capital accumulation and sustained elevated growth of structural 
productivity over the longer term.
    The same forces that have been boosting growth in structural 
productivity seem also to have accelerated the process of cyclical 
adjustment. Extraordinary improvements in business-to-business 
communication have held unit costs in check, in part by greatly 
speeding up the flow of information. New technologies for supply chain 
management and flexible manufacturing imply that businesses can 
perceive imbalances in inventories at a very early stage--virtually in 
real time--and can cut production promptly in response to the 
developing signs of unintended inventory building.
    Our most recent experience with some inventory backup, of course, 
suggests that surprises can still occur and that this process is still 
evolving. Nonetheless, compared with the past, much progress is 
evident. A couple of decades ago, inventory data would not have been 
available to most firms until weeks had elapsed, delaying a response 
and, hence, eventually requiring even deeper cuts in production. In 
addition, the foreshortening of lead times on delivery of capital 
equipment, a result of information and other newer technologies, has 
engendered a more rapid adjustment of capital goods production to 
shifts in demand that result from changes in firms' expectations of 
sales and profitability. A decade ago, extended backlogs on capital 
equipment meant a more stretched-out process of production adjustments.
    Even consumer spending decisions have become increasingly 
responsive to changes in the perceived profitability of firms through 
their effects on the value of households' holdings of equities. Stock 
market wealth has risen substantially relative to income in recent 
years--itself a reflection of the extraordinary surge of innovation. As 
a consequence, changes in stock market wealth have become a more 
important determinant of shifts in consumer spending relative to 
changes in current household income than was the case just 5 to 7 years 
ago.
    The hastening of the adjustment to emerging imbalances is generally 
beneficial. It means that those imbalances are not allowed to build 
until they require very large corrections. But the faster adjustment 
process does raise some warning flags. Although the newer technologies 
have clearly allowed firms to make more informed decisions, business 
managers throughout the economy also are likely responding to much of 
the same enhanced body of information. As a consequence, firms appear 
to be acting in far closer alignment with one another than in decades 
past. The result is not only a faster adjustment, but one that is 
potentially more synchronized, compressing changes into an even shorter 
time frame.
    This very rapidity with which the current adjustment is proceeding 
raises another concern, of a different nature. While technology has 
quickened production adjustments, human nature remains unaltered. We 
respond to a heightened pace of change and its associated uncertainty 
in the same way we always have. We withdraw from action, postpone 
decisions, and generally hunker down until a renewed, more 
comprehensible basis for acting emerges. In its extreme manifestation, 
many economic decisionmakers not only become risk averse but attempt to 
disengage from all risk. This precludes taking any initiative, because 
risk is inherent in every action. In the fall of 1998, for example, the 
desire for liquidity became so intense that financial markets seized 
up. Indeed, investors even tended to shun risk-free, previously issued 
Treasury securities in favor of highly liquid, recently issued Treasury 
securities.
    But even when decisionmakers are only somewhat more risk averse, a 
process of retrenchment can occur. Thus, although prospective long-term 
returns on new high-tech investment may change little, increased 
uncertainty can induce a higher discount of those returns and, hence, a 
reduced willingness to commit liquid resources to illiquid fixed 
investments.
    Such a process presumably is now under way and arguably may take 
some time to run its course. It is not that underlying demand for 
Internet, networking, and communications services has become less keen. 
Instead, as I noted earlier, some suppliers seem to have reacted late 
to accelerating demand, have overcompensated in response, and then have 
been forced to retrench--a not--unusual occurrence in business 
decisionmaking.
    A pace of change outstripping the ability of people to adjust is 
just as evident among consumers as among business decisionmakers. When 
consumers become less secure in their jobs and finances, they retrench 
as well.
    It is difficult for economic policy to deal with the abruptness of 
a break in confidence. There may not be a seamless transition from high 
to moderate to low confidence on the part of businesses, investors, and 
consumers. Looking back at recent cyclical episodes, we see that the 
change in attitudes has often been sudden. In earlier testimony, I 
likened this process to water backing up against a dam that is finally 
breached. The torrent carries with it most remnants of certainty and 
euphoria that built up in earlier periods.
    This unpredictable rending of confidence is one reason that 
recessions are so difficult to forecast. They may not be just changes 
in degree from a period of economic expansion, but a different process 
engendered by fear. Our economic models have never been particularly 
successful in capturing a process driven in large part by nonrational 
behavior.
    Although consumer confidence has fallen, at least for now it 
remains at a level that in the past was consistent with economic 
growth. And as I pointed out earlier, expected earnings growth over the 
longer-run continues to be elevated. If the forces contributing to 
long-term productivity growth remain intact, the degree of retrenchment 
will presumably be limited. Prospects for high productivity growth 
should, with time, bolster both consumption and investment demand. 
Before long in this scenario, excess inventories would be run off to 
desired levels.
    Still, as the FOMC noted in its last announcement, for the period 
ahead, downside risks predominate. In addition to the possibility of a 
break in confidence, we don't know how far the adjustment of the stocks 
of consumer durables and business capital equipment has come. Also, 
foreign economies appear to be slowing, which could dampen demands for 
exports; and, although some sectors of the financial markets have 
improved in recent weeks, continued lender nervousness still is in 
evidence in other sectors.
    Because the advanced supply chain management and flexible 
manufacturing technologies may have quickened the pace of adjustment in 
production and incomes and correspondingly increased the stress on 
confidence, the Federal Reserve has seen the need to respond more 
aggressively than had been our wont in earlier decades. Economic 
policymaking could not, and should not, remain unaltered in the face of 
major changes in the speed of economic processes. Fortunately, the very 
advances in technology that have quickened economic adjustments have 
also enhanced our capacity for real-time surveillance.
    As I pointed out earlier, demand has been depressed by the rise in 
energy prices as well as by the needed slowing in the pace of 
accumulation of business capital and consumer durable assets. The sharp 
rise in energy costs pressed down on profit margins still further in 
the fourth quarter. About a quarter of the rise in total unit costs of 
nonfinancial, nonenergy corporations reflected a rise in energy costs. 
The 12 percent rise in natural gas prices last quarter contributed 
directly, and indirectly through its effects on the cost of electrical 
power generation, about one fourth of the rise in overall energy costs 
for nonfinancial, non-energy corporations; increases in oil prices 
accounted for the remainder.
    In addition, a significant part of the margin squeeze not directly 
attributable to higher energy costs probably has reflected the effects 
of the moderation in consumer outlays that, in turn, has been due in 
part to higher costs of energy, especially for natural gas. It is 
likely that energy cost increases contributed significantly more to the 
deteriorating profitability of nonfinancial, non-energy corporations in 
the fourth quarter than is suggested by the energy-related rise in 
total unit costs alone.
    To be sure, the higher energy expenses of households and most 
businesses represent a transfer of income to producers of energy. But 
the capital investment of domestic energy producers, and, very likely, 
consumption by their owners, have provided only a small offset to the 
constraining effects of higher energy costs on spending by most 
Americans. Moreover, a significant part of the extra expense is sent 
overseas to foreign energy producers, whose demand for exports from the 
United States is unlikely to rise enough to compensate for the 
reduction in domestic spending, especially in the short-run. Thus, 
given the evident inability of energy users, constrained by intense 
competition for their own products, to pass on much of their cost 
increases, the effects of the rise in energy costs does not appear to 
have had broad inflationary effects, in contrast to some previous 
episodes when inflation expectations were not as well anchored. Rather, 
the most prominent effects have been to depress aggregate demand. The 
recent decline in energy prices and further declines anticipated by 
futures markets, should they occur, would tend to boost purchasing 
power and be an important factor supporting a recovery in demand growth 
over coming quarters.
Economic Projections
    The members of the Board of Governors and the Reserve Bank 
presidents foresee an implicit strengthening of activity after the 
current rebalancing is over, although the central tendency of their 
individual forecasts for real GDP still shows a substantial slowdown, 
on balance, for the year as a whole. The central tendency for real GDP 
growth over the four quarters of this year is 2 to 2\1/2\ percent. 
Because this average pace is below the rise in the economy's potential, 
they see the unemployment rate increasing to about 4\1/2\ percent by 
the fourth quarter of this year. The central tendency of their 
forecasts for inflation, as measured by the prices for personal 
consumption expenditures, suggests an abatement to 1\3/4\ to 2\1/4\ 
percent over this year from 2\1/2\ percent over 2000.
Government Debt Repayment and the Implementation of Monetary Policy
    Federal budget surpluses have bolstered national saving, providing 
additional resources for investment and, hence, contributing to the 
rise in the capital stock and our standards of living. However, the 
prospective decline in Treasury debt outstanding implied by projected 
Federal budget surpluses does pose a challenge to the implementation of 
monetary policy. The Federal Reserve has relied almost exclusively on 
increments to its outright holdings of Treasury securities as the 
``permanent'' asset counterpart to the uptrend in currency in 
circulation, our primary liability. Because the market for Treasury 
securities is going to become much less deep and liquid if outstanding 
supplies shrink as projected, we will have to turn to acceptable 
substitutes. Last year the Federal Reserve System initiated a study of 
alternative approaches to managing our portfolio.
    At its late January meeting, the FOMC discussed this issue at 
length, and it is taking several steps to help better position the 
Federal Reserve to address the alternatives. First, as announced on 
January 31, the Committee extended the temporary authority, in effect 
since late August 1999, for the Trading Desk at the Federal 
Reserve Bank of New York to conduct repurchase agreements in mortgage-
backed securities guaranteed by the agencies as well as in Treasuries 
and direct agency debt. Thus, for the time being, the Desk will 
continue to rely on the same types of temporary open market operations 
in use for the past year and a half to offset transitory factors 
affecting reserve availability.
    Second, the FOMC is examining the possibility of beginning to 
acquire under repurchase agreements some additional assets that the 
Federal Reserve Act already authorizes the Federal Reserve to purchase. 
In particular, the FOMC asked the staff to explore the possible 
mechanisms for backing our usual repurchase operations with the 
collateral of certain debt obligations of U.S. States and foreign 
governments. We will also be consulting with the Congress on these 
possible steps before the FOMC further considers such transactions. 
Taking such assets in repurchase operations would significantly expand 
and diversify the assets our counterparties could post in temporary 
open market operations, reducing the potential for any impact on the 
pricing of private sector instruments.
    Finally, the FOMC decided to study further the even longer-term 
issue of whether it will ultimately be necessary to expand the use of 
the discount window or to request the Congress for a broadening of its 
statutory authority for acquiring assets via open market operations. 
How quickly the FOMC will need to address these longer-run portfolio 
choices will depend on how quickly the supply of Treasury securities 
declines as well as the usefulness of the alternative assets already 
authorized by law.
    In summary, although a reduced availability of Treasury securities 
will require adjustments in the particular form of our open market 
operations, there is no reason to believe that we will be unable to 
implement policy as required.

  RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM ALAN 
                           GREENSPAN

Q.1. I believe the Fed's lack of action in November and 
December helped ensure that we would have a recession. Now that 
we have a recession, how rapidly must rates be cut in order to 
turn around the economy? Could tax cuts alone help quickly 
enough to help prevent a further economic slowdown?

Q.2. Why did the Fed not cut rates in November and December 
when economic indicators were already turning downward?

Q.3. If the Fed was able to cut rates by a half-point at the 
emergency meeting in early January, couldn't rates have been 
cut even further for needed stimulus in late January?

Q.4. Do the Fed's economic models need to be updated? If they 
did not accurately forecast the recession, then they need to be 
changed. If they did accurately forecast, then why didn't the 
Fed act?

    Taken together, your questions raise issues about the 
timing and magnitude of the Federal Reserve's response to 
emerging economic weakness. In the second half of 1999 and 
first half of 2000, overall investment demand outstripped the 
available savings. The imbalance that developed threatened to 
destabilize the economy. It drove real long-term interest rates 
up substantially through this period, and in order to contain 
the imbalances the FOMC increased its policy interest rate. 
After mid-2000, the rate of economic growth slowed 
significantly, suggesting that the adjustment toward more 
sustainable economic expansion was under way; long-term 
interest rates began to come down and financial markets took 
out the further Federal Reserve tightening previously thought 
to be necessary. Had the Federal Reserve firmed policy by less 
last spring or eased rates much sooner last fall, it was our 
judgment that we would have risked short-circuiting this needed 
adjustment. The likely result would have been broader and 
deeper imbalances that eventually would trigger a far more 
difficult economic correction than we are currently 
experiencing.
    In the event, the slowing in the economy late last year was 

greater than we or most other economic analysts anticipated. As 
I explained at greater length in my testimony, it appears that 
the 
rapidity and unexpected nature of the weakening owe importantly 

to recent advances in information technology that have enabled 
businesses to respond much more quickly than we anticipated to 
impending overhangs of inventory and plant capacity.
    As soon as it became evident that the economy was softening 

by more than was necessary to contain imbalances and foster 
sustainable economic expansion, we began to reduce the Federal 
funds rate. Because business conditions were weakening 
unusually 
rapidly, our policy shift also needed to be unusually prompt 
and 
forceful. The adjustment of the stocks of inventories and 
capital 
equipment after the unsustainable buildups of late 1999 and 
early 2000 is still under way, the Federal Reserve continues to 
watch the situation carefully to gauge the appropriate policy 
response.
    The structure of the economy is always evolving, and 
consequently the Federal Reserve is continuously updating its 
understanding of how the economy works and how policy should 
most 
appropriately respond to emerging economic and financial 
developments. While we use economic models fit to historical 
data in that process, policymaking involves looking at all 
available information and exercising a substantial element of 
judgment based on our analysis of the implications of recent 
trends.
    You also asked about the possibility that tax cuts alone 
could prevent further economic slowdown. As I noted in my 
discussion with the Senate Budget Committee, history suggests 
that because of unavoidable delays in passage and 
implementation, tax cuts rarely become effective at the time 
they are most needed to spur activity. That said, if tax 
reductions are in train in order to tailor a sensible path 
toward zero debt without subsequent private asset accumulation 
by the Federal Government, making them effective sooner rather 
than later could prove helpful should the current economic 
weakness persist. In any event, clearly, the Federal Reserve is 
not relying on fiscal initiatives to restore sustainable 
economic expansion, but is actively adjusting its policy stance 
to promote that objective.

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