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75–469 PDF 2001

S. HRG. 107–147

FEDERAL RESERVE’S SECOND 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 PURSUANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978

JULY 24, 2001

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

(

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

PAUL S. SARBANES, Maryland, Chairman

CHRISTOPHER J. DODD, Connecticut

TIM JOHNSON, South Dakota

JACK REED, Rhode Island

CHARLES E. SCHUMER, New York

EVAN BAYH, Indiana

ZELL MILLER, Georgia

THOMAS R. CARPER, Delaware

DEBBIE STABENOW, Michigan

JON S. CORZINE, New Jersey

DANIEL K. AKAKA, Hawaii

PHIL GRAMM, Texas

RICHARD C. SHELBY, Alabama

ROBERT F. BENNETT, Utah

WAYNE ALLARD, Colorado

MICHAEL B. ENZI, Wyoming

CHUCK HAGEL, Nebraska

RICK SANTORUM, Pennsylvania

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

JOHN ENSIGN, Nevada

STEVEN B. HARRIS, Staff Director and Chief Counsel

WAYNE A. ABERNATHY, Republican Staff Director

MARTIN J. GRUENBERG, Senior Counsel

GEORGE E. WHITTLE, Editor

(II)

CONTENTS

TUESDAY, JULY 24, 2001

Page

Opening statement of Chairman Sarbanes ........................................................... 1

Opening statements, comments, or prepared statements of:

Senator Gramm ................................................................................................ 3

Senator Dodd .................................................................................................... 5

Senator Bennett ................................................................................................ 6

Senator Reed ..................................................................................................... 6

Senator Allard ................................................................................................... 7

Senator Bayh .................................................................................................... 7

Senator Enzi ..................................................................................................... 7

Senator Miller ................................................................................................... 7

Senator Bunning ............................................................................................... 7

Senator Carper ................................................................................................. 8

Senator Stabenow ............................................................................................. 8

Senator Corzine ................................................................................................ 9

Prepared statement ................................................................................... 47

Senator Ensign ................................................................................................. 34

WITNESS

Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, Washington, DC ........................................................................................... 10

Prepared statement .......................................................................................... 47

Response to written questions of:

Senator Sarbanes ...................................................................................... 53

Senator Ensign .......................................................................................... 56

Senator Schumer ....................................................................................... 57

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Monetary Policy Report to the Congress, July 24, 2001 ....................................... 58

(III)

(1)

FEDERAL RESERVE’S SECOND MONETARY

POLICY REPORT FOR 2001

TUESDAY, JULY 24, 2001

U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC.

The Committee met at 10:05 a.m., in room SH–216 of the Hart

Senate Office Building, Senator Paul S. Sarbanes (Chairman of the

Committee) presiding.

OPENING STATEMENT OF SENATOR PAUL S. SARBANES

Chairman SARBANES. The Committee will come to order. I am

very pleased this morning to welcome Chairman Greenspan before

the Committee on Banking, Housing and Urban Affairs, to testify

on the Federal Reserve’s SemiAnnual Monetary Policy Report to

the Congress.

I do want to note for the Members that once we have a quorum,

I intend to interrupt our proceedings in order to lay before the

Committee the nomination of Harvey Pitt, to be a Member of the

Securities and Exchange Commission.

We held that hearing, as Members will recall, last Thursday, and

we want to move the nomination forward. As soon as we have a

full quorum, we will turn to that, presumably, very briefly. I think

it will go very quickly.

The oversight hearings traditionally held by the House and Senate banking committees on the Federal Reserve’s monetary policy

report were given a statutory basis in legislation last year, which

Senator Gramm and I and other Members of the Committee developed, in consultation, I might note, with the Federal Reserve.

These hearings have come to play, in my view, an important role

in informing the Congress, the financial community, and the general public about the conduct of monetary policy by the Fed. And

I want to thank Senator Gramm for his very constructive contribution in crafting last year’s legislation, and I am pleased the Committee is holding this hearing pursuant to the authorities that were

provided in that legislation.

We now confront a troubling outlook for the U.S. economy. While

excess inventories have been reduced, we still seem to face continuing downward pressures, both from weakening domestic investment activity and weakening export markets.

In the last year, U.S. economic growth has been sluggish, too

slow to keep the unemployment rate from rising. On Friday of this

week, the Commerce Department will release the report on ecoVerDate 11-MAY-2000 09:19 Apr 10, 2002 Jkt 000000 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 75469.TXT SBANK4 PsN: SBANK4
2

nomic growth in the second quarter and it is expected to show the

fourth consecutive quarter of slow growth.

Private-sector job count has fallen by 350,000 in the last 3

months. Initial claims for unemployment insurance stand at the

highest level since the last period of rising unemployment during

and after the last recession.

The Fed’s index of manufacturing output has dropped 5 percent,

5.0 percent, in the last 9 months, which is almost the 5.3 percent

drop that was experienced in the last recession. The unemployment

rate has already risen by 6 tenths of a percentage point to 41⁄2 percent. It would have risen to 51⁄2 percent, had there not been such

a large exodus from the labor market over the last year.

On the positive side, inflation at both the consumer and producer

levels appears to be under control. Core inflation of personal consumption expenditures, which is a different measure than the CPI,

was only 1.7 percent in the last year. The core producer price index

is up only 1.6 percent. In both cases, these levels are little different

from the average rate of core inflation for the entire expansion.

Wage pressures also appear to be contained.

Consumer spending, which has been the principal source of

growth, has held up, despite the weakness of the economy and the

decline in the stock market. But whether that will be sustained

remains to be seen.

It is also hoped that the business inventories that have been

shrinking all year will soon get down to the desired level and begin

to add growth to the economy rather than subtract from it.

To its credit, the Federal Reserve has lowered interest rates repeatedly over the past 6 months. I would point out, however, that

the real Federal funds rate—in other words, when measured relative to the core rate of inflation—is still above, well above the

levels to which the Federal Reserve lowered the real Federal funds

rates in the last economic downturn and the ensuing recovery.

And that is a matter that I hope to pursue with the Chairman

in the question period.

There are obviously a great many questions about the outlook for

the United States and the world economy which the Committee

will want to raise with Chairman Greenspan this morning and I,

like my colleagues, look forward to hearing his statement and his

responses to our questions.

Senator Gramm.

Senator GRAMM. Mr. Chairman, I understand a quorum is now

present. Do you want to go ahead and do the vote before I speak?

Chairman SARBANES. Yes, why don’t we go ahead and do that.

A quorum is now present. I ask unanimous consent that we consider the nomination of Harvey L. Pitt to be a Member of the Securities and Exchange Commission, for the remainder of the term of

Paul Carey, a term which expires June 5, 2002, and for a subsequent term expiring June 5, 2007.

The Clerk will call the roll.

The CLERK. Chairman Sarbanes.

Chairman SARBANES. Aye.

The CLERK. Mr. Dodd.

Senator DODD. Aye.

The CLERK. Mr. Johnson.

3

Senator SARBANES. Aye, by proxy.

The CLERK. Mr. Reed.

Senator REED. Aye.

The CLERK. Mr. Schumer.

Senator SCHUMER. Aye.

The CLERK. Mr. Bayh.

Senator BAYH. Aye.

The CLERK. Mr. Miller.

Senator MILLER. Aye.

The CLERK. Mr. Carper.

Senator CARPER. Aye.

The CLERK. Ms. Stabenow.

Senator STABENOW. Aye.

The CLERK. Mr. Corzine.

Senator CORZINE. Aye.

The CLERK. Mr. Akaka.

Senator SARBANES. Aye, by proxy.

The CLERK. Mr. Gramm.

Senator GRAMM. Aye.

The CLERK. Mr. Shelby.

Senator GRAMM. Aye, by proxy.

The CLERK. Mr. Bennett.

Senator BENNETT. Aye.

The CLERK. Mr. Allard.

Senator ALLARD. Aye.

The CLERK. Mr. Enzi.

Senator ENZI. Aye.

The CLERK. Mr. Hagel.

Senator GRAMM. Aye, by proxy.

The CLERK. Mr. Santorum.

Senator GRAMM. Aye, by proxy.

The CLERK. Mr. Bunning.

Senator BUNNING. Aye.

The CLERK. Mr. Crapo.

Senator GRAMM. Aye, by proxy.

The CLERK. Mr. Ensign.

Senator GRAMM. Aye, by proxy.

The CLERK. The ayes are 21, the noes are zero, Mr. Chairman.

Chairman SARBANES. Very good. The Committee will report the

nomination of Harvey Pitt to the Senate. We will leave the record

open so that those Members who are not present and had not left

a proxy have an opportunity to vote.

Senator Gramm.

OPENING STATEMENT OF SENATOR PHIL GRAMM

Senator GRAMM. Well, Mr. Chairman, first I want to thank you

for the prompt attention you have given to the President’s nominees. I think it is very important that we confirm people for these

financial positions, especially positions like Chairman of the SEC.

Your leadership has been very constructive toward achieving

that goal, and I want to thank you again for this quick action.

Chairman Greenspan, I want to welcome you back before the

Committee.

4

I think it is clear, in looking at our economic circumstances, that

we are in a slowdown, and at this point, everyone is trying to determine exactly what is happening in the economy.

It is obvious to me this is not a traditional post-World War II

slowdown or recession. It is further obvious to me that when, several years back, you were talking about irrational exuberance, you

were right.

I have tried, in the limited amount of time that I have had to

think about this problem, to look at what was happening in terms

of the economy, the acceleration of economic growth, and the reaction of the capital market.

Perhaps now we can say with more certainty than we could then,

that there was an over-reaction.

Clearly, just as the explosion in equity values had a positive impact on investment, as people sought to get in front of this technological explosion, the readjustment, the restructuring, the bursting

of this speculative bubble has had the opposite effect in terms of

investment.

I wonder if we are not in some new situation that is very parallel

to old business cycles.

If I had time, I would go back and read some of the stuff that

we read as graduate students on business cycles that were primarily produced by over-reactions to spurts in technological growth

and the speculative bubbles that result from it.

It is also clear now that we made the right decision in passing

the tax cut. If we had known then what we know now, we might

have been more expansive.

Obviously, now we are caught up in some political gamesmanship of debating whether we should have done the tax cuts and

were they too big or too small?

I think there is, to some extent, a potential debate as to whether

the economy, if this slowdown continues, can carry the big surplus

that we are running.

I hope it can. I like paying off debt. I would like to begin to take

the Social Security surplus and see it invested.

But I think that is a decision we are going to have to make as

we get further along.

I know everyone is interested in hearing you, Mr. Chairman. I

am grateful, at this moment, when there is some uncertainty, that

we have someone as knowledgeable and thoughtful as you.

I conclude, Mr. Chairman, by saying that, despite the decline in

equity values, I still cannot imagine a safer investment than the

long-term future of the American economy, unless it is investing in

Texas.

[Laughter.]

As I tell people, when they come visit my State, if a long-term

investment in Texas is not a good investment, there is not a good

investment on the planet. And, to a very slightly lesser extent, you

can say that about the American economy.

So uncertainties are out there. But when you look at the longterm future, an investment in America and an investment in American equity is still the best long-term investment you can make.

And in the end, if that is not a good investment, then there is no

good investment.

5

And so, Mr. Chairman, thank you for your great work. This Committee is certainly proud of its friendship and association with you.

Chairman SARBANES. I think I should note for the record that we

think Maryland is equally a good investment.

[Laughter.]

And I am sure that each Member of the Committee feels the

same way about his own State, and we will register that for the

record so that each Member doesn’t have to do it.

[Laughter.]

Senator GRAMM. Whether that is irrational exuberance or not, I

don’t know.

[Laughter.]

Chairman SARBANES. Senator Dodd.

OPENING STATEMENT OF SENATOR CHRISTOPHER J. DODD

Senator DODD. Texas has never been accused of irrational exuberance.

[Laughter.]

Thank you, Mr. Chairman, for allowing that unanimous consent

request to be made so that we can all be part of the record.

Let me welcome you as well, Mr. Chairman. It is a pleasure to

have you back before the Committee. We have had you here in better times, obviously, as the economic indicators show. But as Senator Gramm has just said, I cannot think of anyone better I would

rather have at the helm than you at a time like this, and as we

try to sort all of this out.

Many of us here, of course, unlike my good friend from Texas,

have a different point of view with regard to the tax cut. I know

you share a similar view with that of Senator Gramm. But there

are many of us who are worried about the size of that tax cut—

not a tax cut, per se—and whether or not it is going to crowd out

our ability to do other things which also contribute to economic

growth.

I offered an amendment to the tax bill that would have reduced

that tax cut but it would have made a smaller tax cut, and invest

dollars in the infrastructure of the country.

I realize at the time, procedurally, that is hard to do in a tax bill,

to target dollars specifically to one area of the budget.

But the point I wanted to make was that I don’t know of any

period in the history of our Nation where we have ever had sustained economic growth where the physical infrastructure of America was deteriorating. And certainly, no one had to go any further

than to read the accounts of what happened to my good friend and

the Chairman’s beloved City of Baltimore in the last week or so,

the tragedy in that city.

That is a problem that could have occurred in almost any city in

this country. So I will come back to the questions on this, but I was

concerned about whether or not we are going to be able to have the

room within our budget to do this.

I am anxious to still pursue that with you a bit, the strength of

the dollar, the weakness of growth in foreign markets, making it

more difficult for us to export goods and to what extent you see

that continuing on the horizon as a serious problem for us.

6

I will get to those in due time. But, again, I do want to thank

you immensely. You have been a great pilot over the last decade

or more on these matters and I am confident that you will give us

some good advice as well, as we try and get this righted again so

that our economy can enjoy the kind of prosperity we did during

the 1990’s.

And I look forward to your testimony. Thank you.

Chairman SARBANES. Senator Bennett.

OPENING STATMENT OF SENATOR ROBERT F. BENNETT

Senator BENNETT. Thank you, Mr. Chairman.

Chairman Greenspan, welcome again with all of my colleagues.

I look forward to the questioning period. I simply want to take the

opening statement as an opportunity to thank you for your

doggedness in seeing to it that the rate reductions have been as

large as they have been.

A reading of the minutes indicates that there are some of your

colleagues in the Federal Reserve System who would have gladly

opted for 25 basis points when 50 was clearly what was needed.

And if it had not been for your leadership, 25 is probably what we

would have gotten.

In several of those circumstances, I think the rate would be

higher than the 3.75 that it is now, maybe as high as 4.75. And

I think that would make things substantially worse if we had had

that result. So, as I read the tea leaves, it has been your personal

persistence and spine that has gotten it down to 3.75. I would be

happy if it were 3.0.

I will leave that to you because your past performance has been

stellar in that area and I think it needs to be pointed out the Federal Reserve System is not unanimous. There are disagreements

within it. And it has been a time when somebody has had to step

up. And you have done it and I want you to know that it does not

go unnoticed or unappreciated.

With that, Mr. Chairman, I will pass and look forward to the testimony from our witness.

Chairman SARBANES. Thank you very much, Senator Bennett.

Senator Reed.

OPENING STATEMENT OF SENATOR JACK REED

Senator REED. Thank you very much, Mr. Chairman, and welcome, Chairman Greenspan.

As my colleagues have said, in these challenging times, we are

all grateful that your experience is there, working as Chairman of

the Federal Reserve Board.

We have some interesting developments, troubling in some respects. There is a rise in consumer debt. It seems to be rising inexorably. A decline in national and personal savings that we have to

deal with. A gap in our current account deficit that is persistent.

And then worldwide, economies seem to be softening and not responding to individual national stimulus attempts.

Nevertheless, with your stewardship, and your colleagues’, inflation remains in check and unemployment remains relatively low,

although it is beginning to edge up. Consumers continue to spend

and sustain the economy.

7

In many respects, we are at a crossroads. This morning, we hope

that you can give us some clarification of the best route to proceed

forward at this critical juncture.

I thank you for your service and look forward to your testimony.

Thank you.

Chairman SARBANES. Senator Allard.

OPENING STATEMENT OF SENATOR WAYNE ALLARD

Senator ALLARD. Thank you, Mr. Chairman. I want to thank you

for holding this hearing. And I would like to join my colleagues in

welcoming the Chairman. I am anxious to hear what he has to say

today and look forward to hearing what he has to say, particularly

about monetary policy and other economic issues.

As we are all aware, as was mentioned by some of my previous

colleagues here, America is facing increasing economic uncertainty.

And therefore, I think it is critical that Congress address the issues

of long-term solvency for Social Security and Medicare and put the

government on a plan to continue to pay down the national debt

and also continue to cut taxes.

Thank you, Mr. Chairman.

Chairman SARBANES. Senator Bayh.

OPENING STATEMENT OF SENATOR EVAN BAYH

Senator BAYH. Mr. Chairman, thank you for attending today. I

am looking forward to hearing your comments and will give my

own in response to your testimony.

Chairman SARBANES. Senator Enzi.

OPENING STATMENT OF SENATOR MICHAEL B. ENZI

Senator ENZI. Thank you, Mr. Chairman. I welcome Chairman

Greenspan and look forward to hearing his testimony.

Chairman SARBANES. It will be included in the record.

Senator Miller.

OPENING STATEMENT OF SENATOR ZELL MILLER

Senator MILLER. It is good to have you with us Chairman Greenspan I have no remarks at this time.

Chairman SARBANES. Senator Bunning.

OPENING STATMENT OF SENATOR JIM BUNNING

Senator BUNNING. Mr. Chairman, I would like to thank you for

holding this hearing and I would like to thank the Chairman of the

Federal Reserve for testifying.

Last year at this time, we were concerned that the Fed was

thinking about raising rates. The Fed very wisely did not. Things

were going pretty well last July. I know that you were very concerned about the bubble in the equity markets, especially in the

Nasdaq. But the economy was still growing at a very strong pace.

Well, obviously, much has changed in the last year. The growth

rate of the economy has slowed tremendously, almost stopped. Unemployment is up and trillions of dollars have evaporated from the

economy because of the losses in the equity markets.

As you know, I have been very critical of the Fed’s reluctance to

act last fall. I believe the Fed waited too long. I don’t think we

8

would be having the problems we are now having if the Fed had

acted sooner.

I know the Fed has a different opinion on that and I am sure

we will continue to disagree. The Fed has acted. It did not act as

quickly as I thought necessary and I think that the last Fed Fund

rate cut should have been cut substantially, 50 basis points rather

than 25.

We must get our country back on track. The Fed has cut rates

and hopefully, the President’s fiscal policy, along with the Fed’s

monetary policy moves, will fix the economy that is ailing very

badly.

Mr. Chairman, I once again thank you for coming before our

Committee and I look forward to the opportunity to talk with you

during the question and answer period.

Thank you, Mr. Chairman.

Chairman SARBANES. Thank you, Senator Bunning.

Senator Carper.

OPENING STATEMENT OF SENATOR THOMAS R. CARPER

Senator CARPER. Mr. Chairman, welcome. Far be it for me to

carp about your performance and that of the Federal Reserve.

I think you are right on target with respect to your management

of our monetary policy. And I am not going to Monday morning

quarterback what you do.

Thank you for being aggressive. Thank you for continuing to

apply your stewardship to the economic needs and direction of our

country and I look forward to your comments.

Welcome.

Chairman SARBANES. Senator Stabenow.

OPENING STATEMENT OF SENATOR DEBBIE STABENOW

Senator STABENOW. Thank you, Mr. Chairman. And Chairman

Greenspan as well. I welcome you today.

This is a time of nervousness and uncertainty and we welcome

your thoughts. I know there will be a lot of debate and discussion

this morning about the issue of tax cuts and fiscal policy.

Let me just indicate that as we are now seeing checks in the

mail, as they say, most of us on our side of the aisle wish those

in the short term had been larger. We actually had proposed something in the range of $1,000, as opposed to $300, but with more

caution in the long run, rather than locking in 10 years of decisions

at some point, doing something more substantial to help American

families and move the economy now, but with more caution in the

long run.

As to that caution, I hope that you will this morning speak as

you did in January, when you told the Senate Budget Committee,

of which I am a Member, that Congress should consider some type

of trigger along with our tax and spending decisions to make sure

that we don’t return to deficits sometime in the next 10 years,

which I am gravely concerned about.

A prominent Member of this Committee, Senator Bayh, and Senator Snowe and myself took your suggestion to heart and made a

proposal before the Senate. We achieved 49 votes, not enough to

pass it, but certainly a substantial vote for the kind of trigger that

9

would indicate that if tax cuts or spending put us back into deficits

and dipped into Social Security and Medicare, that they would be

suspended until there were revenues available to proceed with the

tax cut.

So I would certainly hope that you would respect and speak

about that, given the recent sluggishness in the economy and weak

economic projections.

Many of us are gravely concerned about what is going to happen

long term as it relates to our debt and, unfortunately, gravely concerned about putting us farther into debt in the long run and what

happens to us starting in 2011 with the baby boomers, many of us

in this room, who are beginning to retire at that point and the

strains on Social Security and Medicare.

So we welcome you again and look forward to your comments

and testimony. And I am hopeful that, as you did at the beginning

of the year, give us wise counsel about how we can proceed in a

way that does not dip into Social Security and Medicare or put us

back into large deficits, which many of us worked very, very hard

to eliminate.

Thank you, Mr. Chairman.

Chairman SARBANES. Senator Corzine.

OPENING STATEMENT OF SENATOR JON S. CORZINE

Senator CORZINE. Welcome, Mr. Chairman.

I am grateful for your insights and respected judgment. I think

it is particularly important in a period of acute uncertainty that I

think we now face, to have the kind of balance that you bring to

the judgments in monetary policy and fiscal recommendations.

I hope that we will be able to draw out some of your perspectives

on an issue that is very much in the public debate that we are now

only beginning to talk and that is the restructuring of Social Security, having many of the same kinds of implications that we faced

as we put in place what I think is a poorly framed 10-year fiscal

policy which leaves us very few options.

And so, I hope that we can wean some of those insights that you

might bring to that process into the discussion today.

I look forward to hearing your comments.

Chairman SARBANES. Thank you very much.

I just want to note for the benefit of Members and actually to the

people attending, with respect to the Harvey Pitt nomination, we

confirm him to become a member of the Securities and Exchange

Commission.

The President has the authority under the statute to choose a

chairman from amongst those composing the commission. And

President Bush has indicated his intention to name Harvey Pitt as

the Chairman. But the Congress does not actually deal with—unlike the Federal Reserve Board, where actually, we deal with the

chairmanship of the Federal Reserve Board and it comes to us for

confirmation.

And that is why the approval we gave was for membership on

the SEC and not as chairman of the SEC.

Chairman Greenspan, we are happy to turn to you and we look

forward to hearing from you.

10

STATEMENT OF ALAN GREENSPAN, CHAIRMAN, FEDERAL

RESERVE SYSTEM

Chairman GREENSPAN. Thank you, Mr. Chairman, and Members

of the Committee. I appreciate the opportunity this morning to

present the Federal Reserve’s semi-annual report on monetary policy.

I have excerpted my remarks from a rather long written text and

would appreciate the full text be included for the record.

Chairman SARBANES. The full text will be included in the record.

Chairman GREENSPAN. Monetary policy this year has confronted

an economy that slowed sharply late last year and has remained

weak this year following an extraordinary period of buoyant expansion.

By aggressively easing the stance of monetary policy, the Federal

Reserve has moved to support demand and, we trust, help lay the

groundwork for the economy to achieve maximum sustainable

growth. Our accelerated action reflected the pronounced downshift

in economic activity, which was accentuated by the especially

prompt and synchronous adjustment of production by businesses

utilizing the faster flow of information coming from the adoption of

new technologies.

A rapid and sizable easing was made possible by reasonably wellanchored inflation expectations, which helped to keep underlying

inflation at a modest rate, and by the prospect that inflation would

remain contained as resource utilization eased and energy prices

backed down.

In addition to the more accommodative stance of monetary policy, demand should be assisted going forward by the effects of the

tax cut, by falling energy costs, by the spur to production once businesses work down their inventories to more comfortable levels and,

most important, by the inducement to resume increases in capital

spending. That inducement should be provided by the continuation

of cost-saving opportunities associated with rapid technological innovation. Such innovation has been the driving force raising the

growth of structural productivity over the last half dozen years. To

be sure, measured productivity has softened in recent quarters,

but by no more than one would anticipate from cyclical influences

layered on top of a faster long-term trend.

But the uncertainties surrounding the current economic situation

are considerable, and until we see more concrete evidence that the

adjustments of inventories and capital spending are well along, the

risks would seem to remain mostly tilted toward weakness in the

economy. Still, the Federal Open Market Committee opted for a

smaller policy move at our last meeting because we recognize that

the effects of policy actions are felt with a lag, and with our cumulative 23⁄4 percentage points of easing this year, we have moved a

considerable distance in the direction of monetary stimulus. Certainly, should conditions warrant, we may need to ease further.

But we must not lose sight of the prerequisite of longer-run price

stability for realizing the economy’s full growth potential over time.

Despite the recent economic slowdown, the past decade has been

extraordinary for the American economy. The synergies of key technologies markedly elevated prospective rates of return on high-tech

investments, led to a surge in business capital spending, and sigVerDate 11-MAY-2000 09:19 Apr 10, 2002 Jkt 000000 PO 00000 Frm 00014 Fmt 6633 Sfmt 6602 75469.TXT SBANK4 PsN: SBANK4
11

nificantly increased the growth rate of structural productivity. The

capitalization of those higher expected returns lifted equity prices,

which in turn contributed to a substantial pickup in household

spending on a broad range of goods and services, especially on new

homes and durable goods. This increase in spending by both households and businesses exceeded even the enhanced rise in real

household incomes and business earnings. The evident attractiveness of investment opportunities in the United States induced

substantial inflows of funds from abroad, raising the dollar’s exchange rate while financing a growing proportion of domestic

spending.

By early 2000, the surge in household and business purchases

had increased growth of the stocks of many types of consumer durable goods and business capital equipment to rates that could not

be sustained. Overall, capacity in high-tech manufacturing industries, for example, rose nearly 50 percent last year, well in excess

of its already rapid rate of increase over the previous 3 years.

Hence, a temporary glut in these industries and falling short-term

prospective rates of return were inevitable at some point. Moreover, as I testified before this Committee last year, the economy as

a whole was growing at an unsustainable pace, drawing further on

an already diminished pool of available workers and relying increasingly on savings from abroad. Clearly, some moderation in the

pace of spending was necessary and expected if the economy was

to progress along a more balanced growth path.

In the event, the adjustment occurred much faster than most

businesses anticipated, with the slowdown likely intensified by the

rise in the cost of energy that until quite recently had drained businesses and households of purchasing power.

Moreover, weakness emerged among our trading partners in

Europe, Asia and Latin America. The interaction of slowdowns

in a number of countries simultaneously has magnified the

softening each of the individual economies would have experienced

on its own.

Some backup in inventories occurred, especially in the United

States. Innovations, such as more advanced supply-chain management and flexible manufacturing technologies have enabled firms

to adjust production levels more rapidly to changes in sales. But

these improvements apparently have not solved the thornier problem of correctly anticipating demand. Although inventory-sales

ratios in most industries rose only moderately, extrapolation of the

downtrend in inventory-sales ratios over the past decade suggests

that considerable imbalances emerged late last year.

As a result, a round of inventory rebalancing was undertaken

and the slowdown in the economy that began in the middle of 2000

intensified. The adjustment process started late last year when

manufacturers began to cut production to stem the accumulation of

unwanted inventories. But inventories did not actually begin falling until early this year as producers decreased output levels considerably further.

At some point, inventory liquidation will come to an end and its

termination will spur production and incomes. Of course, the timing and force with which that process of recovery plays out will depend on the behavior of final demand. In that regard, demand for

12

capital equipment, particularly in the near-term, could pose a continuing problem. Despite evidence that expected long-term rates of

return on the newer technologies remain high, growth of investment in equipment and software has turned decidedly negative.

Sharp increases in uncertainties about the short-term outlook have

significantly foreshortened the timeframe over which business are

requiring new capital projects to pay off.

In addition, a deterioration in sales, profitability, and cashflow

has exacerbated the weakness in capital spending. Pressures on

profit margins have been unrelenting.

Much of the squeeze on profit margins of domestic operations results from a rise in unit labor costs, which has reflected a faster

upward movement in hourly compensation, coupled with the cyclical slowdown in the growth of output per hour. In part, fixed costs,

nonlabor as well as labor, are being spread over a smaller production base for many industries.

The surge in energy costs has also pressed down on profit margins, especially in the fourth and first quarters. The decline in energy prices since the spring, however, should be contributing positively to margins in the third quarter. Moreover, the rate of increase in compensation is likely to moderate, with inflation expectations contained and labor markets becoming less taut in response

to the slower pace of growth in economic activity. In addition, continued rapid gains in structural productivity should help to suppress the rise in unit labor costs over time.

Of course, investment spending ultimately depends on the

strength of consumer demand for goods and services. Here, too,

longer-run increases in real incomes of consumers, engendered by

the rapid advances in structural productivity, should provide support to demand over time. And thus far this year, consumer spending has indeed risen further, presumably assisted in part by the

continued rapid growth in the market value of homes, from which

a significant amount of equity is being extracted. Moreover, household disposable income is now being bolstered by tax cuts.

But there are also downside risks to consumer spending over the

next few quarters. We can expect the decline in stock market

wealth that has occurred over the past year to restrain growth of

household spending relative to income, just as the previous increase gave an extra spur to household demand. Furthermore,

while most survey measures suggest consumer sentiment has stabilized recently, softer job markets can induce a further deterioration in confidence and spending intentions.

While this litany of risks should not be downplayed, it is notable

how well the U.S. economy has withstood the many negative forces

weighing on it. Economic activity has held up remarkably in the

face of a difficult adjustment toward a more sustainable pattern of

expansion.

The economic developments of the last couple of years have been

a particular challenge for monetary policy. Once the financial crises

of late 1998 that followed the Russian default eased, growing optimism, if not euphoria, about profit opportunities produced a surge

in investment that outstripped what the Nation could finance on a

sustainable basis from domestic saving and funds attracted from

abroad.

13

The shortfall showed through in a significant rise in average real

long-term corporate interest rates starting in early 1999. By June

of that year, it was evident to the Federal Open Market Committee

that to continue to hold the funds rate at the then-prevailing level

of 43⁄4 percent in the face of rising real long-term corporate rates

would have required a major infusion of liquidity into an economy

already threatening to overheat, and the Federal Open Market

Committee began to raise its Federal funds rate target.

By summer of last year, it started to become apparent that the

growth of demand finally was slowing, and seemingly by enough to

bring it into approximate alignment with the expansion of potential

supply, as indicated by the fact that the pool of available labor was

no longer being drawn down. It was well into autumn, however, before one could be confident that the growth of aggregate demand

had softened enough to bring it into a more lasting balance with

potential supply.

Growth continued to decline to a point that, by our December

meeting, the Federal Open Market Committee decided that the

time to counter cumulative economic weakness was close at hand.

We altered our assessment of the risks to the economy, and with

incoming information following the meeting continuing to be downbeat, we took our first easing action on January 3. We viewed the

faster downshift in economic activity, in part a consequence of the

technology-enhanced speed and volume of information flows, as

calling for a quicker pace of policy adjustment. Acting on that view,

we have lowered the Federal funds rate 23⁄4 percentage points since

the turn of the year, with last month’s action leaving the Federal

funds rate at 33⁄4 percent.

In reducing the Federal funds rate so substantially this year, we

have been responding to our judgment that a good part of the recent weakening of demand was likely to persist for a while and

that there were significant downside risks, even to a reduced central tendency forecast. Moreover, with inflation low and likely to be

contained, the main threat to satisfactory economic performance

appeared to come from excessive weakness in activity.

As a consequence of the policy actions of the Federal Open Market Committee, some of the stringent financial conditions evident

late last year have been eased. Real interest rates are down on a

wide variety of borrowing instruments. Private rates have benefited from some narrowing of risk premiums in many markets. And

the growth of liquidity, as measured by M2, has picked up. More

recently, incoming data on economic activity have turned from persistently negative to more mixed.

The period of sub-par economic performance, however, is not yet

over, and we are not free of the risk that economic weakness will

be greater than currently anticipated and require further policy response. That weakness could arise from softer demand from

abroad, as well as from domestic developments. But we need also

to be aware that our front-loaded policy actions this year coupled

with the tax cuts underway should be increasingly affecting economic activity as the year progresses, and for 2002, the Federal Reserve Governors and Reserve Bank Presidents see significant

growth and contained inflation.

14

As for the years beyond that horizon, there is still, in my judgment, ample evidence that we are experiencing only a pause in the

investment in a broad set of innovations that has elevated the underlying growth in productivity to a rate significantly above that of

the two decades preceding 1995. By all evidence, we are not yet

dealing with maturing technologies that, after having sparkled for

a half-decade, are now in the process of fizzling out. To the contrary, once the forces that are currently containing investment initiatives dissipate, new applications of innovative technologies

should again strengthen demand for capital equipment and restore

solid economic growth over time that benefits us all.

Thank you, Mr. Chairman. I look forward to your questions.

Chairman SARBANES. Yes, thank you, Mr. Chairman.

I am concerned by this—I hope it is not a growing sentiment

that, in a sense, nothing can be done. But it is reflected in an article this morning in The New York Times which says—first,

the lead paragraph: Despite six interest rate cuts by the Federal

Reserve this year and the possibility of more to come, analysts

say that monetary policy is packing less of a punch so far

than expected.

And one of the investment houses not too long ago stated that

a number of factors have, ‘‘blunted the power of monetary policy

compared to past easing campaigns.’’

And there seems to be a perception that the easing campaign

that the Fed has followed over the last 7 months has sort of come

close to running out the string.

The question I wanted to put to you is to take a look at the real

Federal funds rate, which is of course the market rate less core inflation.

Here’s where the Fed has us now, on the real funds rate. This

is where the Fed went to in the early 1990’s, when we had that

very significant economic downturn.

The conclusion I draw from this, and I want to ask you about

this, is that there is still substantial room for the Fed to ease in

an effort to try to stimulate the economy. And in any event, regardless of any judgment made on what the Fed has done so far, you

have done it very rapidly. I recognize that, month after month. But

what the Fed has done so far doesn’t match the actions the Fed has

taken on previous occasions, actually, under your leadership.

Your leadership has been there for a long time now, under your

leadership. And therefore, there is still room for the Fed to take

substantial measures in terms of trying to move the economy with

respect to interest rate cuts.

Would you address that?

Chairman GREENSPAN. Certainly, Mr. Chairman.

First, let me just say that, clearly, where monetary policy goes

from here will depend crucially on the evolving situation in the

economy.

With respect to the notion of the ineffectiveness of Fed policy, I

think it is important to understand that when you evaluate monetary policy, which we tend to do by disaggregating its impact in

short-term rates, long-term rates, the exchange rate, and a few

other different variables, we never quite, even after we add up all

of our evaluations of those so-called channels of monetary policy efVerDate 11-MAY-2000 09:19 Apr 10, 2002 Jkt 000000 PO 00000 Frm 00018 Fmt 6633 Sfmt 6602 75469.TXT SBANK4 PsN: SBANK4
15

fect, replicate the broader correlations that exist between monetary

policy and economic growth, in effect implying that we don’t fully

capture all of the various different channels which impact on the

economy because of movement in short-term Federal funds rates.

The article to which you refer—which is an interesting and, I

think, thoughtful article—lines up these individual items. And if

indeed that was all that was involved in the process, then I would

say that we would be concerned about what the impact of monetary

policy is.

But if you look back historically, that does not explain the full

impact. I am not saying that there is a black box or anything of

that nature. But the complexity of our economy is such, and the

way liquidity flows through the system is such, that you essentially

get very complex differences in the way monetary policy plays out.

But at the end of the day, it does seem to be effective.

Chairman SARBANES. Well, I just want to note that there is, it

seems to me, room to continue to move with respect to the real

Federal funds rate. We hope the Open Market Committee will consider that.

Let me ask you one more question because my time is about

to expire.

You say in your statement, you ask this question: Do we have

the capability to eliminate booms and busts in economic activity?

And then you say: Can fiscal and monetary policy, acting at their

optimum, eliminate the business cycle?

And then you say: The answer is no because there is no tool to

change human nature, and you develop that.

Now, is the no answer to eliminating booms and busts, or is the

no answer to eliminating the business cycle? Because we could not,

presumably, have a business cycle movement without having the

extremes of it—in other words, having booms and busts.

I am prepared to sort of entertain reasonably the one possibility,

but I am very much against entertaining the other possibility.

Did you mean to say no to both or to the notion of, well, we sort

of have a business cycle that we have to deal with. But don’t we

have the tools to prevent these extremes and have the booms and

the busts?

Chairman GREENSPAN. I think it is a question of nomenclature.

The point that I was endeavoring to make, for which I think

there is ample evidence, is that we have had business cycles before

there was a central bank or, more exactly, during the whole period

when there was no central bank in this country. And so the business cycle is such, clearly, from what historical analysis suggests

with some degree of forcefulness, that there tends to be a general

attitude amongst those who are committed to the economy, that as

things stabilize over an increasingly protracted period of time, euphoria tends to build in, and it is very difficult to contain by policy.

The point I was trying to make, not that fiscal and monetary policy are ineffectual. I am saying that to presume under all conditions that monetary and fiscal policy can create a stable, sustained,

not fluctuating economy, seems to be alien to historical data.

Chairman SARBANES. Senator Gramm.

Senator GRAMM. Well, thank you, Mr. Chairman.

16

I would just say, in adding to what you just said, that the greatest bust in American history occurred when we did have a central

bank, in the Great Depression. And I think that as economists

have looked at that period, the conclusion is that they were doing

the wrong thing.

First of all, let me say that I don’t have a firm fix on exactly

what is happening in the American economy. I guess if somebody

forced me to go into an economics classroom somewhere and give

a lecture today, trying to explain it, I would start by talking about

the end of the cold war and the release of resources from defense

to other economically productive activities.

I would talk about the failure of the Soviet Union, discrediting

not just communism, but socialism, around the world, and the profound changes that have occurred in places like South America,

with the rise of more virulent capitalism and democracy.

I would talk about the unleashing of human energy that came

from winning the cold war and, in the process, bringing enhanced

freedom to everybody, but freedom for the first time to literally

hundreds of millions of people.

And I would try to look at that in terms of what all of this unleashed in terms of new energy, new technology, new investment,

the evolution of new products, and the evolution of a new marketing system using electronic communications.

And I would guess that probably with that background, it is easy

to understand how the capital market would have had difficulty in

assimilating all this information and coming to a correct decision.

It is probably inevitable that in the process, there are periods

where investment would overrun the reality, where you would have

an effort to assess what all these changes mean to equity values,

and there have to be periods where the overassessment occurred.

Going back to the boom and the bust, since we have lived in a

golden age since roughly 1982, if this is the bust, the boom was

sure as hell worth it.

You agree with that, right?

Chairman GREENSPAN. Yes, Senator.

Senator GRAMM. Now if the bust turned out to be a lot worse,

then we might want to reevaluate. But as of today, this has been

a miraculous economic period.

It seems to me that we don’t know how much adjustment has to

occur. But the same technology and basic environment is out there.

And again, I return to the notion of an economic bubble that has

burst with equity adjustments going through the retrenchment.

Clearly, at some point, this process has to begin again. The question is, how long is that—and back to the Chairman’s question—

what can we do in terms of policy that would speed it up without

doing so much that we contribute to a problem in the future, given

this lag of some 18 months, between changes in monetary policy

and the full effect on the economy.

I would like to give you a chance to respond.

Chairman GREENSPAN. Senator, I think the underlying structure

of technological advance is in place, as I indicated in my remarks.

By all of the measures, by all of the evaluations that we make, we

are only partway through a major technological expansion which

17

has elevated the underlying growth of structural productivity,

meaning the trend growth in productivity over periods of years.

In the context of that, the long-term expected rate of return has

risen, as has the long-term expected rate of growth of earnings.

That automatically induces a reevaluation of what the equity values in the economy are.

Whenever you get into that sort of process, there is always the

danger—and it seems to happen more often than not—that if

there are real underlying forces to raise equity values because

of the structural productivity advances which have occurred, there

is a tendency to overdo it. In other words, as I said previously, in

many of the technological areas, as I think I put it in my prepared

remarks, we have seen demand doubling for certain newer

technologies every year, but the supply goes up three or four

times a year. And so what happens is that you get a glut, a huge

retrenchment, but it doesn’t undercut the fact that that demand

was essentially there. And it may indeed even slow down because

of the supply shock effect. But it doesn’t change the longer-term

structural possibilities for higher earnings, higher rates of return,

and higher productivity.

And in that regard, as I have indicated in my prepared remarks,

I see nothing in what has been going on in the most recent period

to alter the view that when we are through this period, and it has

been a very traumatic adjustment process, we will go back to a rate

of increase which is significantly above where we were in the two

decades prior to 1995.

We will not go back to some of the 50 percent increases in capacity, which is what occurred last year in the high-tech area. At least

I hope not. But we will have solid expansion in those areas because

we have to complete this set of the synergies of a very significant

number of technologies. And we have not completed them yet. They

still have a significant way to go.

Senator GRAMM. Thank you, Mr. Chairman.

Chairman SARBANES. Thank you. Senator Dodd.

Senator DODD. Thank you very much, Mr. Chairman.

Again, I raise the issue—let me just get a quick answer, if I can

for you, on the issue of—I realize we are talking about monetary

policy here. But nonetheless, the issue of, the physical infrastructure issue. I made the statement that I cannot recall or I don’t

know of a period of economic growth, sustained economic growth,

without a sustained investment in the maintenance of America’s

physical infrastructure.

I just wonder if you would question that, the legitimacy of that

statement.

Chairman GREENSPAN. Senator, I am not familiar with the various measures that one would be required to determine whether a

particular infrastructure is adequate or not.

We know what the capital stock in, say, State and local governments is. We know what our highway system is. We know what

our sewage issues are. And we know, as was pointed out, pretty

much about, for example, the urban infrastructure, specifically

things like that very significant tunnel near Camden Yards. We

know what those things are. But whether they are adequate or inVerDate 11-MAY-2000 09:19 Apr 10, 2002 Jkt 000000 PO 00000 Frm 00021 Fmt 6633 Sfmt 6602 75469.TXT SBANK4 PsN: SBANK4
18

adequate is difficult to say because, in one sense, nothing is ever

adequate. In other words, there is always more to be done.

So it is a question of judgment and I think one of the important

aspects of a democratic society is to make those judgments as to

what proportion of economic activity is devoted to public infrastructure or the private infrastructure which goes along with it. But

there is no question that there has been significant capital investment by State and local governments in the last 4 or 5 years.

Senator DODD. Thank you. And I will come back to the subject

at hand here.

Let me raise two questions, if I can. One is regarding the international scene. And you referenced that in your statement here.

Again, no one knows better than you the indications we are seeing,

the recent problems in Argentina, certainly throughout Latin

America, by and large, anyway, the Asian problems, even Europe.

We saw the Department of Commerce report, the trade deficit,

a low number of around $28 billion in the last quarter. But while

at first it may seem like a great number, it also indicates a lack

of activity. And obviously, the strength of the dollar is contributing

significantly to that as well.

Now the obvious question, given the globalization of the marketplace and the dependency of the United States on relatively strong

economies internationally.

As you look ahead and speak with some optimism about a recovery beginning toward the end of this year or next year, I wonder

if you could give us some indication of how directly linked you believe the recovery of the United States is going to be dependent

upon a modest recovery or some recovery internationally as well.

And particularly in the Asian and European markets.

Chairman GREENSPAN. Senator, the best way to describe it is

that we are all dependent on each other. It is a simultaneous interaction in which all economies are working in a manner which reinforces either strength or weakness for each other.

The problems that we have seen are, in one sense, more domestic

than they are international. And clearly, Argentina has got some

fairly significant problems which they are addressing and, indeed,

as we have observed in recent days, the financial markets, which

are always the best way to tell how well things are going because

they somehow learn what is actually going on, have actually improved somewhat with respect to Argentine securities, bonds, interest rates, and pressure on the peso-dollar link.

One thing I think we can say is that, unlike 1997, when we had

been through a period of extraordinary acceleration in economic

activity, especially amongst the so-called Asian tigers, we got hit

with a number of problems in which a lot of the difficulties we ran

into were the result of endeavors to hold fixed exchange rates, to

arbitrage those exchange rates in a manner which tried to pick up

profits on differential interest rates, and the profits would depend

solely on the maintenance of those fixed exchange rates.

And they broke, as indeed one would have expected that to happen. That created a lot of contagion in the sense that the investors

in these emerging markets generally pulled back from all emerging

markets.

19

The tinder out there, if I may use the term, is much less than

it was in 1997. There are very few fixed exchange rate problems.

The extent to which debt was extended is much less. The reserves

are better.

That is not to say that we don’t have a problem. I am just merely

saying that the resources are far better than they were back then.

And the probabilities of running into the type of crises which we

ran into there are certainly less.

Having said that, obviously, the United States was in much

stronger shape back then and we acted as a support, as did others

in Europe and elsewhere.

But, overall, I think that as I said, the tinder is less and one presumes that it can be contained without much of a problem.

Senator DODD. Thank you. My time is up. Your comments on

capital spending in the high-tech area, I hope I get a chance to

come back. That is a very important part of your testimony.

Thank you for your answer on this question. Thank you, Mr.

Chairman.

Chairman SARBANES. Thank you, Senator Dodd.

Senator Bennett.

Senator BENNETT. Thank you, Mr. Chairman.

Chairman Greenspan, we have a circumstance where we have

some interesting bedfellows getting together right now on economic

issues—the unions and the National Association of Manufacturers.

Both seem to be very concerned about the strong dollar and the impact of the dollar.

We have some economists, some of whom are friends of yours,

complaining about commodities, basic material prices going down

everywhere at very significant lows.

And all of this comes to the question of the amount of liquidity— that is, the amount of money—available in the economy. The

assumption being that if there were more money available, more

liquidity, the dollar would not be as strong as it is and that

commodity prices would begin to recover.

Taking a basic commodity that is produced out in Utah, as one

fellow put it to me, he says, when copper is scarcer than money,

the price of copper goes up. When money is scarcer than copper,

the price of copper goes down. And the price of copper is going

down.

Would you address that whole question of liquidity and commodity prices and a strong dollar?

Chairman GREENSPAN. First of all I think that the demand for

commodities is, to a substantial extent, more an indicator of industrial activity and its use than it is of financial liquidity. In fact, I

rarely use commodity prices as a single useful indicator for broad

inflation, which is really where the issue of liquidity rests. I use

it, however, to a substantial extent as a measure of what is going

on in areas of new orders, industrial activity, and, indeed, world

trade in various commodities.

The reason why copper and aluminum and, say, steel scrap

prices—— Senator BENNETT. And gold.

Chairman GREENSPAN [continuing]. Are down is more an issue of

the question of what is industrial activity doing. If liquidity were

20

a crucial factor in determining commodity prices, then they should

be buoyed at this stage because, for example, M2 has been going

up at double-digit annual rates in the last number of months. And

we don’t see that.

And I think that the issue with respect to demand for copper is

going to depend very critically on what it always depended on—underlying demand. Demand goes up, industrial production goes up,

industrial demand goes up, the price of copper goes up.

Senator BENNETT. So you would disagree with Lawrence Kudlow

and David Gitlitz and others who say that we are in fact on the

edge of a liquidity crisis. And the word deflation should begin to

be in our vocabulary now.

Chairman GREENSPAN. Yes, Senator, I do disagree.

Senator BENNETT. Let’s talk about deflation in Japan because

there are these economists who are saying that the Japanese model

indicates that inflation is the big problem we worry about, but in

Japan, they are deflating the economy.

Are we in any risk whatsoever repeating the Japanese circumstance?

Chairman GREENSPAN. I think not, Senator. The problem in

Japan is a rupture in their financial intermediation process, meaning moving savings into investment. The major financial intermediary in Japan has been banks. And indeed, unlike the United

States where we have got many alternate mechanisms to move savings through capital markets, through secondary mortgage markets

and the like, the banking system in Japan is disproportionately

what is employed to move savings into investment.

With the dramatic decline in the value of commercial real estate,

which is, I would say, really the vast majority of the collateral

which underlies loans in the banking system there, they have had

a huge increase in nonperforming loans, as the Japanese officials

have indicated and have been endeavoring to address.

But the consequence of that is that lending has come off very

dramatically because the banks are most concerned about the capital position which they have, and the uncertainties with respect to

the nonperforming loans have induced a significant contraction in

lending. And the result is that the Japanese system, which is, remember, the second largest economy in the world, is endeavoring

to function without an operating financial intermediation system.

They are addressing the issue. Clearly, their endeavors at reforms are exactly what they should be, and I hope that they move

as expeditiously as possible in that regard.

But whatever one may say about the United States, and we have

quite significant problems, and unquestionably, the loss of a very

large amount of stock market wealth does press down on the economy, but it is scarcely an issue of lack of liquidity or a lack of financial intermediation that creates problems for us. I would say

that the issue of Japan versus the United States is really two separate types of problems. We do not have that particular problem.

Senator BENNETT. Thank you very much.

Chairman SARBANES. Senator Reed.

Senator REED. Thank you very much, Mr. Chairman. And again,

thank you, Chairman Greenspan.

21

Long-term interest rates are higher now than they were at the

start of the year. It raises the question, as short-term rates have

been pulled down through Federal Reserve action, why have the

longer-term rates not fallen also?

Chairman GREENSPAN. Well, actually, Senator, they declined

quite significantly in the latter part of last year, actually in anticipation of the fact that at some point, monetary policy would be

kicking in, and you could start to see it very late in the year in

Federal funds futures markets. So that the markets were already

adjusting as of January the 1st.

In addition, the changing attitudes toward what the size of the

surpluses was going to be and, hence, the amount of liquidation of

U.S. Treasury securities was altered. That is, the rate of decline in

Treasury outstanding debt moved from a sharp decline to one

which was somewhat more modest, which in effect implied that

there was going to be a greater supply of Treasury bonds, which

is of course a crucial part of our bond market, and that tended to

keep rates somewhat higher.

Nonetheless, they have moved in a way in which some commentators have questioned whether there is an inflation expectation out there. And the best measure that we have got for that is

the so-called differential in the Treasury market which tries to

infer the expected inflation rate in the Consumer Price Index as

the difference between our Treasury index bonds, the ones that we

use for inflation indexing, and the regular bonds. That gap is a useful measure. That did rise significantly for a while, but it has retraced most of the rise. And I would conclude that the failure of

long-term rates to come down more than they have is largely a supply issue and not one of real concerns about inflation.

If anything, one would have to argue it is an expected higher real

rate of return which would be consonant and consistent with rising

economic activity in 2002.

Senator REED. Mr. Chairman, the tax cuts, a very small part of

it that is being distributed this year in the form of rebates, tends

to cut against your efforts because it might be slightly inflationary.

It is putting more money, more incentives for people to go out and

spend.

Do you see that in any way impeding your efforts to keep inflation down?

Chairman GREENSPAN. Senator, it could, under certain circumstances. I don’t see it as impeding us at the moment because,

as I indicated before, all of our measures suggest fairly firmly that

inflation is being contained and that there is no evidence of which

I am aware that the tax cut has significantly altered those inflation expectations.

Senator REED. One of the longer-term consequences of the tax

cut is the potential to further erode national savings since, essentially, government savings are being dissipated.

We have a consistent problem over time of marshaling sufficient

savings for investment. As you see the long term, does this continue to bother you about the lack of not only household savings,

but now, a significant departure from governmental savings?

Chairman GREENSPAN. Well, I certainly agree with you. In other

words, it is not only an issue of normal savings flows to finance

22

capital investment. But with the demographics changing quite dramatically a decade from now, it is fairly apparent that we are going

to have to pick up the rate of productivity growth, which clearly requires capital investment, if we are going to concurrently supply

the amount of goods and services that both retirees, which will be

increasing in very rapid numbers, as well as workers, will require

in the decade, or I should say, in the years beyond, say, 2010, 2011.

Senator REED. It seems that without a productivity increase, and

I think your testimony suggests that at least we are in a productivity pause, a lot of the projected benefits of the tax cut, indeed,

the projected hopes of your policy, would come undone, that a lot

rests upon your presumption or assumption that productivity will

continue to increase as it has over the last several years. And that

is historically—again, one could raise the issue of whether that is

historically borne out.

Chairman GREENSPAN. Well, it is not clear to me that the tax

cut, which is really quite a modest size, is having any material effect on the underlying productivity structure of the economy. As I

said before, it could, if it were very large, and it could have an effect if there were underlying inflationary implications in a lot of it.

But I cannot say that I see any of that at the moment.

Senator REED. But, again, Mr. Chairman, a lot of your, I think

the basis of your analysis, not just in the tax cut, but many other

issues, turn on the notion of productivity increases.

That is probably the biggest uncertainty that we face today.

Chairman GREENSPAN. Well, I don’t know if it is quite uncertain,

but I certainly agree with you that a goodly part of the way I look

at the evolution of the American economy does presuppose the resurrection of measured productivity growth coinciding with what I

believe to be the level of structural productivity growth.

Senator REED. Thank you, Mr. Chairman. Thank you, Chairman.

Chairman SARBANES. Thank you very much, Senator Reed.

Senator Allard.

Senator ALLARD. Thank you. Chairman Greenspan, I think you

would agree with me that housing has played a significant role in

our economy, historically, and continues to play a significant role

today.

These are not necessarily high-tech jobs. And I wondered if you

could elaborate—and you did not mention that, make comment in

your remarks about housing. I just wondered if you could maybe

elaborate on the trends for housing prices, spending on residential

structures, and mortgage interest rates.

Chairman GREENSPAN. Senator, I think one of the things that is

occurring in this country is the evolution of housing into a very sophisticated, complex industry, in the sense that we not only have

got the standard homebuilding aspects of homeownership-related

activities, but we are also beginning to find that as homeownership

rises, and as the market value of homes continues to rise, even in

a period when stock prices are falling, we are observing a rather

remarkable employment of that so-called home equity wealth in all

sorts of household decisions.

Indeed, as I point out in my written remarks, it seems to us that

the rise in the value of homes, which if anything, has accelerated

during this period of rapid decline in stock prices, has created a

23

very substantial buffer of unrealized capital gains which are being

drawn upon through the home equity market, through cash-outs,

and through the turn-over of existing homes, which has been, as

you know, quite substantial despite the weakness in the economy.

In that regard, the housing sector, thinking in terms of the total

sector, has been a very important contributor to the American

economy, and I think one of the major reasons why, as I put it in

my prepared remarks, that that litany of all the negatives which

you can easily line up has not in fact cracked the economy’s underlying stability.

And in that regard, I would say that we are still seeing an increase in homeownership. The rate of ownership has risen, as I recall, to 67 percent. And it is interesting in the sense that, as I indicated before the House last week, a disproportionate amount of

that rise in homeownership is amongst minorities, and a goodly

part of implied construction and existing home turn-over is being

impacted by immigration, strangely enough.

Senator ALLARD. Thank you. In light of other factors such as the

wage rate, what do you see happening to the national homeownership rate?

Chairman GREENSPAN. Well, it has been rising at a fairly pronounced pace. And I should certainly expect that at the existing

level of new home construction that it will continue to do so. And

there is still a fairly large number of households who would like

to become homeowners. And until we see that dissipating, the underlying demographics will push us forward.

Remember, unlike European economies or the Japanese economy,

where labor forces are not growing as fast percentage-wise as ours

are, the level and contribution of new home construction is much

less in their GDP than ours. And I think this is an area where expanding population is a crucial factor in impacting on economic activity, as it works its way through home-building and the overall

infrastructure of the system.

Senator ALLARD. Mr. Chairman, I have one last question.

From an economic perspective, what can be done to address the

issue of affordable housing?

Chairman GREENSPAN. Well, obviously as technology improves,

the ability to significantly increase modular and manufactured

housing in one form or another, you do see the impacts of the ability to own homes improve especially in the moderate- to lower-income groups.

To be sure, you are not getting—let’s put it this way: when I was

young, a mobile home was something which you dragged along behind a car on a highway and, if necessary, lived in. The manufactured home industry has changed very dramatically, as you know,

and has constructed innumerable, multifaceted types of structures

which has enabled the productivity that is embodied in the manufacturing process that has been doubtless the fastest part of productivity growth in this country, and that has been a significant

factor in getting available homes at all levels.

Going beyond manufactured homes, there is still an awful lot of

technology which is going into the improvement of construction capabilities, and I should think that that is by far the best way to

create affordable housing.

24

You can subsidize it, if you want, and that can obviously impact

on the availability of homes. But there is nothing like American

productivity to create lower-cost, usable—in fact, in many cases,

quite impressive—homes, at relatively low prices.

Senator ALLARD. Thank you, Mr. Chairman. Thank you, Chairman Sarbanes.

Chairman SARBANES. I think some of us were also hoping you

would add lower interest rates as a way of getting more affordable

housing since, if you look at the little book about what you pay

monthly, it is very markedly affected by what the interest rate is.

Senator Bayh.

Senator BAYH. Thank you, Mr. Chairman.

Chairman Greenspan, one brief observation and then three very

brief questions.

My observation, I wanted to note the confirmation of Roger

Ferguson, a good individual, by an overwhelming margin in the

U.S. Senate.

I think the vote was something like 98 to 2, or thereabouts.

I thought you might be interested to know that one of our colleagues who was in opposition opined that the reason, therefore,

was his similarity to you.

But I wanted to reassure you that the 98 of us who voted for

Mr. Ferguson felt exactly the same way. So, indirectly, you had a

significant vote of confidence in the U.S. Senate surrounding the

Ferguson nomination.

My three brief questions, Mr. Chairman, really build off of the

questions of my colleagues.

First, with regard to productivity and your comments in response

to Senator Reed. You were very sanguine about following the temporary downtick we have had here, productivity resuming its more

robust pace of recent years.

In previous testimony, I have heard you mention past historic

parallels where we have had new technologies come on the scene,

whether it is the proliferation of electricity, the automobile, the

railroad, or what have you.

And you have indicated previously that there was a spurt of productivity growth for a period of years. It is hard to define exactly

how long. Eventually that regresses to some sort of mean.

How do we go about determining when the current productivity

acceleration, once it resumes, will experience a similar regression?

Chairman GREENSPAN. Senator, that is the most difficult question we have in this particular area. As I said before, we know that

we are only partway through capturing or exploiting all of the various new technologies which are in front of us. But the rate of

growth in productivity obviously is a function of how fast we exploit

that unknown, unrealized potential. And that is very difficult to

judge.

We will know when we are getting to a point when we have run

out of possibilities, as indeed we noticed, for example, in the big

railroad boom. Remember, the railroad boom was extraordinary. It

changed the face of the American economy in, indeed, a very similar sort of way that information technology is doing today.

It peaked in 1920—or, I should say, as I recall, the mileage of

tracks in the United States peaked in 1920. So, obviously, it would

25

go, but you could see the rate of increase starting to slow down and

you knew that there was going to be saturation at some particular

point.

It is when we begin to see elements of saturation. We have seen

some at least early signs in personal computers in households because there has been a very big surge. But still, we have a long

way to go to get it up to where, for example, television is. I think

we will have some advance warning, but I am not sure we will be

able to project very far into the future.

All I can say at this moment is that we are nowhere near there

as yet. But I do believe that when we start to run into the maturities and saturations that invariably hit technologies, we will have

some advance warning of that.

Senator BAYH. An interesting additional element with the proliferation of information technology. It is not just its use through

the economy, but the restructuring of the organization of work

itself around the new technology, which perhaps is an additional

productivity kicker that exists today.

Chairman GREENSPAN. In fact, Senator, that may be more important than we realize. Indeed, that clearly was the case, as best I

can judge, in how electric power worked from the latter part of the

19th century into the 1920’s. You did not get the real kick in productivity until the buildings in which you housed electric power

and electric motors and ran production systems changed. So that

there is this effect of how you do things which gets changed. And

it is increasingly the case that it is not the technology, the hardware, or even the software itself. It is how you reorganize, and it

takes a long while before that takes place.

Senator BAYH. I see my yellow light is on. I will ask my two final

questions together, Mr. Chairman. I will try to be succinct.

One is an issue that you and I have discussed before with the

increased percentage of trade or the increased bubble of trade as

a percentage of world growth and the increase in capital flows.

You mentioned with regard to, I think Senator Dodd’s ques-tion,

some of the strengths in the world economy today that perhaps

can reassure us against the effects of a global financial shock of

some type.

My question to you is in regard to the International Monetary

Fund.

With the growth of world trade, the potential size of the shock

at some future point might be larger. Does the fund have the resources, the wherewithal, to address a future shock?

Is that an issue that we should be focusing on, ensuring that

they do have such resources? Number one.

Number two, with regard to Senator Allard’s question, my final

question with regard to home equity. This has been a good thing

for the American economy, and temporarily helpful in addressing

the consumer issue and the current sluggishness.

My question to you is, since it has historically been a significant

percentage of household savings, is this a worrisome long-term

trend, people drawing down their home equity substantially?

Those are my two questions—the IMF and the home equity

draw-down, in the long run.

26

Chairman GREENSPAN. Let me address the home equity issue

first. If unrealized capital gains were declining, which, of course, is

what happens when you extract equity from homes, yes, it would

be a problem. But there is no evidence of that. Indeed, despite the

fact of significant extraction of home equity gains, the level of unrealized capital gains in homes continues to rise apace. So it is not

a depleting asset, if I may put it that way. It could be, but, fortunately, it is not.

The IMF issue is a more fundamental and more difficult one to

address because what we do know, as we have discussed before, is

that the real volume of trade tends to increase faster than gross

domestic products. The amount of financing of trade increases even

faster than the underlying growth in trade, which means, effectively, that the ratio of international finance to the tax bases of the

industrialized countries—let’s assume that is the major players in

the IMF—is rising inordinately. And that somehow suggests that

if we were to maintain an international presence proportional to

the increase in the aggregate finance, it would mean that an ever

larger proportion of the tax base of the industrialized countries

would have to be dedicated to that particular process.

Since that is readily dismissable as most unlikely, it therefore

says that, yes indeed, we do have certain limits that must of necessity be imposed on international financial organizations, largely because of the allocation of resources and the technologies which have

so augmented the size of international finance.

And I think everyone is becoming increasingly aware of that,

which means that how you come at international financial problems has to be altered and, in a sense, fitted into what the degree

of finance is available from the industrialized countries to finance

the IMF, the World Bank, and the long series of developing banks

that we have in our system.

Senator BAYH. Thank you, Mr. Chairman.

Chairman SARBANES. Thank you, Senator Bayh.

Senator Enzi.

Senator ENZI. Thank you, Mr. Chairman. I want to continue

some of the international questions because we are learning that

we are more internationally connected all of the time.

Both the House and the Senate have passed a Sudan peace act.

They are substantially the same with one exception. And that is

the one that prohibits companies that are developing oil and gas

in the Sudan from being able to raise capital in the United States

or to have their securities traded in the U.S. market.

The New York Times had condemned that in an editorial. What

are your views of the provisions of the possibility of politicizing the

capital markets?

Chairman GREENSPAN. Well, it seems like a very minor issue,

Senator but it is obviously far more important, as you imply. The

clear outcome of such a law would effectively be to move financing

from New York to London. Indeed, there is even some concern

within the banking system that in order to comply with such a law,

the banks would have to make certain that their customers were

not in violation of the statute, which is very difficult to do.

The effect of that I think would be essentially to move a considerable amount of financing out of the United States to

27

London, Frankfurt, Tokyo. And since such a crucial part of the effectiveness of the American economy is a very sophisticated capital

market and its financial infrastructure, I am most concerned that

if we move in directions which undermine our financial capacity,

we are undermining the potential long-term growth of the American economy.

I find the motive for the legislation obviously commendable. But

I think it is not been thoroughly thought through and I don’t think

that the implications of this particular type of statute are useful to

the United States and, indeed, I think it is downright harmful.

Senator ENZI. Thank you. And another international issue that

has come to my attention—and you and I have been corresponding

about it and I appreciate all the information you have provided, is

about the Bank for International Settlements. Of course, the private shareholders in the United States, about 130,000 shares’ worth, are owned by mutual funds and private investors.

I am kind of concerned about what is going to be done with those

shares that are being repurchased. And of course, I am also concerned about a price that appears to be below the fair value.

What is going to be done with those shares and when will the

Federal Reserve make a decision as to whether or not to buy or receive these private shares?

Chairman GREENSPAN. Well, of course, we are not involved as

purchaser in any way with those shares. Our sole relationship here

is the fact that we have two seats on the board of the Bank for

International Settlements: myself and the president of the Federal

Reserve Bank of New York, Bill McDonough. We very recently

joined the board on the grounds that it was our increasing conclusion that it was in the best interests of the United States for us

to be on that board after having for many generations decided not

to be there.

We consulted with the State Department, the Treasury Department, and a number of people on the Hill to be sure that they saw

it the way we did and, indeed, that was the case.

With respect to the individual share issue, this was handled in

a way which as best I can judge, was reasonably sensible. They had

a number of investment banks, reputable investment banks, try to

make evaluations of what the appropriate price should be for those

minority shareholders, and it is the same procedure that goes on

in the private sector all the time. And while we raised questions

in the beginning and certain things got changed, as I recall as a

consequence. But at the end, we looked at the results, thought

them fair, and voted in favor.

Senator ENZI. It was my understanding that this was being done

so that the central banks would own all of the shares.

Our central bank will not own any of the shares?

Chairman GREENSPAN. We do not own shares and will not own

shares.

Senator ENZI. I will be addressing a few additional questions on

that that don’t pertain to the economy. But I do have a definite interest in it and think that it will have some effect on the economy.

So I thank you for your answer.

Chairman GREENSPAN. I would be glad to answer in any detail

you need.

28

Senator ENZI. Thank you.

Chairman SARBANES. Thank you, Senator Enzi.

Senator Corzine.

Senator CORZINE. Yes, thank you, Mr. Chairman.

Mr. Chairman, I identify with one item that you put in your

written statement. You said forecasts of inflation, however, like all

economic forecasts, do not have an enviable record.

We have seen, and I would look at some of the forecasts that we

had at the first part of the year relative to where growth is now

and at least in an evolving sense, that maybe the second half is not

going to be as strong as was projected by both outside and public

economists.

But I want to tie this to a view that we have, a personal view,

and some would call it political view that we have, over-committed

with regard to our tax cut.

You used the term, modest tax cut, earlier in responding to a

question. And certainly, if one looks at this certainly in the context

of extenders, sunsets, omissions that are almost certain to be included in any interest expense, one could at least make the case

that modest is not where we are.

And my framing of this is, we are about to address another issue

that is going to take forecasting activities into account with regard

to Social Security, withdrawing 2 percent of the payroll taxes potentially to finance private accounts.

I am concerned about our ability to be effective in these forecasts

and dealing with decisions on a discrete, 10- or 25-year timeframe,

as opposed to how I believe the Fed very appropriately looks at an

evolving situation.

I guess my first question is, have we been too aggressive in using

these kinds of forecasts to put in place judgments with regard to

how flows of revenues will come to the Treasury?

I am concerned that actually that yield curve that you spoke so

eloquently about may reflect—and I think when you used the

word supply, it actually implies that people think we have a substantial change in the underlying conditions of our debt markets

going forward.

And aren’t we running a serious risk of aggravating that potentially by some of the discussions with regard to Social Security?

So I will give you an open field there. But I am very troubled

by the commitment that we are making to the political arena to

these long-term decisions that can be very damaging to the longrun underlying health of the economy.

Then one more technical situation.

We seem to be having a debate about whether trust funds and

assets that go into trust funds may be real or accounting devices.

It strikes me that IOU’s from the Federal Government in a

Social Security trust fund are real assets. They have interest

rates maybe administered as opposed to market-implied, but they

are real.

And I wonder if you would have any insights that would help us

with a problem that seems to recur in the political debate.

Chairman GREENSPAN. Senator, I think the problem that we

have is lack of a choice to make long-term forecasts because the

policies which are being discussed are of that nature. Go back, as

29

you remember, 30, 40 years ago. It was very rare that budgetary

processes or tax policies extended beyond 1 or 2 years. And the

major reason was we did not have to. But as we have gotten to an

ever increasing proportion of the budget which are entitlement programs, and as we have endeavored to make long-term commitments in one form or another which necessarily imply both the receipt side and the outlay side as we go forward, we have had no

choice but to try to do the best we can in making long-term forecasts and making judgments as to the fiscal impact of both the receipt side and the outlay side. It is a precarious exercise.

Indeed, I think when I was here in February, or certainly I do

remember in early Budget Committee discussions in the Senate on

that issue, that there is a great deal of uncertainty as you get into

the 5-, 7-, 10-year period. But if you introduce the policy or the law,

there is an implicit forecast that you are making with respect to

that statute. And it is better to do as best you can even though,

admittedly, the farther out you go, the less certain you can conceivably be.

So I grant you there is a problem in these longer-term forecasts

and these longer-term estimates. I do not deny that people make

decisions on the basis of them without full understanding, I believe, of how weak some of the forecasts are, and how weak, as the

people who make them such as myself, perceive them to be.

There is no choice and we have just got to do the best we can.

With respect to the trust funds——

Senator CORZINE. And with regard to that, is there a time when

it would be proper public policy to review those with changed

conditions?

Do you believe that we should?

Chairman GREENSPAN. I think we should be doing that all the

time. In other words, you are in continuous session, if I may put

it that way, and the basic purpose is to continuously evaluate what

is in the law, what has been done. And I think that is the purpose

of a number of the hearings that at least I appear at is to review

what the statutes that you passed are doing. And clearly, in many

instances, and appropriately so, you have changed them.

With respect to the trust fund question, I think there is a tricky

question here. And the issue essentially is, as I pointed out earlier,

that the crucial question of savings in this economy really relates

to the ability for us to build an adequate capital stock to pro-duce

enough goods and services in the future to accommodate both

retirees and workers in the future. The finance that is involved

to do that is utterly a secondary question. If you don’t achieve that

end result, it is an exercise that cannot be called an effective retirement program.

The issue with Social Security should be are we building the

level of capital assets that will be required to produce the real

goods and services? And in order to do that, are we accumulating

the amount of savings that we need to finance the investments

which will produce the goods and services? And here, whether you

are talking about a private system or whether you are talking

about a public system, the question is not what assets are in the

fund, but whether the claims are increasing.

30

It is wholly irrelevant whether in fact you have U.S. Treasuries,

corporate bonds, or corporate stock. It is important with respect to

what the rate of return is. But I have argued elsewhere that there

is an illusion there, which we have to be careful about, of shifting

retirement funds from the private sector to the public sector, and

I don’t think that that is a particularly good idea.

But I think the standard has got very little, if anything, to do

with what the nature of the securities are, but what is the rate of

savings implicit in the program.

Senator CORZINE. They are assets, however they are generated.

Chairman GREENSPAN. The crucial question is—are they ultimate claims on real resources? And the answer is yes.

Senator CORZINE. Thank you, Mr. Chairman.

Chairman SARBANES. Thank you, Senator Corzine.

Senator Bunning.

Senator BUNNING. Thank you, Mr. Chairman.

I am sorry Senator Bayh has departed. If he’s going to quote me,

I would like to have an opportunity to respond, only to the point

that if he would have followed up and used the full text of my reasons for voting against Roger Ferguson for a spot on the Federal

Reserve, he would have found out that I want an independent Federal Reserve. And I did not think that a person who thought exactly the same as Chairman Greenspan would be an independent

thinker on the Federal Reserve.

Mr. Chairman, I would like to start off by asking the same question that I asked at Gov. Ferguson’s confirmation hearing.

Hindsight being 20/20, do you now think that the Fed waited too

long to reduce the target Fed fund rates? And I am speaking about

last September, October, November, December?

Chairman GREENSPAN. No, Senator. Let me tell you why.

When we examine the impact of monetary policy on the economy

in the context of the discussion I was having with the Chairman,

we find that there are long and variable lags. And in that context,

the difference of whether or not you move in one period or 3 or 4

weeks later has very little effect, except under conditions where

there is a potential cracking of the confidence in the economy.

In fact, back in early December, I remember discussing in a

speech concerns that I had—indeed, I think I may have even used

it before this Committee—about with the sharp reduction in the

rate of growth, the dangers that the fabric of consumer confidence

could be breached was a serious issue because, while the technology was changing very rapidly, human nature doesn’t, and you

could very rapidly induce a major contraction. And I think that

possibility was there in December, early December.

Senator BUNNING. You don’t think it was earlier than that?

Chairman GREENSPAN. No. But let me go to the point. The question you raise

I think is a substantive question which I think would have been

of grave concern, say, in January.

In the event, the fabric of consumer confidence has not been

breached. In other words, we did not get the type of concerns that

could have been affected by a failure of monetary policy to respond

earlier. Had we had that breach, then I would say the point you

are making would have some strength to it. In the event it did not,

31

and we are now 7 months beyond the event, and whatever the

risks were back then, they have changed. That is not to say that

we don’t have risks in the future, but it is very difficult now to

argue—— Senator BUNNING. But we have had quite a few alternate

changes by the Fed since that time.

Chairman GREENSPAN. Sure. No, what I am basically saying is,

to the extent that—in your judgment, for example, not in mine— but let’s assume that it would have been desirable to move earlier

and we did not move, and the event of a breaching of confidence

occurred at that time, then I would say that the argument you are

making is a substantive one.

I am merely saying that it did not happen and by now, whatever

the consequences between moving in, say, November or January

were, are now fairly dissipated in the system—— Senator BUNNING. I understand, because we have had quite a

few Fed fund rate cuts since that time.

Chairman GREENSPAN. Right.

Senator BUNNING. Therefore, people are expecting the economy

now to pick back up. But it hasn’t. And we don’t expect it to do

it, and there is always a lag when Fed fund rates are cut when the

economy starts to respond to them.

That is why I say the Greenspan Fed is great reducing. But

going up, it is another question. We can get into that argument.

During your testimony last week, you stated: Despite all the

shocks that are involved in both the domestic and international

economy, our economy is still not doing well, but clearly far better

given what has happened than I would have forecasted 6, 8, 9

months ago.

Considering that 9 months ago places us in the month of October

of last year, why did the Fed wait until January to begin easing

monetary policy?

If you knew what you knew last September and October, then

why did you not act to it and respond to it immediately?

Chairman GREENSPAN. Let me amend my remarks of last week.

Senator BUNNING. Okay.

Chairman GREENSPAN. It was 6 months, not 8 or 9. In other

words, if I said 8 or 9, I was mistaken.

Senator BUNNING. I am just quoting what you said. Those are

your quotes.

Chairman GREENSPAN. No, no, it is perfectly valid. I am just saying that I was wrong. I did not mean to say—I had not actually

done the arithmetic.

I think we became aware that we were having a serious problem

in December because the anecdotes were really quite remarkable.

You would see one business person after the other saying, my

orders have just fallen through the floor.

Senator BUNNING. They were coming to you 2 months after they

came to me, then, because I had them coming to me at the end of

September and they are saying, the economy has hit the wall.

What are we going to do about it?

Chairman GREENSPAN. Now certain parts of the economy were

hitting the wall. The same people came to me.

Senator BUNNING. Thank you, Mr. Chairman.

32

Chairman SARBANES. Thank you, Senator Bunning.

Senator Carper.

Senator CARPER. Has Mr. Schumer already gone?

Chairman SARBANES. But you were here earlier.

Senator CARPER. I was.

Chairman SARBANES. For quite a while and then left, and Senator Schumer has just arrived, more or less.

Senator CARPER. Mr. Chairman, I guess most questions have

been asked and probably answered during the time that I was out.

Let me just venture a guess that maybe you haven’t spent much

time focusing on energy and the implications of the change, the

drops in energy prices and what effect that that is having on our

economy and is likely to have.

As I look at what is hopefully going to happen here in the second

half of the calendar year of the effect of what you have done, the

monetary policy has to be kicking in right about now. The effect

of the rebates will have some impact, I think a positive one, in the

next couple of months. And the effect of the energy policy and the

drops in prices.

Certainly, in a psychological sense, they have to have an effect,

and also, in a very real dollars and cents sense.

Your thoughts, please.

Chairman GREENSPAN. Senator, I think it is more than psychological. It is really quite important.

First of all, as I indicated in my prepared remarks, the profit

margins were very significantly squeezed by the sharp rise basically in natural gas, electric power, and actually, as I recall, a

number of petrochemical feedstock products. The result of that

was, in the fourth quarter and especially in the first half, some

really significant downward pressure on profit margins. It was a

significant part of the increase in unit costs in the consolidated

domestic system.

We started, of course, to get very dramatic declines in natural

gas prices starting very late last year. We went from, as I recall,

$10 per million BTU’s down to approximately three today in the

spot market. But remember, businesses use longer-term contracts.

And so the contract prices have had much less of a sharp rise and

decline. But they are declining. And as I indicated in my remarks,

we expect that lower prices of energy, with the exception of electric

power, have worked to improve profit margins by lowering costs.

In the household sector, remember the extraordinary problem

that we had with respect to natural gas during the winter. The

bills that people got were just awesome and unexpected, and there

is no doubt that they impacted on consumer expenditures. People

pulled back. Those rates are falling. You can see them quite appreciably, to that extent, it is opening up consumer purchasing power.

The gasoline price changes have been really quite dramatic. It

was a shortage of refinery capacity earlier this year which prevented the increases in crude inventories being put through the refineries into inventories of gasoline, especially reformulated gas,

which caused a big spike in prices, which has now reversed, as the

refinery margins, which went up very sharply earlier this year,

have now come all the way back down.

33

And in that regard, even electric power is beginning to ease. It

has been an extraordinary event in California, as you know, to run

into really quite mild weather. And the combination of conservation

in California and the weather has brought down the load factor

well beneath sort of a restricted capacity to produce. Now the summer is not behind us yet and there is considerable concern that you

can get spikes and they can run into trouble. But we have gotten

through a goodly part of the summer with prices very dramatically

below where they were. We are talking well under 10 cents per

kilowatt hour in the wholesale market now. And that has been a

small fraction of some of the prices we saw back earlier in the year.

Senator CARPER. Obviously, this is something that you think

about a great deal. And I do as well.

I think the factors were aligned, the stars were aligned appropriately earlier this year to, with the energy crisis, particularly

with electricity in California, but natural gas and others, the stars

were aligned in order to compel us as a Nation to work with our

new Administration, our new President, and the Senate and the

Congress, to formulate an energy policy that says, let’s produce

more energy, and as we do that, let’s conserve more energy.

And I have a concern now that as the crisis appears to be abating—I filled up with gas yesterday in Harrington, Delaware, Mr.

Chairman. I filled it up for $1.23 a gallon, which I haven’t seen for

a while, before I came over here——

Chairman SARBANES. People will be coming from all over the

country to buy that gas.

[Laughter.]

Senator CARPER. And if they come, they can come to the Delaware State Fair, which runs through Saturday, Mr. Chairman.

Chairman SARBANES. It is the same thing in Salisbury, Maryland, I hasten to add.

[Laughter.]

Senator CARPER. But Mr. Chairman, my fear is that as the crisis

abates, we may let this opportunity to formulate a meaningful

energy policy for our country slip away as well.

Do you have any quick thoughts you would want to add on that?

Chairman GREENSPAN. Senator, I fully agree with that. I think

that we have to remember that the reason why energy demand has

come off as much as it has is the economy is slowing, and that the

world economy being the crucial element in crude oil demand having slowed, has induced a temporary marked rise in crude oil inventories, especially in the United States.

It has given us a sense of, well, there is no particular problem

at all. But when you look at it in detail, it gets to be really quite

significant in the sense that, with the technologies that we have

managed to mount over the last decade or so, we have the capacity

to drain natural gas reservoirs at a far faster pace than we did,

say, 10, 15 years ago, which means that you have to get a continuously increasing amount of drilling just to stay where you are.

But since we have committed such a substantial part of our new

electric power requirements to natural gas, we are running into a

long-term problem of how do we square this ability to, one, have

natural gas an increasing source within our electric power system,

and at the same time have a rate of drilling and new finds of natVerDate 11-MAY-2000 09:19 Apr 10, 2002 Jkt 000000 PO 00000 Frm 00037 Fmt 6633 Sfmt 6602 75469.TXT SBANK4 PsN: SBANK4
34

ural gas adequate to meet that overall demand. And I think that

we are being sort of tranquilized by the lower price of natural gas.

We are not, incidentally, back to where we were 2 or 3 years ago,

but we obviously have come off a very extraordinary spike.

So the need to have drilling capacity in the United States is urgent, largely because, unlike oil, we cannot import indefinite

amounts. Most of our imports—in fact, the vast proportion—are

coming from Canada. And they eventually are going to run into

some problems. As I recall, I think a sixth of our demand is met

from Canadian natural gas.

Liquified natural gas, which we could effectively bring from

anywhere in the world, is a cryogenic, very complex process of

trans-portation which has got a lot of problems and environmental

concerns associated with it. Natural gas is a critical issue in this

country and we have to, one, focus on how we can conserve it and

how we can produce it because we are going to have a problem

out there.

The electric power grid infrastructure is obviously something

which I think needs to be addressed and that is something which

increasingly we are going to become aware needs some major

overhaul.

These are issues which you cannot address overnight. They are

long-term problems. And unless we address them while we are in

fact in temporary surplus, we are going to find that it is going to

become really much more difficult and the type of problem which

is going to induce us to make the types of decisions which are probably mistakes.

Senator CARPER. Thank you for your timely and sage counsel

very much.

Thank you, Mr. Chairman.

Chairman SARBANES. Thank you.

Senator Ensign.

OPENING STATEMENT OF SENATOR JOHN ENSIGN

Senator ENSIGN. Thank you, Mr. Chairman.

Chairman Greenspan, we are considering some legislation later

this year to raise the minimum wage. Specifically, Senator Kennedy has a bill to raise the minimum wage $1.50 an hour over the

next 2 years.

Can you comment on what you think the impact will have on the

economy. Should this legislation become law. Is it going to enhance

the slowdown? Will it have any effect at all?

Chairman GREENSPAN. Senator, I haven’t looked at the impact of

the minimum wage on the labor markets and its impact on the

structure of the economy. I did, however, make some extended remarks on the issue before the House and, indeed, before the Senate

previously on the question that a lot of economists raise as to

whether the minimum wage is an effective tool for maintaining and

supporting long-term growth in earnings.

My major concern here, as I have said previously on numerous

occasions, is that we are dealing with basically a number of teenagers who, even in the tightest of labor markets, have been unable

to get jobs.

35

For example, at the peak of the pressures last year and the year

before, we still had a significant amount of teenage unemployment.

And if these individuals were able to work at a rate lower than the

minimum wage because they cannot earn the minimum wage, they

would get the very early technical skills that you need to enter the

work force, and that you enter at the lowest level and you work

your way up. My concern is that to prevent people from getting in

at the lower ladders—cutting off the lower part of the ladders—I

think essentially delegates a lot of people to a very long and unfortunate period of trying to find the proper place in the labor market.

So I think, with the evidence showing that the minimum wage

tends to create unemployment, that it is a tool which we should be

very careful about using. And I understand the politics of this. I

am fully aware of the fact that I am discussing a subject which

everybody thinks I am on the wrong track on. But that is the

way I perceive what the evidence shows. And I must say that a

significant number of economists hold the same view, perhaps

even a majority.

Senator ENSIGN. Perhaps to follow up further on the impact, with

regard to the economy today, if you could consider that and get

back to me in writing. We know that there are other wages that

are tied to a minimum wage as the baseline.

And so, as the minimum wage is raised, other wages are raised

as well. During good economic times, did the increased minimum

wage weaken the economy? That can certainly be argued.

During more difficult economic times, could increasing the

minumum wage lead us further into a slowing of the economy?

I would be curious to see your comments on that?

Chairman GREENSPAN. Senator, would you like me to do that in

the form of a letter?

Senator ENSIGN. In a letter would be fine.

A couple of other things that I want to explore. First, I want to

get back to Senator Corzine’s comments on assets.

The op-ed yesterday in The Wall Street Journal was addressing

whether they are real assets. The point of the op-ed in The Wall

Street Journal that was being made was that the reason that you

cannot look at a trust fund or these reserves that are owed as a

real asset is, even though it is the word of the United States, if

those obligations are higher in the future, as everybody has said,

there is only two ways to redeem those assets.

The first way is, to cut benefits and, the second, is to raise taxes.

The point that you were making about the rate of return, it was

kind of glossed over that whether it is public or private. The rate

of return would seem to me in this proposal, when we are looking

at Social Security reform, that it is incredibly important to whether

or not we can meet the baby boomers’ needs into the future.

In other words, we can raise the rate of return on real assets.

Benefits don’t have to be cut and taxes don’t have to be raised.

If we are not able to raise the rate of return, then something’s

going to have to give.

Chairman GREENSPAN. I happen to agree with that. I don’t think

that is what the issue is. You have to have increasing productivity

to produce the goods, and implicit in that is a real rate of return

on asset investment.

36

I think the question really is a different one. If you, for example,

create an amount of savings or let’s say an increase in the Social

Security trust fund, all else being equal, that will create a surplus

in the unified budget and a reduction in the debt outstanding. And

in that regard, you could say that the government surplus is equal

to that and, indeed, since it is also by definition government savings, the question is not that, but whether the unified budget overall remains in surplus. Because what the argument has been in the

past is, yes, we did invest in Social Security trust funds, but we

consumed the savings, and in that regard, there was no government savings associated with it.

I don’t think it has anything to do with what type of securities

are there. The question basically is that if you have a Social Security surplus, even if it is less than what would be actuarially required were it a private pension fund, it nonetheless is savings. If,

however, you use those funds for increased government expenditures and therefore, reduce the unified surplus to balance, the government savings have disappeared. But you are still holding in the

Social Security trust funds special issues of the U.S. Treasury.

Senator ENSIGN. Except that, your point is, and I think that you

have argued this before, that the history of these two bodies up

here is to use the surplus, to spend it, and subsequently to grow

the size of government.

I think what many people fear is we are counting on that money

for Social Security. People like to get reelected, and the easiest way

to get reelected is to give things away.

And if you protect that money in a private account, politicians

cannot give that money away.

Chairman GREENSPAN. No, I have argued in that regard myself.

Senator ENSIGN. Thank you, Mr. Chairman.

Chairman SARBANES. Senator Schumer.

Senator SCHUMER. Sorry, Mr. Chairman. I am trying to rearrange my schedule here.

I just have three questions on three different subjects.

The first is, I know that Senators Sarbanes and Reed talked to

you about the somewhat befuddling drop of 275 basis points in interest and very little effect on long-term rates.

I guess I would like to ask a broader question. Have you seen

any evidence that the cost of credit has dropped for consumers at

all since these rate drops because not only our country, but I guess

the whole world is sort of hanging on every move of the American

consumer, who is supposed to get us out of this little decline we

are in.

Chairman GREENSPAN. Short-term rates have dropped quite considerably. And adjustable-rate mortgages have, which are not insignificant or irrelevant to this. I haven’t seen the numbers lately, but

a good deal of consumer credit interest rates are down.

Senator SCHUMER. Right.

Chairman GREENSPAN. So the answer is yes.

Senator SCHUMER. But what proportion of consumer borrowing

depends on short-term as opposed to long-term rates?

Chairman GREENSPAN. I would have to supply that for the

record. Clearly, long-term mortgages are the major issue.

37

Senator SCHUMER. One other thing. You mentioned that one of

the reasons—I think this was to Senator Reed—that you thought

that rates hadn’t come down enough was that the rate of decline

of Treasury debt had been not as great as we thought.

Was that due to the economy, the slowing of the economy? Is

that due to the tax cut?

Chairman GREENSPAN. I think it is basically due to a series of

things. One, the tax cut, two, expenditure increases, which were

higher than expected. And three, the economy.

Senator SCHUMER. Right. So the tax cut did have a negative effect on this.

Chairman GREENSPAN. Oh, yes, no question.

Senator SCHUMER. Because one of the things I argue about, our

surplus, which, as you know, when you helped make it happen

with your prodding, was hard-earned, is it gave you and it gives

the Fed the flexibility that they might not have had in a deficit situation in terms of reduction of rates and things like that.

Don’t you worry that this tax cut might impair some of your effectiveness in terms of the decline, the ability to get the economy

going?

It seems a direct implication of what you are saying. We had this

discussion once that it would have been more prudent to go a little

more slowly on the tax cut, given the squishiness of the economy.

It seems to me that what you have said here is vindication of

that view.

Chairman SARBANES. Especially the future tax cut, not the tax

cut for this year. Or you may argue that you needed a stimulus.

But this projected tax cut.

Senator SCHUMER. I meant the 10-year deal.

Chairman SARBANES. Yes.

Chairman GREENSPAN. I think the qualification that the Chairman makes is an important qualification. Remember when this

issue of the tax cut came up before this Committee and the Budget

Committee, I said I was in favor of a tax cut. But at the time, the

Congress had a bill up and the administration had a bill up. And

my view was that I was not going to comment on the merits of either one. But I did think a tax cut was a desirable thing to do. I

still do. And I would like to leave it at that, if I may.

Senator SCHUMER. Only because I like you so much, I will leave

it at that, as you may.

[Laughter.]

But there is an obvious follow-up question which I will let hang

in the air and you don’t have to answer it. I will just say, the next

question is, it seems to me that even in the short-term retrospect,

the 10-year tax cut was too large for the good of our economy.

And at least I would say, I wish that had been a more pointed

point at the time. Caution should always be the watchword of our

policies in this regard.

It has taken our party a long time to learn that on the spending

side. And I think we also have to learn it on the tax cut side.

But let’s go on to the next question, unless you want to answer.

[Laughter.]

Chairman GREENSPAN. Fortunately, one of my colleagues has

given me some numbers on the interest rates on consumer loans.

38

For example, between November and May, new car loans are

down by a full percentage point. Personal loans are down almost

as much. And credit card loans are down almost as much.

Senator SCHUMER. There is some drop. But on the long-term

side, not.

Chairman GREENSPAN. Correct.

Senator SCHUMER. And that is what Senator Sarbanes—that is

where the long-term tax cut——

Chairman GREENSPAN. Long-term, 30-year mortgage rates have

not moved appreciably.

Senator SCHUMER. I find it just amazing that so quickly we have

learned that maybe we did something—not wrong. I don’t disagree

with you that we needed a tax cut. I know that some of my colleagues do. But we went overboard.

We do need a fiscal watchdog, particularly when people say it is

1.35 and we all know it is not. We know the debt that we lose—

the paydown on the debt that we lose and with all these little gimmicks that were put in there—estate tax cut goes down in 2010,

college tuition, up through 2006.

But I will leave it at that. The next question I have is about

Social Security.

We are now beginning to grapple with the issue. You were the

major voice when first I believe the fellow from Brookings, whose

name escapes me—and then the President proposed that 15 percent, approximately 15 percent of the trust fund be used for investment in equities, as a way of getting some kick in the market.

Not doing what the President proposed, which I think takes the

money out of Social Security and lets people invest, but, rather,

have the trust fund itself invest.

And since that time, it seems that there has been some writings

about ways to deal with your very legitimate concern, which is that

you don’t want the government—the Sudan problem. And I agree

with—I cannot remember who brought it up, but my colleague from

Wyoming I think it was, that that would be terrible.

As much as I believe I want to end slavery in Sudan, this would

be cutting our nose to spite our face and send our capital markets

right overseas.

But that there are ways to greatly insulate the government’s—

this trust fund, the Social Security trust fund investing in equities,

requiring that it be broad-based funds, setting a whole group of

people whose term expire.

The best proof is you and the Fed. I think you are, as you should

be—as you know, I fought a 20-year battle mostly against some of

my colleagues on the Democratic side when I was in the House, to

insulate the Fed from the political vicissitudes.

Has your thinking changed at all on that, or evolved a little bit,

or maybe softened a little bit, because these things that I have

read—Aaron is the guy from Brookings. I am sorry.

Chairman GREENSPAN. Henry Aaron.

Senator SCHUMER. Henry Aaron, yes. He has written a pretty

interesting piece, a proposal on how to insulate the trust fund

from that.

Chairman GREENSPAN. Yes, I vaguely recall.

39

Let me just say this. As I have testified, there is a big distinction

between defined contribution plans and defined benefit plans. We

have got in the Federal Government several defined contribution

plans, including the Federal Reserve.

Senator SCHUMER. Right.

Chairman GREENSPAN. The crucial issue is that in a defined contribution plan, where the rights to the fund itself in here in the individual, and should those funds be misused in some form or another, the losses go to the individual.

In a defined benefit plan where, in effect, the Federal Government guarantees the benefits, the recipient could not care less

what is in the fund, what they do with it, or anything else. It has

no effect on the individual.

I regret that I haven’t had a chance to review Henry Aaron’s

piece. I do recall I had problems with it when I read it. But essentially, my concern is that, as much as we endeavor to insulate

these particular types of funds, we never fully succeed. And I might

say that the evidence of State and local funds, which are defined

benefit plans, generally have not been as well run. And indeed,

there has been a good deal of political gamesmanship played and

I don’t want to get back into political history—but there are people

back there who I think would have found ways very readily around

some of these constrictions and it is that which worries me, mainly.

Senator SCHUMER. Thank you both, Mr. Chairman.

Chairman SARBANES. We will now move to a second round for

those who have stayed on, I want to participate.

Mr. Chairman, I want to run through some points with you very

quickly.

First of all, I want to come back to a point made at the outset

because I am very concerned about this sort of drumbeat in the

press. This is a story reporting on your testimony over on the

House side.

It said:

In an effort to stave off recession, the Federal Reserve has slashed interest rates

six times this year, totalling 2.75 percentage points, the most aggressive credit-easing campaign in nearly two decades.

Now this drumbeat that the Fed has done much more than it is

ever done before and somehow, it is way out at the end of the

string in terms of what it is trying to do, it just runs directly

counter to this chart, on the real Federal funds rate, which, after

all, you have to adjust related to inflation.

Chairman GREENSPAN. Is that with the PCE deflator or with the

CPI deflator?

Chairman SARBANES. Core CPI. Here’s how far you have come

now. This is where you went back in the early 1990’s. It is also

illustrated by this chart, which shows the—and this is how you

came down back then.

Here, you have done it more quickly, and I commend you for

that. I think that was the right move.

But I just want to make the point that there is still room to go.

I do not regard the Fed as having engaged in the most aggressive

credit-easing campaign in nearly two decades. I think you have followed a vigorous policy since January. But I don’t think it is the

40

most vigorous and I don’t think you ought to be dissuaded from

doing more by some notion that somehow you have gone out to the

limits or close to the limits in terms of what you have already done.

Now I want to touch just once more on this boom and bust and

business cycle.

We are not in a recession. Correct? Everyone talks this gloom

talk and we are concerned about the economic downturn. But the

fact is we have not yet had a quarter with negative growth.

Chairman GREENSPAN. That is correct, Senator.

Chairman SARBANES. And to have a recession, if we stick with

the definition we have consistently used in the past, we would need

to have two successive quarters of negative growth.

Is that correct?

Chairman GREENSPAN. That is one definition of recession, and

the one that I suspect is used by most people.

Chairman SARBANES. Right.

Chairman GREENSPAN. But there are others. For example, the

National Bureau of Economic Research, as you know, endeavors

after the fact to designate peaks and troughs in the business cycle.

Chairman SARBANES. Right.

Chairman GREENSPAN. And it doesn’t always exactly coincide

with the two quarters of GDP negative growth.

Chairman SARBANES. Of course, I agree with what Senator

Gramm said when he was here. We have had a pretty good run

here on the economy, and to the extent that we are getting this

slowing, which has not yet, in my view, crossed into a recession,

I think we can attribute some of this success to a careful mix of

fiscal and monetary policy that has enabled us thus far at least to

avoid what I would call a bust.

It hasn’t avoided the business cycle, but avoided a bust. And I

think we need to continue to work toward that objective.

That leads me to the point, you say in your statement: Surely,

one reason long-term rates have held up is changed expectations in

the Treasury market, as forecasts of the unified budget surplus

were revised down, indicating that the supplies of outstanding marketable Treasury debt are unlikely to shrink as rapidly as previously anticipated.

Now, my criticism of the excessive tax cut was that, when it projected out into future years, not whatever we did to get a stimulus

this year, but projected out into future years, it led to these forecasts with respect to the unified budget surplus that were significantly revised down. And that is occurring all the time. It is constantly being revised downwards.

And in a sense, it broke the kind of relationship that had been

set up between a restrained fiscal policy and the ability, then, of

the Fed to accommodate or adjust its monetary policy.

So it seems to me that as we look ahead, the task of the Fed has

been made much more difficult in terms of bringing down the longterm rates because of this development.

Would you agree with that?

Chairman GREENSPAN. I think it is a marginal issue, Senator, in

the sense that it is true that mortgage rates have not been lowered

and Treasury rates are higher. But as I indicated to one of your

colleagues earlier, if you go back to the period before we started

41

to ease, the anticipation was that that was about to happen,

because you could see it in the Federal funds futures markets, correctly obviously in retrospect, and you got a dramatic decline in

long-term rates.

So while I don’t deny that clearly—I mean, the logic of it is indisputable—that the greater the surplus, the lower the rates, other

things equal, I don’t think the orders of magnitude are large

enough to really materially affect the outcome, even though I grant

you that—— Chairman SARBANES. I was just picking up off your own statement that, surely, one reason long-term rates have held up is

changed expectations.

Chairman GREENSPAN. Yes, the point you are making I think is

a correct point.

Chairman SARBANES. Right.

Chairman GREENSPAN. It is just I don’t think the orders of magnitude are really very large.

Chairman SARBANES. Senator Bennett.

Senator BENNETT. Thank you very much, Mr. Chairman. I appreciate the second round.

First, Chairman Greenspan, on an issue that nobody else has

talked about and that we can dispose of relatively quickly, I would

like to meet with you or whomever you might designate at the Fed

to talk about critical infrastructure protection concerns.

You know from my past history with Y2K, I am concerned about

what happens if the computers fail. And when we got through with

the Y2K experience, Senator Dodd and I, it hit me, well, we have

missed this one in terms of what would happen if the computers

failed by accident, what would happen if they failed on purpose?

And I have now wallowed in the intelligence community and the

defense community and have a sense of what is going on there.

But if I were someone who wished this country ill, I would not

attack the defense computers. I would try to get into the Fed wire

and see to it that it is shut down.

And you have all kinds of computers, contractors and so on. And

I would like to ask you to allow me to wallow in that as well in

my effort to see to it that the Congress comes up to speed on the

issue of credit infrastructure protection.

Chairman GREENSPAN. Senator, if the Fedwire got shut down for

any material period of time, with the huge volumes that are going

over it, I can assure you we would have difficulties. And as a consequence, as soon as you would like to get together on that issue,

we would be more than pleased to make available to you what we

do to prevent that from happening.

Chairman SARBANES. I might note, Senator Bennett did really

stellar work on the Y2K issue. He headed up a special committee

of this Committee. And with Senator Dodd, I think they made a

really major contribution in pushing various sectors in the economy

to get up to standard.

And I am pleased he’s continuing his interest in these problems.

Senator BENNETT. Let me talk now about the national debt.

As we have had these exchanges over the years, when the surplus first started to rear its lovely head, much to the surprise of

everyone, we immediately tried to decide what to do about it. And

42

your testimony to us at the time was don’t do anything about it.

Just let it run.

Pay down the national debt. If you find that you are paying down

the debt too much, you can always increase it again. Therefore, you

counseled us to kind of hold our fire on that and let it go forward.

I think that was wise counsel.

Then as the surplus began to loom even larger, you endorsed a

tax cut as one of the ways to deal with it.

Without engaging in an exchange with my friend from New York

as to the appropriateness of the size of this tax cut, or the timing

of this tax cut, it now looks as if some kind of surplus is going

to be with us in one form or another, for a relatively long period

of time.

Maybe not 50 years, but at least to the degree that we can tell,

10 years.

So let’s step aside from the debate on taxes and simply talk

about paying down the national debt and the size of the national

debt that would be a logical number to focus on.

Can you give us any kind of reasonable target as to where the

debt ought to be?

And I always view this not in absolute terms, but in relative

terms. That is, the debt as a percentage of GDP, is the number

that I talk about.

And I would be very grateful if you could respond to that. If that

is the wrong relative relationship, tell me and say where it is that

we ought to be.

Chairman GREENSPAN. No, no. I agree with you on that, Senator. Right now, as you know, our debt to the public is $31⁄4 trillion,

which is roughly 3 percent plus of the GDP.

Senator BENNETT. Wait a minute. No. Three percent of GDP?

Chairman GREENSPAN. What did I say? Three percent?

Senator BENNETT. Yes.

Chairman GREENSPAN. Sorry about that. I am missing a digit.

Senator BENNETT. Yes. I was going to say, it sounds closer to 30

percent to me.

Chairman GREENSPAN. It is a little over 30 percent of GDP.

Senator BENNETT. Yes.

Chairman GREENSPAN. Well, it is wishful thinking, maybe.

[Laughter.]

The estimates that we make try to figure out how far down you

can get the debt down. And we have come up against the issue that

you still want to have savings bonds, which serve many useful purposes. There are State and local holdings which are not an insignificant amount and are very useful to State and local governments

to have U.S. Treasury issues that focus on their ability to escrow

accounts and do a number of other things. Then there is a significant amount of debt held by foreign accounts, whether they are

central banks or private foreigners, which probably would be very

difficult to reduce prior to maturity. In other words, theoretically,

we could bid them away, but at extraordinary premiums.

So if you look at the process of the maturities of the debt, it is

evident that when you get below a trillion dollars, you are running

into downside resistance, which at that point would be less than

10 percent of the GDP. That is a very valuable thing to do, in my

43

judgment. When you are running into a situation in which the demographics of the society are such that you are going to have an

ever-increasing problem of maintaining the retirement benefits

that, to start off the period with a very low Federal debt is probably a wise thing to do.

And that is indeed what I think we are doing. I think that is

what the policy of this Government and the Congress is, and I

think that is sensible.

Senator BENNETT. If we hit the targets in the surplus forecasts

that we had, we will do that on the path that we are currently on?

Mr. GREENSPAN. I would think so. Crucial to the forecast, however, is that structural productivity is fairly close to where earlier

projections have put it, and as far as I am concerned, there is no

reason to doubt that.

Senator BENNETT. I see. Thank you. Thank you, Mr. Chairman.

Chairman SARBANES. Thank you. Well, it is one of the prerogatives of being the Chairman that you can ask even a few more

questions right at the end.

I am going to impose on you for just a couple of minutes.

First of all, I cannot let the statement about the minimum wage

simply go unchallenged. Alan Kruger at Princeton did a study of

the impact of the minimum wage and reached the conclusion that

it had not had a negative effect on unemployment.

Chairman GREENSPAN. I am quite familiar with that study.

Chairman SARBANES. And contrary to the impression that might

have been drawn from your previous response, that most of the

people drawing a minimum wage are teenagers, in fact, upwards

of two-thirds of them are adults.

Chairman GREENSPAN. My concern is mainly on the teenagers.

Chairman SARBANES. Well, the problem there, of course, is how

do you address that without depressing the wage for the adults?

But there are lots of people who do household work, for example,

and many other activities that I think would simply see a cut in

their wage and in their standard of living without markedly affecting the job market.

So it is a difficult issue. But we have tried to put this floor under

people and it seems to me a worthwhile endeavor.

The Fed now has under consideration a regulation dealing with

predatory lending. Gov. Ferguson, when he was here, indicated

that it would probably be some time in the fall when the Fed would

be able to finalize that regulation.

I just want to underscore that I think there is a tremendous

opportunity for the Fed to make a very significant contribution in

addressing this problem in this regulation as you move toward

finalizing it.

Some of the major players in the sub-prime lending market are

in fact moving now to change their own practices in response to

many of the criticisms that have been leveled. Clearly, I think

there is a perception on the part of many that there are certain

practices going on that really cross the line in terms of what is

appropriate or reasonable.

And I think the Fed has a real opportunity in this regulation to

really move us ahead on that issue. And I simply encourage the

Fed to do that.

44

I know you have spoken yourself on the predatory lending issue

and we appreciate the observations you have made. And I just

wanted to leave that with you.

Finally, the Open Market Committee meets 8 times a year, every

6 weeks. Is that about it, roughly speaking?

Chairman GREENSPAN. That is correct, Mr. Chairman.

Chairman SARBANES. And has that always been its pattern?

Chairman GREENSPAN. That is a good question. I think not. Let

me ask our historians here.

Mr. KOHN. It used to be 12 times a year.

Chairman GREENSPAN. We used to meet 12 times?

Mr. KOHN. Twelve times a year.

Chairman GREENSPAN. How did San Francisco Bank handle that

when they had to go by train?

[Laughter.]

Mr. KOHN. Well, in fact, there were 4 times required and then

there was an Executive Committee in the early 1950’s that met.

But at least from the 1970’s on, it was about 12 times a year.

And that 12 times a year may have begun before that.

Chairman SARBANES. Well, I am just inquiring because I don’t

think you can probably get away with it, but there is an inordinate

focus that takes place around an Open Market Committee. You

have everyone sort of holding their breath for 2 or 3 weeks before

and sort of letting out their breath for 1 or 2 weeks afterwards.

It is almost like polls in a presidential campaign. Nothing happens in between. Everyone waits for the poll. So you get everyone

waiting for the Open Market Committee.

Actually, we try to do these hearings on a regular and periodic

basis, in part, as we discussed, to make them more a normal part

of the business.

Do you sense that with these Open Market Committees? You are

doing it fairly frequently, I don’t know that I have any suggestion.

But there is a tremendous amount of commotion that springs up

around every Open Market Committee meeting.

Chairman GREENSPAN. I don’t know how you avoid that, Mr.

Chairman I think that so long as we move in discrete fashions,

meaning that we actually alter the rate in a discrete manner, it

has an impact on the money markets.

Historically, when we used to work with so-called net borrowed

reserves, where we were not focusing on interest rates directly, it

was actually quite possible for us to increase and decrease at very

small increments and, indeed, there were many occasions when big

disputes would occur among so-called Fed-watchers as to whether

we had tightened or eased. And in that context, we did not have

the impact that you are referring to.

I am not sure it is a serious problem. One of the reasons I say

that is we have developed a Federal funds futures market. That

means people in the investment community are increasingly reacting to the same events that we react to. And so more often than

not, when we move, it is not a shock to the system because it has

already been anticipated and embodied in the forward markets.

There are occasions, whether by deliberate action on our part or

other reasons such as events occurring very quickly without a

chance for anyone to fully absorb them, that we would move more

45

or less than the market would expect. The consequence is market

adjustments, and we want market adjustments. The purpose of

having a policy is to effectively impact on the market structure

itself. But I know of no way that by altering the number of meetings or how we do them which could address the real problem that

you allude to.

Chairman SARBANES. Let me observe that we tried to move

Gov. Ferguson through in short order, so he’s now of course been

confirmed.

The President has announced his intention to nominate—he’s

named two people so far for vacancies on the Federal Reserve

Board. But that is an intention to nominate. We have not yet received those papers here and the nomination has not officially been

sent to us, so we await that development before we can move forward to holding hearings, which obviously, we would intend to do

in an effort to get the board back up to full strength.

I mean, you are down so far, you even have had some worries

about a quorum problem, as I understand it.

Chairman GREENSPAN. Yes. We have five members, and most of

the time we are dealing with quorums of four. But there are very

rare occasions when we would need five votes for certain actions

on our part. So we would be concerned if we fell below five. And

clearly, we would be hopeful that we could be moved back up to

the full complement of seven.

Chairman SARBANES. We will be very sensitive to that concern.

And finally, let me announce that the final vote on the nomination of Harvey Pitt to be a Member of the Securities and Exchange

Commission was 21 to nothing, all Members of the Committee having voted.

I yield to Senator Schumer right here at the end.

Senator SCHUMER. Thank you. I have one last question. I appreciate both Chairs’ indulgence. It is not about the previous subjects.

It is about an issue that greatly concerns me, which is the balance of payments deficit. I won’t get into what it is. We all know

what it is. Just to say that foreign ownership of U.S. Treasuries because of this is now 35 percent, corporate bonds, 45 percent, and

in our huge equity market, it is up to 11 percent already.

So, I guess the worry we all have is that at some point, foreign

investors won’t be there to continue paying for our investments,

and then we could face some really catastrophic disinvestment.

And I know that we are at the end of the hearing, so I know the

answers will have to be brief. But do you have any historical guidance for us on this? I know you have studied it, as to what to do

about this issue, if anything?

Is recession the only way to deal with it? We all know it is a

problem. What should we be doing about this, if anything?

Chairman GREENSPAN. Senator, I could say that we have spent

an inordinate amount of time at the Federal Reserve addressing

exactly this issue. And I think, as I have mentioned to you before,

we have concluded that the propensity to import goods in the

United States relative to our incomes is higher than our trading

partners. And so if everyone were growing at the same rate in the

world, we would have a chronic balance of payments deficit. That,

in effect, is the source of the historical balance of payments deficit.

46

Most recently, at times, it has been engendered not from the export and import side, but from the capital investment side where

the desire to hold U.S. dollar-denominated assets was greater than

was being required by our trade deficit and, in a sense, the trade

deficit opened up because the system must balance.

We think it is a difficult issue. We have long been concerned

about the issue that you are raising. At some point something has

got to give somewhere. But we have had that concern for over 5

years and it is still maintained itself. We don’t know a simple solution to this. But clearly, it is a policy problem that engages us and

engages the Administration as well.

Senator SCHUMER. From the dollar stance that we have had, does

that bear some reexamination?

Chairman GREENSPAN. As you know, Senator, with respect to the

dollar, I, like all of my colleagues, other than the Secretary of the

Treasury who has been designated the spokesman by all of us—correctly, in my judgment—on the issue of the dollar, as a consequence of that, I regret that I cannot respond.

Senator SCHUMER. That is twice today.

[Laughter.]

Thank you, Mr. Chairman.

Chairman SARBANES. Mr. Chairman, one final observation.

I have talked with the Secretary of Commerce, Secretary Evans,

who is interested in this issue of improving the Federal Government statistics, the statistical infrastructure.

Of course, some of that agency is under his jurisdiction, although

not all of it. We are trying to work together. And I have also talked

with the CEA people about it.

And I just wanted to, in a sense, get you back on record. I recall

you testified before a committee at one point, while you eschewed

advocating any increase in spending—in fact, I think you said, I

have your quote here: I am extraordinarily reluctant to advocate

any increase in spending. So it is got to be either a very small

amount or a very formidable argument that is involved. And I find

in this case that both conditions are met.

I take it that is still your view about improving the Federal statistical infrastructure.

Chairman GREENSPAN. That is correct, Mr. Chairman.

Chairman SARBANES. Thank you. The Committee is adjourned.

Thank you very much.

[Whereupon, at 12:59 p.m., the hearing was adjourned.]

[Prepared statements, response to written questions, and additional material for the record follow:]

47

PREPARED STATEMENT OF SENATOR JON CORZINE

Thank you, Mr. Chairman for holding this important hearing. I want to thank

Chairman Greenspan for appearing before the Committee today. As we all know,

when Mr. Greenspan speaks—America, and much of the rest of the world, listens.

Mr. Chairman, it is of vital importance that Congress discusses the many issues

that shape our economic and monetary policy so that as we proceed in our legislative agenda we remain ever mindful of working to strengthen America’s economy

and seeking to improve the lives of our citizens.

As we all are well aware, our economy has struggled of late. The efforts of the

Fed, in attempting to revive our lagging economy, have been well documented. Yet

despite six interest rate cuts this year, our economy remains sluggish. Our most

prominent economists all seem to disagree as to when the true effects of the Fed’s monetary policy will kick-in. But all agree that the effects, to-date, have been relatively modest. As Richard Stevenson pointed out in his piece in today’s New York

Times:

‘‘. . . in this business cycle the three main vehicles through which lower

rates affect business, investor and consumer behavior—the stock, bond and

currency markets—have remained persistently unresponsive to the Fed’s actions.

There is little doubt that the challenge the Fed finds itself confronting is a

daunting one. Consider our current economic condition.

A long overhang of business investment.

Extraordinary current account deficits.

A negative personal savings rate.

Low productivity growth.

Disappointing corporate earnings.

Long-term interest rates that resist monetary policy and remain steadfastly high.

Rising unemployment and the reverse wealth effect seem destined to negatively

impact the one thing that has, to this point, served as the safety pin of our economic

fortunes—consumer confidence and spending.

The Fed’s task becomes even more daunting when you consider that the global

economy is also showing indications of a slowdown.

That said, our economic situation would certainly be much, much worse had it not

been for the Fed’s aggressive actions this year. Ultimately, I believe the Fed ratecuts will provide the necessary jolt to turn our sluggish economy into a healthy one.

The question before us is how we can bring about this economic revival sooner

rather than later.

As always, I look forward to hearing Chairman Greenspan’s thoughts regarding

the state of our economy and our future economic outlook. Judging from the number

of flashbulbs, cameras and tape recorders that are present today, I can tell I am

not alone.

Thank you, Mr. Chairman. —————

PREPARED STATEMENT OF ALAN GREENSPAN

CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

JULY 24, 2001

I appreciate the opportunity this morning to present the Federal Reserve’s semiannual report on monetary policy.

Monetary policy this year has confronted an economy that slowed sharply late last

year and has remained weak this year, following an extraordinary period of buoyant

expansion.

By aggressively easing the stance of monetary policy, the Federal Reserve has

moved to support demand and, we trust, help lay the groundwork for the economy

to achieve maximum sustainable growth. Our accelerated action reflected the pronounced downshift in economic activity, which was accentuated by the especially

prompt and synchronous adjustment of production by businesses utilizing the faster

flow of information coming from the adoption of new technologies. A rapid and sizable easing was made possible by reasonably well-anchored inflation expectations,

which helped to keep underlying inflation at a modest rate, and by the prospect that

inflation would remain contained as resource utilization eased and energy prices

backed down.

In addition to the more accommodative stance of monetary policy, demand should

be assisted going forward by the effects of the tax cut, by falling energy costs, by

the spur to production once businesses work down their inventories to more comfortable levels, and, most important, by the inducement to resume increases in

48

capital spending. That inducement should be provided by the continuation of costsaving opportunities associated with rapid technological innovation. Such innovation

has been the driving force raising the growth of structural productivity over the last

half-dozen years. To be sure, measured productivity has softened in recent quarters,

but by no more than one would anticipate from cyclical influences layered on top

of a faster long-term trend.

But the uncertainties surrounding the current economic situation are considerable, and, until we see more concrete evidence that the adjustments of inventories

and capital spending are well along, the risks would seem to remain mostly tilted

toward weakness in the economy. Still, the FOMC opted for a smaller policy move

at our last meeting because we recognized that the effects of policy actions are felt

with a lag, and, with our cumulative 23⁄4 percentage points of easing this year, we

have moved a considerable distance in the direction of monetary stimulus. Certainly, should conditions warrant, we may need to ease further, but we must not

lose sight of the prerequisite of longer-run price stability for realizing the economy’s full growth potential over time.

Despite the recent economic slowdown, the past decade has been extraordinary for

the American economy. 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 growth rate of structural productivity. The

capitalization of those higher expected returns lifted equity prices, which in turn

contributed to a substantial pickup in household spending on a broad range of goods

and services, especially on new homes and durable goods. This increase in spending

by both households and businesses exceeded even the enhanced rise in real household incomes and business earnings. The evident attractiveness of investment opportunities in the United States induced substantial inflows of funds from abroad,

raising the dollar’s exchange rate while financing a growing portion of domestic

spending.

By early 2000, the surge in household and business purchases had increased

growth of the stocks of many types of consumer durable goods and business capital

equipment to rates that could not be sustained. Even though demand for a number

of high-tech products was doubling or tripling annually, in some cases new supply

was coming on even faster. Overall, capacity in high-tech manufacturing industries,

for example, rose nearly 50 percent last year, well in excess of its already rapid rate

of increase over the previous 3 years. Hence, a temporary glut in these industries

and falling short-term prospective rates of return were inevitable at some point.

This tendency was reinforced by a more realistic evaluation of the prospects for returns on some high-tech investments, which, while still quite elevated by historical

standards, apparently could not measure up to the previous exaggerated hopes.

Moreover, as I testified before this Committee last year, the economy as a whole

was growing at an unsustainable pace, drawing further on an already diminished

pool of available workers and relying increasingly on savings from abroad. Clearly,

some moderation in the pace of spending was necessary and expected if the economy

was to progress along a more balanced growth path.

In the event, the adjustment occurred much faster than most businesses anticipated, with the slowdown likely intensified by the rise in the cost of energy that

until quite recently had drained businesses and households of purchasing power.

Growth of outlays of consumer durable goods slowed in the middle of 2000, and

shipments of nondefense capital goods have declined since autumn.

Moreover, weakness emerged more recently among our trading partners in

Europe, Asia, and Latin America. The interaction of slowdowns in a number of

countries simultaneously has magnified the softening each of the individual economies would have experienced on its own.

Because the extent of the slowdown was not anticipated by businesses, some

backup in inventories occurred, especially in the United States. Innovations, such

as more advanced supply-chain management and flexible manufacturing technologies, have enabled firms to adjust production levels more rapidly to changes in

sales. But these improvements apparently have not solved the thornier problem of

correctly anticipating demand. Although inventory-sales ratios in most industries

rose only moderately, those measures should be judged against businesses’ desired

levels. In this regard, extrapolation of the downtrend in inventory-sales ratios over

the past decade suggests that considerable imbalances emerged late last year. Confirming this impression, purchasing managers in the manufacturing sector reported

in January that inventories in the hands of their customers had risen to excessively

high levels.

As a result, a round of inventory rebalancing was undertaken, and the slowdown

in the economy that began in the middle of 2000 intensified. The adjustment process

started late last year when manufacturers began to cut production to stem the accuVerDate 11-MAY-2000 09:19 Apr 10, 2002 Jkt 000000 PO 00000 Frm 00052 Fmt 6633 Sfmt 6621 75469.TXT SBANK4 PsN: SBANK4
49

mulation of unwanted inventories. But inventories did not actually begin falling

until early this year as producers decreased output levels considerably further.

Much of the inventory reduction in the first quarter reflected a dramatic scaling

back of motor vehicle assemblies. However, inventories of computers, semiconductors, and communications products continued to build into the first quarter, and

these stocks are only belatedly being brought under control. As best we can judge,

some progress seems to have been made on inventories of semiconductors and computers, but little gain is apparent with respect to communications equipment. Inventories of high-tech products overall have probably been reduced a bit, but a period

of substantial liquidation of stocks still seemingly lies ahead for these products.

For all inventories, the rate of liquidation appears to have been especially pronounced this winter, and the available data suggest that it continued, though

perhaps at a more moderate pace, this spring. A not inconsequential proportion

of the current liquidation undoubtedly is of imported products, and thus will presumably affect foreign production, but most of the adjustment has fallen on

domestic producers.

At some point, inventory liquidation will come to an end, and its termination will

spur production and incomes. Of course, the timing and force with which that process of recovery plays out will depend on the behavior of final demand. In that regard, the demand for capital equipment, particularly in the near term, could pose

a continuing problem. Despite evidence that expected long-term rates of return on

the newer technologies remain high, growth of investment in equipment and software has turned decidedly negative. Sharp increases in uncertainties about the

short-term outlook have significantly foreshortened the time frame over which businesses are requiring new capital projects to pay off. The consequent heavier discounts applied to those long-term expectations have induced a major scaling back

of new capital spending initiatives, though one that presumably is not long-lasting

given the continuing inducements to embody improving technologies in new capital

equipment.

In addition, a deterioration in sales, profitability, and cash flow has exacerbated

the weakness in capital spending. Pressures on profit margins have been unrelenting. Although earnings weakness has been most pronounced for high-tech firms,

where the previous extraordinary pace of expansion left oversupply in its wake,

weakness is evident virtually across the board, including most recently in earnings

of the foreign affiliates of American firms.

Much of the squeeze on profit margins of domestic operations results from a rise

in unit labor costs. Gains in compensation per hour picked up over the past year

or so, responding to a long period of tight labor markets, the earlier acceleration

of productivity, and the effects of an energy-induced run-up in consumer prices. The

faster upward movement in hourly compensation, coupled with the cyclical slowdown in the growth of output per hour, has elevated the rate of increase in unit

labor costs. In part, fixed costs, nonlabor as well as labor, are being spread over a

smaller production base for many industries.

The surge in energy costs has also pressed down on profit margins, especially in

the fourth and first quarters. In fact, a substantial portion of the rise in total costs

of domestic nonfinancial corporations between the second quarter of last year and

the first quarter of this year reflected the increase in energy costs. The decline in

energy prices since the spring, however, should be contributing positively to margins

in the third quarter. Moreover, the rate of increase in compensation is likely to moderate, with inflation expectations contained and labor markets becoming less taut

in response to the slower pace of growth in economic activity. In addition, continued

rapid gains in structural productivity should help to suppress the rise in unit labor

costs over time.

Eventually, the high-tech correction will abate, and these industries will reestablish themselves as a solidly expanding, though less frenetic, part of our economy.

When they do, growth in that sector presumably will not return to the outsized 50

percent annual growth rates of last year, but rather to a more sustainable pace.

Of course, investment spending ultimately depends on the strength of consumer

demand for goods and services. Here, too, longer-run increases in real incomes of

consumers engendered by the rapid advances in structural productivity should provide support to demand over time. And thus far this year, consumer spending has

indeed risen further, presumably assisted in part by a continued rapid growth in

the market value of homes, from which a significant amount of equity is being extracted. Moreover, household disposable income is now being bolstered by tax cuts.

But there are also downside risks to consumer spending over the next few quarters. Importantly, the same pressure on profits and the heightened sense of risk

that have held down investment have also lowered equity prices and reduced household wealth despite the rise in home equity. We can expect the decline in stock marVerDate 11-MAY-2000 09:19 Apr 10, 2002 Jkt 000000 PO 00000 Frm 00053 Fmt 6633 Sfmt 6621 75469.TXT SBANK4 PsN: SBANK4
50

ket wealth that has occurred over the past year to restrain the growth of household

spending relative to income, just as the previous increase gave an extra spur to

household demand. Furthermore, while most survey measures suggest consumer

sentiment has stabilized recently, softer job markets could induce a further deterioration in confidence and spending intentions.

While this litany of risks should not be downplayed, it is notable how well the

U.S. economy has withstood the many negative forces weighing on it. Economic activity has held up remarkably in the face of a difficult adjustment toward a more

sustainable pattern of expansion.

The economic developments of the last couple of years have been a particular

challenge for monetary policy. Once the financial crises of late 1998 that followed

the Russian default eased, efforts to address Y2K problems and growing optimism— if not euphoria—about profit opportunities produced a surge in investment, particularly in high-tech equipment and software. The upswing outstripped what the Nation could finance on a sustainable basis from domestic saving and funds attracted

from abroad.

The shortfall of saving to finance investment showed through in a significant rise

in average real long-term corporate interest rates starting in early 1999. By June

of that year, it was evident to the Federal Open Market Committee that to continue

to hold the funds rate at the then-prevailing level of 43⁄4 percent in the face of rising

real long-term corporate rates would have required a major infusion of liquidity into

an economy already threatening to overheat. In fact, the increase in our target Federal funds rate of 175 basis points through May of 2000 barely slowed the expansion

of liquidity, judging from the M2 measure of the money supply, whose rate of increase declined only modestly through the tightening period.

By summer of last year, it started to become apparent that the growth of demand

finally was slowing, and seemingly by enough to bring it into approximate alignment with the expansion of potential supply, as indicated by the fact that the pool

of available labor was no longer being drawn down. It was well into autumn, however, before one could be confident that the growth of aggregate demand had softened enough to bring it into a more lasting balance with potential supply. Growth

continued to decline to a point that by our December meeting, the Federal Open

Market Committee decided that the time to counter cumulative economic weakness

was close at hand. We altered our assessment of the risks to the economy, and with

incoming information following the meeting continuing to be downbeat, we took our

first easing action on January 3. We viewed the faster downshift in economic activity, in part a consequence of the technology-enhanced speed and volume of information flows, as calling for a quicker pace of policy adjustment. Acting on that view,

we have lowered the Federal funds rate 23⁄4 percentage points since the turn of the

year, with last month’s action leaving the Federal funds rate at 33⁄4 percent.

Most long-term interest rates, however, have barely budged despite the appreciable reductions in short-term rates since the beginning of the year. This has led

many commentators to ask whether inflation expectations have risen. Surely, one

reason long-term rates have held up is changed expectations in the Treasury market, as forecasts of the unified budget surplus were revised down, indicating that

the supplies of outstanding marketable Treasury debt are unlikely to shrink as rapidly as previously anticipated. Beyond that, it is difficult to judge whether long-term

rates have held up because of firming inflation expectations or a belief that economic growth is likely to strengthen, spurring a rise in real long-term rates.

One measure often useful in separating the real interest rates from inflation expectations is the spread between rates on nominal 10-year Treasury notes

and inflation-indexed notes of similar maturity. That spread rose more than threefourths of a percentage point through the first 5 months of this year, a not insignificant change, though half of that increase has been reversed since. By the nature

of the indexed instrument, the spread between it and the comparable nominal rate

reflects expected CPI inflation. While actual CPI inflation has picked up this year,

this rise has not been mirrored uniformly in other broad price measures. For example, there has been little, if any, acceleration in the index of core personal consumption expenditure prices, which we consider to be a more reliable measure of

inflation. Moreover, survey readings on long term inflation expectations have remained quite stable.

The lack of pricing power reported overwhelmingly by business people underscores the quiescence of inflationary pressures. Businesses are experiencing, the

effects of softer demand in product markets overall, but these effects have been

especially marked for many producers at earlier stages of processing, where prices

generally have been flat to down thus far this year. With energy prices now also

moving lower and the lessening of tautness in labor markets expected to dampen

wage increases, overall prices seem likely to be contained in the period ahead.

51

Forecasts of inflation, however, like all economic forecasts, do not have an enviable record. Faced with such uncertainties, a central bank’s vigilance against inflation is more than a monetary policy cliche; it is, of course, the way we fulfill our

ultimate mandate to promote maximum sustainable growth.

A central bank can contain inflation over time under most conditions. But do

we have the capability to eliminate booms and busts in economic activity? Can

fiscal and monetary policy acting at their optimum eliminate the business cycle,

as some of the more optimistic followers of J.M. Keynes seemed to believe several

decades ago?

The answer, in my judgment, is no, because there is no tool to change human nature. Too often people are prone to recurring bouts of optimism and pessimism that

manifest themselves from time to time in the buildup or cessation of speculative excesses. As I have noted in recent years, our only realistic response to a speculative

bubble is to lean against the economic pressures that may accompany a rise in asset

prices, bubble or not, and address forcefully the consequences of a sharp deflation

of asset prices should they occur.

While we are limited in our ability to anticipate and act on asset price bubbles,

expectations about future economic developments nonetheless inevitably play a crucial role in our policymaking. If we react only to past or current developments, lags

in the effects of monetary policy could end up destabilizing the economy, as history

has amply demonstrated.

Because accurate point forecasts are extraordinarily difficult to fashion, we are

forced also to consider the probability distribution of possible economic outcomes.

Against these distributions, we endeavor to judge the possible consequences of various alternative policy actions, especially the consequences of a policy mistake. We

recognize that this policy process may require substantial swings in the Federal

funds rate over time to help stabilize the economy, as, for example, recurring bouts

of consumer and business optimism and pessimism drive economic activity.

In reducing the Federal funds rate so substantially this year, we have been responding to our judgment that a good part of the recent weakening of demand was

likely to persist for a while, and that there were significant downside risks even to

a reduced central tendency forecast. Moreover, with inflation low and likely to be

contained, the main threat to satisfactory economic performance appeared to come

from excessive weakness in activity.

As a consequence of the policy actions of the FOMC, some of the stringent financial conditions evident late last year have been eased. Real interest rates are down

on a wide variety of borrowing instruments. Private rates have benefited from some

narrowing of risk premiums in many markets. And the growth of liquidity, as measured by M2, has picked up. More recently, incoming data on economic activity have

turned from persistently negative to more mixed.

The period of sub-par economic performance, however, is not yet over, and we are

not free of the risk that economic weakness will be greater than currently anticipated, and require further policy response. That weakness could arise from softer

demand abroad as well as from domestic developments. But we need also to be

aware that our front-loaded policy actions this year coupled with the tax cuts under

way should be increasingly affecting economic activity as the year progresses.

The views of the Federal Reserve Governors and Reserve Bank Presidents reflect

this assessment. While recognizing the downside risks to their current forecast,

most anticipate at least a slight strengthening of real activity later this year. This

is implied by the central tendency of their individual projections, which is for real

GDP growth over all four quarters of 2001 of 11⁄4 to 2 percent. Next year, the comparable figures are 3 to 31⁄4 percent. The civilian unemployment rate is projected

to rise further over the second half of the year, with a central tendency of 43⁄4 to

5 percent by the fourth quarter and 43⁄4 to 51⁄4 percent four quarters later. This easing of pressures in product and labor markets lies behind the central tendency for

PCE price inflation of 2 to 21⁄2 percent over the four quarters of this year and 13⁄4

to 21⁄2 percent next year.

As for the years beyond this horizon, there is still, in my judgment, ample evidence that we are experiencing only a pause in the investment in a broad set of

innovations that has elevated the underlying growth in productivity to a rate significantly above that of the 2 decades preceding 1995. By all evidence, we are not yet

dealing with maturing technologies that, after having sparkled for a half-decade, are

now in the process of fizzling out. To the contrary, once the forces that are currently

containing investment initiatives dissipate, new applications of innovative technologies should again strengthen demand for capital equipment and restore solid

economic growth over time that benefits us all.

52

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SARBANES

FROM ALAN GREENSPAN

Q.1. Productivity Growth: Structural productivity growth caused

much of the rapid growth that our economy experienced from 1995

to 2000. Chairman Greenspan postulated that structural productivity growth rates have returned to the pre-1974 rate of 2.75 percent per year, compared to the 1974–1995 rate of 1.5 percent per

year. Given that quarterly productivity growth rates are highly

variable, yet the productivity growth rate for the first quarter of

this year was negative 1.2 percent. Do you think there is enough

empirical proof to validate your hypothesis that we have seen fundamental change in structural productivity? On the basis of the

evidence outstanding, do you believe that it is wise to make projections and implement revenue decisions on these 10-year projections

of productivity?

A.1. Longer-term projections of output growth necessarily involve

projections of structural productivity growth. The only issue is

what is the appropriate rate of structural productivity growth to

write down. Deriving an estimate of past growth in structural

productivity is complicated by the inherent volatility of quarterly

labor productivity data and the important impact economic cycles

have on measured productivity, often exaggerating the productivity

numbers in a period of boom and understating them in times of

weakness. In addition, the raw data used to construct productivity,

output and labor hours, are subject to revision. Indeed, the most

recent revisions to the national income and product accounts released at the end of July show that productivity grew 2.6 percent

over the 1998 to 2000 period, down from the previous estimate of

3.2 percent. Still, actual productivity grew 2.3 percent over the

1995 to 2000 period, substantially faster than the 11⁄2 percent pace

over the previous twenty years. Moreover, labor productivity rose

1.6 percent over the four quarters ending in the second quarter of

this year, a time of cyclical weakness.

Looking ahead, the outlook for structural productivity depends

critically on the prospective returns on investment and the corresponding growth of business investment. There continue to be

good reasons for expecting returns on investment, especially in

newer technologies, to remain high, and for investment to turn up

and resume solid growth, once many of the near-term uncertainties

that have been holding down capital outlays recede. In these circumstances, the outlook for structural productivity growth continues to be favorable, and it seems reasonable to expect productivity performance in the coming years to continue to be in excess

of that which prevailed over the 2 decades ending in 1995.

Q.2. Consumer Leverage: According to the OCC, consumers are

more highly leveraged now than at any measured point in history.

Not only are debt service payments at historic highs, but the increase in debt has been financed through instruments other than

mortgages. For example, The Chicago Sun Times reported that the

average credit card debt per household is $8,123 and has grown

threefold over the past decade. Debt service payments constitute

over 14 percent of disposable income. If the economy continues to

worsen, do you think that the precarious position that consumers

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are in today could create a vicious cycle in which poor economic

conditions and high personal debt interact to reduce demand more

than expected?

A.2. As financial markets have developed over recent decades,

mortgage and consumer credit have become increasingly available

to households. This has contributed to household debt expanding

more rapidly than disposable personal income, bringing the household debt-to-income measure to higher levels. So long as household

earnings unfold in line with expectations, high debt levels do not

pose much of a problem. But, when employment conditions and

earnings deteriorate more than had been contemplated, strains

can emerge that potentially could affect demand. The slowdown

in earnings growth in the past year has contributed to a rise in

the debt-service burden, and delinquency rates on various types

of household debt have risen mildly. Acting to cushion the impact

of earnings shortfalls for many borrowers, and to cushion household demand, has been the still-high level of assets. Indeed, the

excess of household assets over household debt, household net

worth, recently has been about five and a half times disposable

income; despite declines in equity prices over the past year or so,

this continues to exceed historically more typical ratios of net

worth to income of five or a little less. Thus, household debt positions should not pose a serious threat to household spending, given

generally strong asset positions, absent a considerable deterioration

of labor market conditions. Nonetheless, this is a matter that deserves continued close attention in the period ahead.

Q.3. Unemployment: While the standard measure of unemployment

has increased over the past two years to 4.4 percent, there is some

concern that real unemployment is much higher. Specifically,

measures of unemployment that include so-called ‘‘discouraged

workers,’’ the unemployed who have stopped looking for work, have

been rising at a much faster rate. Chairman Greenspan, do you

think that the real unemployment problem is larger than is generally perceived?

A.3. The evidence on this matter is not completely clear, though all

measures of unemployment remain below levels that prevailed in

the mid-1990’s. An alternative measure that I have found helpful

from time to time, those unemployed plus those outside the labor

force who report that they want a job now, has risen by an amount

similar to the official unemployment series. Some broader measures published by the Bureau of Labor Statistics that include discouraged workers, as well as marginally attached workers and

those working part-time for economic reasons, have registered increases that have been a little larger than the official series. However, none of these measures suggest that the rise in the official

series is seriously distorting the deterioration in job market conditions that has occurred over the past year.

Q.4. Balance of Payments: CBO’s budget estimates for the next

decade assume a strong growth in business investment. For the

economy to match this lofty goal, funds have to be available to be

invested. These funds can come from either domestic or international savings. If the international component of funding grows,

our current account deficit will continue to grow. But for the fundVerDate 11-MAY-2000 09:19 Apr 10, 2002 Jkt 000000 PO 00000 Frm 00057 Fmt 6633 Sfmt 6601 75469.TXT SBANK4 PsN: SBANK4
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ing to come from within, America will have to save more. Do you

agree with CBO that business investment will be robust over the

next 10 years, and if so, where will the funding for investments

come from? Finally, do you believe that any policy changes will be

necessary to ensure that there is enough funding available for

American businesses to continue to make productive investments?

A.4. There continue to be good reasons to be optimistic about the

outlook for business investment over the next decade. As noted in

the response to Question 1, the prospects for returns on investments, especially those involving new technologies, remain favorable, looking beyond the recent period of weakness. The investment

boom of the second half of the 1990’s was financed by the swing

from Federal Government deficits to surpluses, as well as through

the current account; meanwhile, the contribution from personal

saving actually fell. Looking ahead, there are reasons to believe

that personal saving will be providing more resources to support

growth in investment, but probably much more will be needed.

Thus, it is important that the Federal Government preserve discipline in managing its finances, or else even more will be required

from abroad.

Q.5. Consumer Confidence: Chairman Greenspan, in your testimony you said ‘‘softer job markets could induce a further deterioration in confidence and spending intentions.’’ In your view, what role

does consumer confidence play in setting monetary policy?

A.5. Consumer confidence plays little direct role in setting monetary policy, but can play a very important indirect role to the degree it has a bearing on the outlook for household consumption or

housing spending or risks to that outlook. Household spending is

by far the largest component of aggregate demand, and shifts in

measures of consumer confidence can provide a helpful early warning of impending shifts in consumption or housing demand.

Q.6. Economic Effects of the Shrinking Surplus: At the beginning

of the year Congress projected the Federal Government running a

surplus of $281 billion. Today that projection is down to $160 billion. Chairman Greenspan, what do you believe the economic implications of the shrinking surplus are with regard to national savings, investment, and interest rates?

A.6. In assessing the deterioration in the Federal budget, it is important to keep in mind that portion which is due to a cyclically

weaker economy and to technical factors, such as timing shifts in

corporate receipts. Such influences are only temporary and will

later be reversed. Forthcoming projection updates by CBO and

OMB should prove helpful in sorting out temporary from more lasting influences on the budget, such as tax cuts and other factors affecting average tax rates. These reports should also contribute to

the dialogue on potential output growth in the coming decade.

Nonetheless, fiscal measures approved this year imply smaller surpluses going forward. Taken alone, this implies an effect on national saving and interest rates. However, other factors bearing on

private saving and interest rates have also taken on a different

cast since earlier this year, complicating any assessment.

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Q.7. Uncertainty: Chairman Greenspan, in your testimony before

this Committee in July 2000, you projected real GDP growth for

the year 2001 to be between 3.25 and 3.75 percent. In February of

2001, you revised your GDP growth projections downward to between 2 and 21⁄2 percent. And last week you again revised your

projections for real GDP down to 1.25 to 2 percent. Does this mean

that we, as policy makers, need to keep a more vigorous eye on the

possibility of even slower growth than your current projections?

A.7. Economic forecasts should always be viewed as having confidence intervals around them, the central tendencies of the Board

members and Reserve Bank presidents are no exception. After each

of its meetings from last December to June, the FOMC has informed the public that it has seen the risks to the outlook to be

weighted on the side of economic weakness, reflecting its concern

that the economy might grow more slowly. As a consequence, the

Federal Reserve has been especially attentive to the possibility that

the economy could grow more slowly than anticipated and has

responded aggressively to evidence that the weaker growth was

emerging.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR ENSIGN

FROM ALAN GREENSPAN

At the July 24 hearing on the Federal Reserve’s semiannual

monetary policy report, you asked me to respond for the hearing

record to a question you raised with respect to the impact of minimum wages on economic conditions.

I am pleased to enclose my response, which I am also transmitting to the Committee for inclusion in the record.

As I noted during my testimony before the Senate Banking Committee on July 24, my opposition to the minimum wage stems from

my belief that by denying jobs to many potentially low-wage workers—especially younger workers—the minimum wage, on balance,

hurts the very group it is intended to help. I believe by denying

these workers an opportunity to accumulate labor market skills,

the minimum wage inhibits economic growth over the long term.

You asked whether I thought that an increase in the minimum

wage might retard economic growth in the short term as well, and

whether any deleterious effects would be greater during periods of

relative economic stagnation. Although research into the economics

of the minimum wage has only rarely addressed its implications for

the macroeconomy, I expect that these implications are relatively

small. At the minimum wage levels currently under discussion, the

reduction in aggregate employment and the accompanying

misallocation of human (and other) resources are not likely to exert

much influence on economic growth. However, I would expect an

increase in the minimum wage to modestly boost inflation.

The economic effects of an increase in the minimum wage are

naturally greater the longer it takes market wages to ‘‘catch up’’ with the new legislated minimum. For a given increase in the minimum wage, this period is likely to be shorter during times of

strong economic growth or high inflation. Moreover, the adverse

impact of the minimum wage on the employment opportunities of

low-wage workers is presumably mitigated by the faster job creVerDate 11-MAY-2000 09:19 Apr 10, 2002 Jkt 000000 PO 00000 Frm 00059 Fmt 6633 Sfmt 6601 75469.TXT SBANK4 PsN: SBANK4
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ation that accompanies good economic times. Conversely, when

overall rates of job growth are low, the negative impact of a higher

minimum wage likely would show through more clearly to higher

unemployment rates of low-wage workers.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SCHUMER

FROM ALAN GREENSPAN

At the July 24 hearing on the Federal Reserve’s semiannual

monetary policy report, you asked me to respond for the hearing

record to a question you raised with respect to the proportion

of consumer debt that depends on short-term versus long-term

interest rates.

I am pleased to enclose my response, which I am also transmitting to the Committee for inclusion in the record.

During my testimony before the Senate Banking Committee on

July 24, you asked for information on the proportion of household

borrowing that depends on short-term interest rates versus the proportion that depends on long-term rates.

As background, let me present the latest data on the extent of

the decline in interest rates on both types of household loans since

the middle of last year, when long-term interest rates began to

drop on signs that the pace of economic growth was moderating.

Since mid-2000, interest rates on both 30-year fixed-rate mortgages

and adjustable-rate mortgages have fallen about 11⁄2 percentage

points, while interest rates on home equity lines of credit—which

generally are linked to the prime rate at banks—have declined 21⁄2

percentage points. In addition, the average interest rate on credit

cards has fallen 11⁄2 percentage points, while the average rate on

auto loans has dropped nearly a full percentage point. In sum, interest rates on all major types of household credit have declined

considerably.

With that background, let me turn to your specific question.

About three-quarters of all household borrowing is in the form of

home mortgages, and most of these mortgage loans carry fixed interest rates. This year, fixed-rate loans have accounted for more

than 80 percent of home mortgage originations—an unusually high

proportion because households generally view current fixed rates as

quite attractive. As for non-mortgage borrowing, credit card debt is

about 40 percent of this total, while auto loans and other loans—

generally with maturities of 3 to 5 years—make up the balance.

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